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Redemption decisions have become more common for those with pension plan. If you get this offer, the most important questions to address include when you would receive your payment and how long you expect to live. The sooner you receive your lump sum payment, the more it will be worth to you in retirement. On the other hand, the longer you live to collect the monthly payments, the larger they can be over time. For example, if you were offered $48,000 in exchange for waiving a $462 monthly payment, you may want to play the percentages and take the buyout if you’re over a certain age. Otherwise, monthly payments might be a better way to go
A pension plan is a retirement benefit offered by some employers. Basically, it offers you a guaranteed amount of money every month starting with retirement and lasts until the end of life.
Increasingly, as a way to save money, companies are offering their current and former employees an option known as a “buyout.” That means they will pay you lump sum in advance in exchange for any other payments. For example, you might have these two hypothetical choices:
Monthly payments: $462 per month for life, starting at retirement
Flat rate purchase: $48,000 immediately, with no further payments
The question is what to do with such an offer?
“There are a number of important points to consider before choosing a lump sum or annuity,” Jeremy L. Suschak of DBR & Co. said SmartAsset. “First, the owner of the pension should take care of his health. It’s crucial to think about this first, as health-related factors can end up being contentious financial trade-offs.”
Suschak raises a question known as longevity risk. In essence, the value of the monthly pension is based on how long you will live. You don’t have to worry about the risk of bankruptcy, like with the federal government Pension Benefit Guaranty Corporation provides monthly payments well above $462.
For example, say you’re starting out collecting your pension at the age of 67. Someone in good health can potentially expect to live another 25 years, making this pension worth $138,600, or $462 per month over that time. But that can only be true for someone in good health. If you expect to live, say, another 10 years, then that same pension is only worth $55,440. So the healthier you are, the more this pension is likely to be worth.
Longevity risk and your personal risk tolerance are important items to understand when making a key decision for your upcoming retirement. AND financial advisor can help you understand these conditions and build a plan for the future.
Assume you have no cost of living adjustments on the retirement annuity or the rate of return on the lump sum payment. Then, at $462 a month and $5544 a year, you need to reach 8.65 years to have a lump sum pension payment of $48,000.
“In this simplified scenario, where the retiree’s life expectancy is less than 8.65 years, a lump sum would be preferable,” Bryan M. Kuderna, Founder The financial team of Kudernahe said.
This analysis presents a payoff date issue, since the value of any redemption is based on when you would withdraw it. If you get this redemption at or near retirement and withdraw $462 per month, even with a 10% rate of return, the money would only last about 14 years.
On the other hand, let’s say you are offered the same redemption at age 37 and put the entire amount in the S&P 500 index fund with a historical average annual return of 10%. By age 67, when you might want to retire, it would be worth $837,571 if you didn’t add anything.
With these numbers, the sweet spot is around 14 years. If received at age 53, assuming the same standard S&P 500 return, the $48,000 lump sum can grow to about $182,000. This is the tipping point where your lump sum investment will exceed the amount you would accumulate over a reasonable lifetime.
Ultimately, suggests Suschak, “pension owners should think about the type and amount of other income streams available to them in retirement. All sources of income, including pensions, should be considered against the anticipated level of spending in retirement.”
What Social security payments will you receive What do you have in other retirement accounts and how safe are they? Overall, where does this pension fit into your retirement plans?
These questions help define how much you should prioritize the security of monthly payments over the potential possibility of a lump sum. If you have significant other sources of income, you may want to choose a lump sum and invest it. On the other hand, if this is a significant part of your retirement plan, it may be wise to prioritize the security of annuity payments over the investment options of redemptions. Talk to a financial advisor if you are interested in professional advice tailored to your circumstances.
Whether you decide to buy out your pension depends on when it is offered to you and your life expectancy, among many other factors. For most pensions, the sooner your employer offers a buyout, the better the deal can be. But the closer you are to retirement age, the more you’ll want to prioritize monthly payments.
AND financial advisor can help you create a retirement plan for the future. Finding a financial advisor doesn’t have to be difficult. SmartAsset’s free tool connects you with a financial advisor(s) and you can have a free introductory chat with your advisor to decide which one is right for you. If you’re ready to find an advisor who can help you reach your financial goals, get started now.
Keep an emergency fund handy in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t exposed to significant fluctuations like the stock market. The trade-off is that the value of current money can be reduced by inflation. But a high interest account allows you to earn compound interest. Compare the savings accounts of these banks.
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