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Lump It or Leave It?

James McGlynn

AS THEY APPROACH retirement age, workers sometimes get to choose between a monthly pension and a lump-sum payout. It’s a choice I recently made—one I researched carefully. In the end, I made an unusual decision that took a few extra steps.

Let me start at the beginning. In 1984, I began working for American National Insurance Company as an investment analyst. I left the company in 1991, but still qualified for a small pension. Now, at age 62, I was offered three choices. I could receive a monthly pension of approximately $300 starting at 65, or I could take the pension earlier and receive a smaller monthly benefit, or I could take a lump sum of nearly $50,000.

To start, I wanted to know if one offer was considerably more valuable than the others. To compare, I went to a website that provides quotes for immediate annuities. It turns out my company pension would pay more each month than an immediate annuity I could buy for $50,000, but not a lot more.

Still, having an additional stream of monthly income sounded appealing. But there were other considerations. I’m already getting a larger monthly pension payment from another insurance company—Union Central, now part of Ameritas Life—where I worked from 1999 to 2015.

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I also plan to take Social Security at age 70, which will give me a healthy stream of inflation-indexed income. Finally, I’ve purchased three deferred-income annuities that will begin paying me income starting at ages 76, 80 and 85, respectively. Should I live until 85, I’ll be receiving guaranteed income from five different sources.

Viewed from this perspective, another payment of less than $300 a month started to seem less significant. Besides, my old employer had announced it’ll be acquired by another company. I didn’t want to monitor a small pension from a company that wasn’t my prior employer.

That’s when I decided to take the lump-sum payment. My planning, however, wasn’t done. Instead of receiving the lump sum directly, I opted to have my old employer deposit a tax-deferred payment into my IRA. Why? I wanted to convert that money to a Roth IRA while I still had time to avoid a potential extra expense.

What extra expense? Like most retirees, I’ll be eligible for Medicare at age 65, which is just over two years away. Medicare Part B and Part D premiums are higher if you have a high taxable income. But Medicare’s income lookback period is two years, which meant that I could convert the $50,000 to a Roth IRA without facing higher Medicare premiums—but only if I was quick about it and did the conversion this year.

There was one further wrinkle. The stock market had recently declined, so I converted $50,000 and immediately put the money in stocks. If the stocks rebound, the gains will be tax-free. How will I pay the tax owed on the Roth conversion? I realized a hefty long-term capital gain. I’ll use that money to pay the conversion tax bill.

James McGlynn, CFA, RICP, is chief executive of Next Quarter Century LLC in Fort Worth, Texas, a firm focused on helping clients make smarter decisions about long-term-care insurance, Social Security and other retirement planning issues. He was a mutual fund manager for 30 years. James is the author of Retirement Planning Tips for Baby Boomers. Check out his earlier articles.

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SanLouisKid
SanLouisKid
7 months ago

My wife had a very small pension that offered the same choices. We went with the pension because it will pay for her lifetime and my guess is she’ll live to 100+ (family history, good genes, exercises, eats healthy, etc.). The pension is small and will be worth a lot less in 35+ years but it’s a very, very small part of her retirement income and will not affect her standard of living at all. It’s nice to have a mix of income.

Mark Eckman
Mark Eckman
7 months ago

I was given this decision by AT&T and took the lump sum for two reasons. First was the difference in cash flow as mentioned. But more important, I did not and still do not trust AT&T’s management to deal fairly with the pension plan.

UofODuck
UofODuck
7 months ago

I faced a similar choice when I retired after 40+ years in the investment business. What I decided to do was take the two small pensions as joint and several annuities, but take the much larger retirement from my final employer as a lump sum and roll it into an IRA. The investment returns in the years since I retired have more than justified this strategy. As the old saying goes, however, “past returns are not a guarantee of future returns.”

Seth Dodson
Seth Dodson
7 months ago

Another factor when making this decision is if your heirs will be able to inherit/receive your pension benefits should you unexpectedly die before you start collecting them. Heirs will likely receive greatly reduced pension benefits after an untimely early death.

Also stock market returns are likely to exceed the expected actuarial rate of return set by the pension – thereby making the lump sum invested in the stock market more attractive than retaining the pension. In our case the projected pension rate of return was set by the Pension Benefit Guaranty Corporation based on a historical US corporate bond rate. While the historical US corporate bond rate the Pension Benefit Guaranty Corporation employs was VERY generous given the current interest rate environment, it was well below historical stock market returns.

Michael1
Michael1
7 months ago

To add to this thorough thinking, here’s one other consideration that could apply to some folks. We ideally would keep taxable income to a minimum in the first few years of retirement so we can realize some capital gains at a 0% tax rate. Receiving a pension in monthly payments could make it difficult to keep taxable income at a level low enough to do this in any significant way. I wrote about this more here

Ron Leaf
Ron Leaf
7 months ago

I have been evaluating the same question. Another approach that I used was to determine the rate of return the lump sum would need to generate to match the monthly payments over my life expectancy. I found the monthly payments offered the more attractive options.

Matthew Lane
Matthew Lane
7 months ago

I’ll echo everyone else’s sentiments Mr. McGlynn. Very well thought out. I remember your article last year (June-ish 2020, I believe) where you laid out how you’ve laddered your QLACs and such. Opened up a world I didn’t know about at the time. Kind of like building a fortress around your latter years. Highly recommend giving it a read. Thanks

James McGlynn CFA RICP®
James McGlynn CFA RICP®
7 months ago
Reply to  Matthew Lane

Thanks Matthew. I am surprised that QLAC’s haven’t become more popularized. The low yields aren’t helpful.

Rick Connor
Rick Connor
7 months ago

Well written and well thought out article James. My wife had a similar decision some years ago. We discussed it and she chose to roll it over to her IRA. I wish I had been smarter about Roth conversions at the time.

James McGlynn CFA RICP®
James McGlynn CFA RICP®
7 months ago
Reply to  Rick Connor

Thanks Rick. I think the more people know about Roth accounts the more they wish they had converted.

OldITGuy
OldITGuy
7 months ago

An excellent article. I actually agree with your conclusion. However, I do feel there is one other aspect that a person may want to be aware of before taking a lump sum payment. I’m not a lawyer so my understanding may be incorrect, but one consideration is the legal protections afforded to a pension (or 401K) that don’t exist for an IRA. As I understand it, it varies widely from state to state. But the general thought is a pension is backed by both the pension guarantee fund and (in the case of a 401K as well) is protected by overarching federal law from creditors. An IRA on the other hand, depending on the state you reside in, can be subject to creditors (depending on a range of variables). Of course, since I’m not a lawyer my understanding of this may be incorrect. Maybe one of the Humble Dollar authors have already addressed this topic in a previous article or will do so in a future article.

That said, yours was an excellent article.

James McGlynn CFA RICP®
James McGlynn CFA RICP®
7 months ago
Reply to  OldITGuy

I just checked and in Texas the IRA is protected. After the money comes out it loses the protection. Thanks for raising the point.

Jonathan Clements
Admin
Jonathan Clements
7 months ago
Reply to  OldITGuy

I’m not a lawyer, either. But as I understand it, the money should remain fully protected, though it may be wise to keep it segregated in a rollover IRA:

https://humbledollar.com/money-guide/retirement-accounts-2/

OldITGuy
OldITGuy
7 months ago

Thanks for the reference. But if I’m reading it correctly a rollover IRA only retains partial protection. Specifically, the article you referenced states:

…What if somebody slips on your sidewalk and successfully sues you? Again, employer-sponsored plans should be protected. But solo 401(k) plans and IRAs, including rollover IRAs, are at risk under federal law. There’s a good chance, however, that your state’s law provides protection. To find out the rules in your state, head to IRAFinancialGroup.com and scroll down…

When I referenced “creditors” in my comment I was including creditors from a lawsuit; not just creditors during a bankruptcy. Again, I’m certainly not a lawyer but it does sound like there’s some level of reduced protection (depending on the state of residence and specific circumstances).

Paula Karabelias
Paula Karabelias
7 months ago
Reply to  OldITGuy

Why not have an umbrella liability policy? It’s not very expensive.

Paula Karabelias
Paula Karabelias
7 months ago

Also, if you are sued , you will likely need a lawyer even if ultimately your retirement assets are protected. If you have an umbrella policy, the insurance company provides your legal defense , and all of your assets can be protected.

Jonathan Clements
Admin
Jonathan Clements
7 months ago
Reply to  OldITGuy

Again, like you, I’m not a lawyer. But if you had a huge legal settlement against you — more than the value of your taxable account assets — you would, I assume, file for bankruptcy, at which point your retirement account assets would be largely or entirely protected. But I readily concede that I could be wrong!

steveark
steveark
7 months ago

That’s a well thought out decision. It caught my eye because before she elected to be a stay at home mom my wife taught for nearly ten years. Now in retirement she receives $300 per month from a teacher pension. In her case there was no choice between lump sum and monthly payments so we were spared the mental gymnastics you so ably performed. And while it isn’t big money it is like frosting on a cake. Like the money that comes in when friends coerce me into small consulting gigs it is purely excess and discretionary.

Guest
Guest
7 months ago

Sounds like a well thought through plan Mr. McGlynn and I’m glad it works for you. Thank you for sharing.

Last edited 7 months ago by Guest

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