Retirement is all about cash flow—how much income you have coming in and how much you have going out in expenses. One of the most significant decisions you'll face as you approach retirement is whether to take a lump sum rollover from your employer or opt for the pension plan. This decision isn't just about a simple present value formula; it's about integrating it into a comprehensive retirement cash flow plan that accounts for your unique situation.
In this post, I'll walk you through how we approach this decision using the Retirement Budget Calculator and a specialized spreadsheet to ensure you're making the best choice for your financial future. Check out the video below to learn how you can apply this analysis to your own retirement decision.
Step 1: Building a Comprehensive Retirement Cash Flow Plan
The first step in evaluating whether to take a lump sum or a pension is to build a comprehensive retirement cash flow plan using the Retirement Budget Calculator. This tool helps us understand how much guaranteed income you'll have coming in and what your expenses will be going out.
Once we've mapped out your income and expenses, we can model future scenarios, estimating taxes, portfolio withdrawals, and growth rates. This gives us a clearer picture of how your plan might work over time, considering factors like life expectancy and inflation.
Step 2: Comparing Scenarios
With a solid cash flow plan in place, we create two different models:
- Scenario 1: You take a partial lump sum and receive a reduced pension.
- Scenario 2: You take no lump sum and receive the full pension.
These models help us compare your outcomes under different circumstances. For example, we might look at how long your money would last if you lived to an average life expectancy versus if you lived to 100. We also consider the "secure income score," which compares the amount of guaranteed income (like pension and Social Security) against your essential expenses. In one of our test scenarios, a straight pension provided 83% of essential expenses as guaranteed income, a strong position heading into retirement.
Step 3: Evaluating Key Factors
Beyond just numbers, there are other important factors to consider:
- Inflation: How will inflation impact your purchasing power over time?
- Longevity: How long are you likely to live, and what happens if you live longer than expected?
- Investment Management: Are you comfortable managing a large sum of money if you take the lump sum?
- Tax Planning: How will your decision impact your tax flexibility in retirement?
- Legacy Planning: Is it important to leave something behind for your heirs or beneficiaries?
Step 4: Analyzing Pension and Lump Sum Values
We also take a deeper dive into the financial aspects, such as calculating the present value of future income streams using a safe rate of return (like the 10-year Treasury rate). We compare this against what you could get if you took the lump sum and purchased an annuity on your own. In many cases, the pension offered by your employer might be a better deal, but it's always worth checking.
We also evaluate how much of the pension would be covered under the Pension Benefit Guarantee Corporation (PBGC) in case your employer faces financial difficulties. For example, in one scenario, the PBGC covered only 67% of a straight pension, while a reduced pension with a partial lump sum was 100% covered, reducing the risk if your employer can't meet its obligations.
Step 5: Considering Life Expectancy and Longevity Risk
One of the biggest risks retirees face is outliving their savings. A pension or annuity can act as longevity insurance, ensuring that you have a steady income stream even if you live longer than expected. However, if you take the lump sum and invest it, there's a risk that you might run out of money if your investments don't perform as expected or if you spend too quickly.
A MetLife study found that 34% of retirees who took a lump sum depleted it within five years—an alarming statistic that highlights the importance of making a well-informed decision.
Final Thoughts: Making the Best Decision for You
Retirement is about income and expenses, not just your net worth. For some, taking the pension is the best option. For others, the lump sum might be better. The key is to make this decision in the context of your overall financial plan, considering factors like inflation, longevity, guaranteed income, and your comfort with managing investments.
By doing a thorough analysis, you'll be able to sleep better at night, knowing you're making the best decision for your unique situation.
Ready to take control of your retirement? Sign up now and try the Retirement Budget Calculator for free to start planning with confidence.
