Pension Buyout Guide Weighs Lump Sum vs. Annuity

The Consumer Financial Protection Bureau (CFPB) released a new guide to help retirement plan participants understand pension payout options and “make the right decision about their retirement income.”

Plan advisers and sponsors may be familiar with the give-and-take assessment involved in lump sums and annuity payouts, but plan participants widely could use some help, says CFPB Director Richard Cordray, adding that available data suggests many thousands of retiring consumers face this decision unprepared every year.

“Clear information about the trade-offs they face can help consumers make the right financial decision for their retirement security,” Cordray says. To this end, the guide gives near-retirees the information they need to understand the trade-offs of taking their pension in a monthly payment or in a lump sum. In addition, to help consumers who have already chosen a lump-sum payout option from a private-sector pension plan, the CFPB guide also provides tips and warnings about how to protect and best manage this money.

Key considerations discussed in the report include the length of time income is likely to be needed and the level of an individual’s money management skills, among other key themes. For example, according to the guide, the monthly payment option is probably more appropriate if the retiring individual and spouse are in good health and/or if either of the two has a family history of longevity. A lump-sum payout, however, might make sense if the consumer is single and terminally ill or in generally poor health, or the consumer already has sufficient income to cover basic living expenses. Good money management skills, naturally, will make taking a lump sum less risky overall, but it’s not a guarantee of success.

“Another factor to consider is that a consumer’s pension is typically insured by the Pension Benefit Guaranty Corporation,” the guide warns.

Other tips include:

• Check for lump-sum calculation errors: Many factors determine a lump-sum payment amount, including age, years of work, earnings history, taxes withheld, and the terms of the plan. Consumers can detect errors by taking a look at their most recent pension statement or a consumer can contact a pension counselor for assistance or to resolve errors.

• Account for tax consequences: Consumers will pay taxes on a lump-sum payout. This money is generally treated as ordinary income for that year. For this reason, an employer is required to withhold 20% on the amount. In addition, a consumer could pay a 10% early withdrawal penalty tax if they have not reached retirement age. Consumers can defer income taxes on their lump sum by rolling over the funds into a qualified retirement account.

• Consider future needs of surviving spouse: If married, consumers should consider the long-term financial well-being of their spouse. A family history of longevity and good health may mean the possibility of spending 20 or more years in retirement. Most pension plans provide monthly benefits to a surviving spouse or another beneficiary after the pension holder’s death through a joint and survivor payout option.

• Protect the lump sum from fraudsters: Older consumers are often targets of scammers and fraudsters. Consumers should verify information, ask questions, and seek advice from trusted professionals, if they are offered high returns and low risk to invest their lump sum.

A free copy of the guide can be downloaded here.