July 16, 2019
Here are 4 steps to help you make an informed decision
Gone are the days when a worker would spend an entire career with one employer and retire with a gold-plated pension.
Job hopping is the new normal. If you leave a job where you've paid into a defined benefit pension plan, then you need to choose between receiving a lifetime monthly pension when you retire or taking a lump sum now - known as the commuted value - which must be transferred to a locked-in retirement account.
The choice can be mind-numbing for workers both young and old. On the one hand, the monthly pension can seem like a paltry amount in the future compared to taking the commuted value today. Choosing the pension also means putting faith in management or ownership to take care of its beneficiaries for the rest of their lives.
On the other hand, investing a lump sum can seem daunting for a novice investor. Even someone with more experience in the markets might pause at the notion of investing a lump sum when stocks are at an all-time high. The money is also locked-in until you're 55, with few exceptions to access the funds earlier.
Workers don't typically have much time - maybe 60 days - to make a decision that could have a life-changing effect on their finances. You might seek the help of an investment adviser figuring that, as a professional, he or she should be able to explain the pros and cons of both options and help you rationally weigh them against each other.
A word of caution: All too often, the adviser tells you to take the lump sum and invest it with them. They'll have charts that show the growth of an investment over the amount of time you have left until retirement, charts that show how much money you will be able to withdraw every year based on that growth and charts that show the impressive past returns of the mutual funds they're recommending.
The argument to take the commuted value is compelling. Seeing the growth of the lump sum investment over time makes the lifetime pension seem even smaller by comparison. Furthermore, being in control of your own retirement money, with the "help" of your adviser, sounds better than leaving it in the hands of your old company.
But keep this in mind: It's the investment adviser's job to sell you investments, not to weigh the pros and cons of taking a lifetime pension versus a lump sum. That's not to say every adviser has a hidden agenda, or that you shouldn't consult a professional to help you make the choice between your options.
The point is to first do as much of the research yourself so you can make an informed decision.
Here are four steps to help get you started:
1) Read the paperwork. What exactly is your employer asking you to decide? If there's anything you don't understand, like how much your spouse would get if you were to pass away before or after you retire, or how much (if at all) your monthly benefit will increase with inflation, write down the specific questions you have.
2) Call your pension and benefits department. The package has a phone number on it for a reason. Ask specific questions and make multiple phone calls until you know as much as you can. The pension and benefits team inside your human resources department may not know whether the pension plan is underfunded, but they'll know specific details about your entitlements. Find out if they're holding any workshops for soon-to-be retirees so you can learn more about the plan.
3) Make a useful comparison. It's not useful to compare a monthly benefit amount to a lump sum. Instead, you need to calculate what the future value of your lump sum needs to be to provide the same monthly benefit as your pension option, without running out before you die. This means the adviser's job is not just to show you a chart with values going up and to the right, but to also explain probabilities, safe withdrawal rates, and worst-case market returns.
4) Understand the risks. The biggest risk with a lifetime pension is that the company paying the pension goes bankrupt - or won't have enough money to pay your full benefits when you retire. The risk when you opt for the commuted value is that your investments won't perform well enough to provide you with enough money to replace the pension for your entire retirement.
This is not an exhaustive list of questions to consider. But it's a good place to start.
Arm yourself with enough knowledge to make an informed decision and seek advice when your situation is more complex. And also understand that an adviser may have a conflict of interest that favours one outcome over the other.
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