Retirement: Lock in Lifetime Income

By Jane Bennett Clark, Kiplinger's Personal Finance | January 13th, 2017

If you’re lucky enough to be eligible for a pension, before you clock out you’ll probably be asked to choose between a lump sum and guaranteed lifetime payments. With the guaranteed payments, you’ll have the security of knowing they will last as long as you do. With a lump sum, you can invest the money yourself and potentially end up with more than you’d draw from a pension over your lifetime. Plus, you have access to the entire amount from the get-go, and whatever remains in the account when you die goes to your heirs. On the downside, your investment won’t necessarily do better than the total amount of the payouts, especially if the market performs worse than you anticipate or you live longer than you expect.

To estimate which choice offers you the biggest potential payout, you’ll have to figure out the returns you’ll need from the lump sum to re-create the pension’s stream of income over your expected life span. If you think you can reap the same paycheck by investing the money at a doable 4 percent over 25 years, taking the lump sum would be a reasonable choice — unless you expect to live beyond those 25 years (maybe your parents and grandparents all lived to be 100). The same goes if you’d need to earn 8 percent on your money to create the same income stream.

Married couples who choose lifetime payouts face another decision: whether to take the single-life option or the joint-life option, which has lower payouts to reflect the longer time over which the pension is likely to be paid out before the surviving spouse dies. Most couples choose joint life, which is the default option; you both must sign off if you choose single life. The minimum payout for joint life is 50 percent, although some plans let you choose a higher percentage — say, 75 percent — for a commensurately lower payout from the beginning. No matter who dies first, the reduced benefit usually kicks in for the survivor.

You could use a chunk of your own savings to buy yourself a pension, in the form of an immediate or deferred-income annuity. These products also guarantee lifetime income, but the key word is lifetime: Unless you buy a costly rider, the payouts stop when you die, even if it’s the month after you start getting the paycheck. Plus, buying an annuity means giving up liquidity. Don’t put all your retirement assets in this basket. One approach is to invest enough so that the payout combined with Social Security and any other guaranteed income will cover your fixed expenses.

Jane Bennett Clark is a senior editor at Kiplinger’s Personal Finance magazine. Send your questions and comments to moneypower@kiplinger.com. And for more on this and similar money topics, visit Kiplinger.com.