Taking Your Lumps

Mark used to work for a company that had a pension plan. He's being offered a lump sum payout, or he can opt to receive a monthly annuity until death when he reaches the age of 67. Which is the best alternative?

QUESTION: Mark in Texas used to work for a company that had a pension plan. It’s still in place. He’s being offered a lump sum payout, or he can opt to receive a monthly annuity of $264 until death when he reaches the age of 67. He’s 54 now. Which is the best alternative?

ANSWER: I’ll tell you, 95% of the time, you’d be right to roll it into an IRA in good growth -stock mutual funds that have a long track record. You are going to come out ahead that way, and here’s how I know that.

Almost all pension calculations for the value of that lump sum that they are offering you … there is a financial formula where they take that series of payments that they are obligated to pay you based on your expected date of death from age 67 through age 78. They look at those payments and then back all that out in a financial formula at either 7% or 8% interest and that’s how they came up with that lump sum.

The advantage of rolling it to an IRA instead of your current 401(k) is you have much more control and many more options. You have 8,000 mutual funds to choose from in your IRA, and when it’s your 401(k) you have to mess with human resources to move stuff around. If you have an IRA, you are just in control of it.

The other advantage, in addition to making more than 7% over a long period of time, I think, is that when you die, the pension dies with you. The IRA does not die with you. It goes to your heirs, so you get to pass that lump sum on. It’s almost always better to take the lump sum as long as you don’t spend it.