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After the vesting period, all funds my employer contributes to the pension fund on my behalf are listed as being "mine", and upon end of employment (retirement, voluntary termination, etc), I have the choice of accepting a payment either in the form of an annuity or a lump sum.

From my understanding, if they have contributed X dollars (say $25000), accepting the lump sum would allow me to invest it en masse any way I wish (after taxes, of course). If I accept the payment as an annuity, like the lottery, I will eventually get all of it, but it will take substantially longer.

Why would you choose one of the other?

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The decision regarding lump sum and vs annuity will depend on your exact situation, and the market at the time you "retire". It will also depend on how comfortable you are will managing your own investments. If you investing plans were all on autopilot during your career the monthly pension check might be what you are comfortable doing.

Factors to consider include your spouses retirement funds, other investments, your age, your health, and the interest rate at that moment.

In general the annuity is used to purchase an insurance product that will pay out X dollars per month. Most private pensions don't adjust for inflation so that is what you will get for the rest of your life. You do have options regarding what happens after you die. Some keep the same level benefit the life of the spouse, some reduce the benefit, some eliminate the benefit.

If you live for 50 years after retirement they will pay much more than they planned, if you die two months after retirement they will have paid very little. You can exhaust the lump sum if you live for decades or the market has a bad stretch.

Things to consider also include what other income will you have to cover you between the day you retire and the day you get social security. Is this your only source of income? Or is it only part of a package of 401K, IRA, and social security, plus regular savings.

You need to sit down with a fee based planner and map out the options. Most companies have tools on their employee benefits website that will help you to estimate your balances for these plans today, and in the future. The fee based planner can help you understand your medical plan options, which can be even more important with all the changes that will take place in the next few years.

  • The pension option I had offered far fewer options than the immediate annuity. It offered a payout which would change up to the year of retirement, then it fixes. For a 25% reduction, that amount would be second to die to include spouse. No other beneficiary options. Your other points are +1, good response. – JTP - Apologise to Monica Jun 23 '13 at 2:04
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To start, not "after taxes". This payout from a lump sum pension is transferable to an IRA, with all the flexibility that affords you:

  • Ability to withdraw at your own pace after 59-1/2, not the fixed payout of the pension.
  • Ability to convert to Roth if you wish, at any time (e.g. in lower bracket years or to 'top off' your bracket as you wish.
  • Ability to leave the IRA to designated beneficiaries, pension typically can go to spouse, but that's it.

As far as the investing aspect is concerned, I was in a similar situation 8 years ago. I saw the math (i.e the return) that would be used, vs the lump sum. The pension is a fixed, guaranteed, relatively low rate of return, as you'd expect. You should be able to do the math and get an idea of what rates they are using. I was comfortable that I'd get more than that rate over the long term.

I counseled a number of co-workers when this choice was presented to us, and my advice leaned towards the lump sum transfer to IRA. Many went with my suggestion. Those that didn't came back to me. They finally realized what I was saying about (a) the spousal benefit reducing the payout (dual life vs single) and (b) the fact that an annuity of this nature leaves nothing to your heirs. These two factors mean that even though the promised rate upon annuitization was say, 6%, it's not like a 6% CD, it's an immediate annuity.

The group was literally divided across the line of those who were good listeners and those who were afraid to ask questions. I link above to a good site to see the current IA rates. You need to make your own decision of course, but your decision must be well informed, knowing the pros and cons for one choice vs the other. For us, the flexibility discussed above was key, for others, the IA is the right move, but again, as long as it's understood.

(Note this is a beautiful question, I've not written about this on my site, even though I've discussed all the pieces. I'll edit here if I use this as a template for an article, and credit money.SE as my source.)

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    +1 for setting the OP right about the tax situation. One wrinkle that I faced in a similar situation was that the plan rules were that if I took the money as a lump sum, the "interest rate" at which previous (vested) contributions were said to have been increasing over the years would be reduced to 4.5% whereas if I took the annuity, it would be based on the dollar amount computed as if previous contributions had been earning 8%. After long service, the reduction for lump sum payment would have been substantial. – Dilip Sarwate Jun 23 '13 at 2:05
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    @DilipSarwate - Thanks! Yes, one needs to get the exact details on the math. No understanding = no real basis for decision. – JTP - Apologise to Monica Jun 23 '13 at 2:06

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