Should You Keep Your Pension or Do the Lump-sum Buyout?

Published April 25, 2018
The majority of people who are offered a lump-sum buyout should keep their pension, but there are some situations where it is worthwhile to consider taking the lump-sum buyout and using a portion of it to purchase an annuity.
  • For most people, it does not make sense to give up their valuable lifetime pension benefit in favor of a lump-sum buyout
  • But, in some situations, taking the lump-sum buyout and using some of the proceeds to purchase an annuity may have a beneficial impact on tax, estate and investment planning
  • Consider speaking with one of Blueprint Income’s retirement professionals to see if this strategy makes sense for you

You’re approaching retirement, or perhaps your employer is making changes to their pension plan, and you’ve been given two options: (1) keep your pension, or (2) give it up in favor of a lump-sum buyout. How do you decide? It’s a nerve-wracking decision with numerous consequences that we at Blueprint Income thought we could make easier for you. Read on to learn more about pension buyouts, retirement income planning, and annuities.

Pension Buyouts

In earlier posts, we discussed how pension buyouts work. Typically, an employer hands their pension plan over to an insurance company to handle. In doing so, you continue receiving your monthly pension benefit, but the check will come from the insurer instead. Corporate pension de-risking becomes more complicated if you are offered an upfront payment, called a lump-sum buyout, in return for forgoing your promised pension benefit.

At Blueprint Income, we are proponents of pensions, and think that those lucky enough to have a pension should keep them. However, in certain situations, it may be worthwhile to take the lump-sum buyout and use a portion of the proceeds to purchase an annuity (or not, depending on your own personal situation). This is particularly relevant if you don’t need your pension income to meet your expenses in retirement. To make this decision, you would want to first take stock of your retirement assets and income. Below are some considerations for your decision-making process as well as useful information about the differences between a pension and an annuity.

In addition to the information provided below, we encourage you to consult the Consumer Financial Protection Bureau (CFPB) guide before making a decision on whether to accept a lump-sum buyout.

Tax Planning

Pension income is often taxable income, with your tax rate determined by the cumulative amount of income earned that year, among other factors. In addition to income from your pension, you may expect to have additional taxable income streams such as Social Security, withdrawals from a tax-deferred retirement account or other supplemental income. When these income streams are combined with your pension income, they may provide more income then you need and push you into a higher tax bracket.

How an Annuity Can Help

Taking a lump-sum payment today (into a tax-preferred account) and, potentially using some of the payout to buy annuity income, can place you in a lower tax bracket throughout retirement without impacting your retirement preparedness. How?

  1. First, if the lump-sum buyout rolled over in a traditional retirement account, you won’t have to withdraw any money from it until age 70½. At that point, you’ll be mandated to withdraw at least the required minimum distribution (RMD) mandated by the IRS each year going forward.
  2. Second, if you do decide to use some of the proceeds of the lump-sum buyout to purchase an annuity, you can have that annuity start as late as age 85. Annuities are allowed to start this late through a structure known as a Qualified Longevity Annuity Contract (QLAC) and defer RMDs in addition to providing guaranteed retirement income.

Please make sure to consult a tax professional before using this strategy.

Estate Planning

Like annuities, a pension plan may allow for a survivor benefit that extends pension payments to your spouse. This is particularly important for single-income households, where one person’s accumulated retirement savings are expected to cover the needs of two people in retirement. Though these benefits are important for protecting the financial security of one’s spouse, they cannot be transmitted to other beneficiaries, most notably children.

How an Annuity Can Help

Because pension and annuity benefits are tied to your longevity, or that of your spouse, dying prematurely may lead to lower monthly income for your spouse or end payments altogether. With some annuities, you can pass on your remaining principal to heirs in the event that you die prematurely, something you cannot typically do with a pension. If you are concerned that you may not live long into retirement and want to prioritize leaving a legacy, it may make sense to take a lump-sum buyout. If you use a portion of that to purchase an annuity, select the option that refunds any remaining value upon death to your beneficiaries.

Investment Planning

For some people, the bulk of their retirement savings is tied up in a pension. While pensions do a great job of de-risking your retirement by reducing longevity risk (read more here), some may not provide adequate protection against inflation or cost-of-living increases and fail to provide investment exposure to market upswings.

How an Annuity Can Help

In these cases, some people may benefit from increased market exposure through self-directed tax-advantaged retirement accounts such as an IRA or 401(k). Taking the lump-sum payout and using some of that income to purchase an annuity is an easy way to ensuring that you have sufficient guaranteed, lifetime retirement income while leaving you with leftover money to invest in the market.

An Annuity Vs. a Pension

Annuities and pensions both provide guaranteed retirement income, but there are some differences that you should be aware of before replacing a pension with an annuity.

  1. Pensions generally provide more income than annuities. If you take the lump-sum buyout and use it to buy an annuity, expect to get a smaller income benefit than the pension offered. Because insurers are required to invest more conservatively than employers, annuities are more expensive. You can run an annuity quote here.
  2. Pensions sometimes have inflation protection; annuities often do not. If your pension has an annual cost of living adjustment that increases your pension benefit to account for inflation, consider yourself lucky! Annuities typically don’t have this option, and when they do, it’s expensive. Read more here.
  3. Pensions and annuities have different backing. If something goes wrong with a pension plan, there’s a different course of action than something going wrong with an annuity. That’s not to say that one provides better protection than the other, but it’s important to be aware of the difference. Read more here.

Next Steps

If you’re considering taking a pension lump-sum buyout and interested in buying an annuity, here are the next steps:

  1. Understand the different types of annuities.
  2. Run an annuity quote to see how much income you’ll be able to get.
  3. Reach out to our team at [email protected] if you’re interested in a retirement spending analysis that will take your whole financial situation into account.

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Lauren Minches

Lauren Minches

Financial Planning Professional

Lauren is an actuary by training with expertise in retirement, finance, and risk. She writes about annuities to make them easier to understand and evaluate. Her goal is to help people create retirements with more time for living and less time thinking about money.