You may find yourself with a decision to make after the dust has settled on your divorce. You’ve ended up with a pension from your ex-spouse. The Qualified Domestic Relations Order will instruct the spouse’s employer to carve out your portion of the pension and place it in an account in your own name. You’ll be able to access the pension based on your own date of birth, although you will have to wait until your spouse is of minimum retirement age according to the plan rules. This is usually age 55, but can vary from plan to plan.
You may have to choose between a monthly check for your lifetime or a lump sum in cash. Note that either of these is reduced if you take money out prior to the normal retirement age for the plan, usually between 60 and 65. For instance, it is typical to see a 5% per year reduction for every year younger than age 60. So, if you are age 55, there would be a 25% reduction in the monthly check for the rest of your life. Or, if you choose the lump sum, there would be a 25% reduction in the amount of funds sent to you.
But, the main purpose of this article is to discuss the wisdom of retaining an annuity for life or taking a lump sum of money. The decision should be based on your confidence in the growth of your lump sum over time. Should you risk it? Will the lump sum continue to grow over time and provide as much benefit as the monthly checks would have? There is a great deal of peace of mind that goes with the monthly check. Social Security is a guaranteed source of monthly income. A pension added may be a comfortable level of guaranteed income that can alleviate your concerns about the performance of an investment portfolio.
Needless to say, an investment advisor will assure you that he or she can out-perform the growth needed to match that stream of monthly checks. But, remember, he has much to gain by your rolling over that pension to his or her management. Do your research and make that determination without the influence of someone who will gain from a decision to take the lump sum. Can you be assured of a continuous stream of payments for 30 years? That is quite possibly the length of time that the pension annuity checks will land in your mailbox or bank account. Negative market returns could decimate your portfolio, leaving you with little more than a Social Security check each month. According to Money Magazine, you have just over a 50% chance of seeing the money last 20 years.
Ideally, you have also received an IRA Rollover from your ex-spouse’s 401k, giving you the flexibility to take larger withdrawals when necessary or, ideally, maintain the minimum required distributions. The MRD will serve to stretch that IRA for a very long life expectancy, depending on the performance of the underlying investments. With a Rollover and a pension annuity, you will have the comfort of the guaranteed income and flexibility of the IRA distributions. If you will have no such rollover or other funds from which to make withdrawals, the lump sum would be advisable, since you would only have the pension.
A pension can be compared to an annuity, where one invests a lump sum to secure a guaranteed lifetime income. For instance, annuity investments are impacted by the fact that insurance companies must make a profit. In this respect, the pension is superior since there are no large investment fees associated with it. Additionally, an annuity is tied to the current interest rates. With unusually low rates, the upfront investment in an annuity purchases a smaller monthly check.
Pension annuities are not normally inflation-adjusted, so it would be wise to set aside a portion of that check each month to meet any future shortages due to inflation. You should definitely plan on securing the services of a qualified Certified Financial Planner to crunch the numbers. And you would be wise to make sure that your CFP doesn’t stand to gain from a certain decision. The decision you make can affect you for the rest of your life and should be approached with careful analysis.