This is a question that often comes up with clients that have had the fortune of working for a company that offers a defined-benefit plan. According to the Bureau of Labor Statistics (BLS), as of March 2023, only 15% of private industry workers had access to a defined-benefit plan. Also, according to the BLS, in 2022 only 13% of people worked for the public sector where defined-benefit plans are more common.
For defined-benefit plan participants, the retiree often has the option of taking the annuity or lump sum where they can roll it into an IRA or other qualified retirement plan without tax consequences. Even with the annuity option, a decision such as whether to take a single life or joint life option must be made. The standard form of payment for funding purposes is the life annuity and the normal form or required form of payment is the qualified joint-and-survivor form of payment for a married participant.1
Many defined-benefit plans today offer a lump-sum option and most participants elect the lump sum.2 Items to consider between choosing lifetime income versus a lump sum are if there are any health issues of the participant, what is the value of the lump sum compared to the lifetime income that can be collected, is there a desire to transfer the assets to heirs such as children, is there a concern about overspending and longevity risk?3
Benefits of Choosing the Annuity Option
• Known amount of annual payment can provide higher confidence in being able to meet retirement goals and potentially enable higher spending in retirement
• Being less exposed to financial market volatility can provide more retiree peace of mind
• The consistent payments until the death of the participant can protect against longevity risk or outliving one’s retirement savings
Disadvantages of Choosing the Annuity Option
• The potential that annual payments will not be able to keep pace with inflation
• Will the company’s plan remain viable- how much protection is offered by the Pension Benefit Guaranty Corporation (PBGC) or the state and is there a risk of lower future benefits?
Benefits of Taking the Lump Sum
• Enables a retiree to invest as they see fit according to their risk profile and objectives in retirement
• With appropriate asset allocation and a historical level of market performance, the lifetime value from a lump sum can be higher than the annuity payments
• May provide for more flexible beneficiary options than the annuity option
Disadvantages of Taking the Lump Sum
• Likely will require more time and attention managing investments; although a financial advisor/planner can work with the retiree to manage this responsibility
• Savings may not hold up in retirement and there may be a greater risk of the retiree outliving their savings especially if overall spending is higher than projected and financial markets perform worse than expected; ongoing financial planning and thoughtful adjustments can help mitigate this risk
Ideally, the distribution decision should be made as part of a comprehensive retirement financial plan.4 Analyzing the specific defined benefit plan options and determining the client’s risk profile and retirement objectives can help guide the ultimate decision.
1, 2 The American College of Financial Services, HS 355, 13-2, RICP® Curriculum
3 fpPATHFINDER, “Should I Take My Pension as a Lump Sum?”
4 The American College of Financial Services, HS 353, 2-25, RICP® Curriculum
