The biggest retirement decision an executive will make

Many executives and managers getting ready to retire from the nation's largest companies will soon make one of the most important financial decisions of their lives. Those lucky enough to receive a private pension will choose between a one-time lump-sum payout or a monthly payment for life. This irrevocable decision will affect their finances throughout their retirement years.

This choice is imminent for the large chunk of soon-to-be retirees who plan to call it quits on March 31. That's because most executives wait until they receive their 2015 bonus and stock grants; the bonuses are paid in February or March, which often matches the timing of stock grants vesting.

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More than a third of retirement-age workers covered by a pension plan took lump-sum payouts when they left their jobs or retired, according to a 2013 study from the Employee Benefit Research Institute (to download the study, click here). But the benefits of taking a lump sum versus a monthly annuity vary on a case-by-case basis. Here's a breakdown of the benefits for each side of this debate.

There are, of course, some advantages of lump-sum payout. People taking their pension in a lump sum receive the full value now. For example, if the pension is valued at $500,000, you get all of that money at one time. Once you have those funds, you can do the following:

  • Invest this money for growth, income or a combination of both. This strategy can allow you to outpace inflation and keep your purchasing power.
  • Withdraw a significant chunk of funds if needed for a large purchase, such as a new car.
  • Leave the funds to your spouse, children or a charity when you die.
  • Have more control over the timing of withdrawals. Many pension plans require a person to take their pension by age 65. If you elect the monthly annuity, you must take the income even if you don't need it. And it's taxable income.
  • Rolling the pension funds into an Individual Retirement Account (IRA) enables the money to grow, tax free, until the first withdrawal at age 70. This is ideal for a person who decides to continue working elsewhere and doesn't need the pension money soon.
  • Get the maximum benefit from your pension if you are in poor health.

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The main disadvantage of the lump sum is that there are no lifetime guarantees of income. Here are some advantages of monthly payments:

  • Provides stable income and, for many people, peace of mind.
  • Helps diversify income sources between a pension, Social Security benefits and outside investments.
  • Less reliance on income from your investment portfolio.
  • If you live a long life, the monthly amount could exceed the value of the lump-sum payment.

The main disadvantage: Most pension plans don't increase over time, which eats into purchasing power. A second problem with a monthly payment is that a person in poor health will only receive only a small percentage of the total amount if he or she passes away within a short time after retirement.

As I mentioned earlier, every person's choice is different, based on individual finances. Here are a few additional items to consider:

  • If you will receive a pension from two or more employers, consider taking a lump sum from one plan and a monthly check from the others.
  • If receiving the lump sum will burn a hole in your pocket, take the monthly check. Most people believe that they can control their spending. However, my experience tells me a different story. If a person does not have a history of being disciplined with money, this behavior doesn't change overnight.
  • If your employer is having significant financial problems, consider taking the lump sum. Although many qualified pension plans are covered by the Pension Benefit Guaranty Corp., they may not insure the entire benefit.
  • Research the impact of income taxes on your pension plan. Nonqualified pension plans can't be rolled into an IRA, so the retiree needs to pay taxes when they receive their money. On the other hand, funds from qualified pension plans can be rolled into an IRA or other qualified plan income-tax free.

— By Lisa Brown, partner and wealth advisor at Atlanta-based financial planning and wealth management firm Brightworth