Retiring With a Pension? Interest Rates are Impacting Your Lump Sum - Merkle Retirement Planning (2024)

FAQs

Is it better to take lump sum pension or monthly payments? ›

As discussed below, under the right circ*mstances you might get more money from the lump sum payment, but that will depend on market returns and there's an element of risk to any investments. If you take the monthly pension, your payments are mostly secure and your budgeting and investing needs may be simpler.

For calendar year plans with a 1-year stability period, 2024 lump sums for this participant are 6%-17% lower than 2023 lump sums. This is on top of an even larger drop in lump sum values between 2022 and 2023.

One of the most obvious ways a change in interest rates affects your 401(k) is the rate of interest you earn on money market investments that pay either a guaranteed or a floating interest rate. As the federal funds rate rises or falls, so will the interest rate of the money market funds in a retirement plan.

As a general guide, you can use the 6% Rule when evaluating the two options. It's a straightforward tool to help assess which choice makes more financial sense over time. Here's how the 6% Rule works: If your monthly pension offer is 6% or more of the lump sum, it might make sense to go with the guaranteed pension.

The drawbacks of taking a lump sum

Taking a lump sum out of it early on could affect your income for the rest of your life considerably. Pension value can decrease: If you choose to withdraw and hold the money in cash, for example in a savings account, the value can decrease in real terms.

Investors can avoid taxes on a lump sum pension payout by rolling over the proceeds into an individual retirement account (IRA) or other eligible retirement accounts.

A higher interest rate implies that future cash flows are discounted at a higher rate, reducing their present value. Therefore, as interest rates rise, the total value of future pension payments diminishes, resulting in a lower lump sum value.

A moderate inflation rate of around 2% is generally considered healthy. It encourages spending and investment because people expect prices to rise, but not too quickly. However, high inflation can erode your purchasing power.

For example: If you're an aggressive investor and plan to stay invested in 90% to 100% stocks, a 10% estimated rate of return makes sense. If you're an average investor with a 60/40 portfolio (or similar), I recommend an estimated return between 6% and 8%.

If two-thirds of your government pension is more than your Social Security benefit, your benefit could be reduced to zero. If you take your government pension annuity in a lump sum, Social Security will calculate the reduction as if you chose to get monthly benefit payments from your government work.

How much can I take from my pension as a lump sum? ›

You should check with your pension provider to see if they offer income drawdown - some won't offer it. There are no restrictions on the amount you can take using income drawdown. You can still take 25% of your pension pot as a tax-free lump sum.

Employers and plan trustees are permitted to stop their plans at any time if they follow certain procedures. If a pension plan stops when it doesn't have enough money to pay all of the benefits it owes, a federal government agency called the “Pension Benefit Guaranty Corporation (PBGC)” may get involved.

In a given year, for instance, it is much closer to 50/50 whether a lump sum at the start works out better than splitting it up over the twelve months, and you stand to be better off with monthly investments if the market falls in the shorter term.

Since your interest is calculated on your remaining loan balance, making additional principal payments every month will significantly reduce your interest payments over the life of the loan. By paying more principal each month, you incrementally lower the principal balance and interest charged on it.

If the market struggles, your annuity payments will remain the same and your company will likely to be required to make greater contributions to the pension plan to compensate for lower than expected investment returns. If you take a lump sum, no one is responsible for taking care of your money other than you.

Joint and survivor options are often best for those who are married, older than their spouse, or in poorer health than their spouse. To help mitigate premature death risks while still receiving a higher payment than joint and survivor amounts, you can also choose a single-life annuity (either term or period certain).