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Low interest rates mean a higher lump sum— but don't let that be your deciding factor
Q: I would like to have some basic information on how to choose between a lump sum payment from an employer pension plan or receiving monthly payments from the pension. What should I consider when trying to make a decision?
—Ruth
A: A Defined Benefit Pension Plan as Ruth is describing provides for a lifetime monthly income. The pension administrator will typically offer an exit to this plan called the commuted (lump sum) value. This is a one-time decision that can’t be reversed.
The commuted value calculates to a higher amount when interest rates are low, which explains why commuting is becoming a more popular choice these days.
Here are some pros and cons to consider to help you make this important decision.
| Pension Lifetime Monthly Benefit | Commuted Pension (Lump sum) |
| A guaranteed income for life. No concern about investment volatility or running out of funds. | Not guaranteed to last for life. Investment volatility could impact investment growth. Must be disciplined in investment approach. |
| Better positioned for a long lifetime | A better option if you have reason to believe your lifespan will be shorter than the average. |
| The simple no-nonsense choice | This choice has investment decisions and monitoring but provides more lifestyle flexibility |
| Tax is spread equally over your lifetime | The lump sum (commuted) value may have provisions to shelter some of the amount from current year tax but a significant amount will be immediately taxed. |
| 100% taxable income for life | Once the initial tax bill is behind you, the resulting amount can be reinvested and only the growth will be subject to tax. |
| Do not have the option to adjust the pension benefit amount. | Withdrawal from investments can be matched to inflation or other lifestyle needs. |
| No residual value (leftover) value to your estate | There could be funds left over as an inheritance if you die earlier than expected. |
| Can spend right up to the last dollar. | Need to leave a buffer amount of approx 5% to allow for an investment downturn. |
| Need to have 2 years of safe, liquid funds in case of a market downturn. | |
| Short term goals cannot rob funds from long-term goals | Short term goals CAN rob funds from long-term goals |
| Fully protected from creditors | Partially protected from creditors. |
To commute or not to commute? It comes down to how long you expect to live and how much control over the assets you need or want to have. Consult with a professional to help you with this key financial decision.
Tom Feigs is a Certified Financial Planner at Money Coaches Canada
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