There is an incisive educational interview released by Morningstar, "Pension Lump Sum or Annuity: 5 Swing Factors," that discusses the factors most individuals overlook in regard to choosing how to receive their benefits. With many individuals in Houston receiving layoffs (and having more rounds to come) it is especially timely to consider all the factors that affect this choice.
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Annuity versus Lump Sum: What's the Difference?
When taking a pension, most people understand that they have an option between a lump sum benefit (that can be rolled to an IRA) and an annuity. They know that an annuity means a guaranteed stream of income for as long as they live and that a lump sum is a pool of money for them to invest.
Considerations for Choosing Either the Annuity or Lump Sum Option
The dilemma we find is that most people do not realize there are other significant factors to consider when making the decision about how to take their pension. For example:
- Personal health and longevity
- Portfolio diversification
- Current interest rates and discounting
- Market risk and tolerance
Prior to taking an annuity, the pension health and other guaranteed income sources should be evaluated. When determining if a lump sum makes sense, interest rate discounting must be understood, especially for those at Chevron or BP.
Lastly, the interview makes a very good point in regard to investing the lump sum. It warns there is risk involved both from the market and the individual. Additionally, there's a risk of choosing the wrong advisor to work with and seek guidance from.
"My key piece of advice, though, is, if you are looking for guidance on this question, go with someone who doesn't have a vested interest in what you choose."
Among the various choices you must make after selecting a lump sum or annuity, one crucial one is understanding that a commission-based advisor probably has a strong vested interest in having you take that lump sum while an RIA may recommend a different path that suits your needs better. Why the differing advice? Once you roll a lump sum over to an IRA and let a commission-based advisor help you invest it, they can also bill you on and receive a commission for those funds. A fee-only advisor like WJA doesn't get paid through commissions or trail-end compensation so there's no vested interest in your decision. Instead, these kinds of advisors can focus on providing guidance that's in your best interest.
