If you read part one of this blog series, How A Financial Advisor Can Help You Evaluate A Pension, but thought, “I’d like to understand the math that goes into this decision”, you are in luck! Although it takes a bit of work, there are 3 steps you need to take before you take the final step of evaluating how it fits in your overall financial plan.
Have an advisor help you determine the probability you, your spouse or both are still alive in a specified number of years. “How do you do this?” you may ask. Good question! The government publishes life expectancy tables that will give you and your advisor the typical life expectancy for single or married couples. From there, the discussion can evolve around you and your spouse’s current health, longevity expectations and financial situation, to develop a reasonable decision to claim benefits.
Calculate the internal rate of return of the different pension options. Simply put, is it worth taking a risk and investing the money instead of relying on the guarantee of the pension benefit? This rate of return will be a key point to discuss, but not the only thing to discuss. It’s also worth noting that the “guarantee” of a pension is only as good as the solvency of the company/government offering it. Should the company/government default on its debt (file for bankruptcy), your pension payout could take a significant hit.
Test these different options under different scenarios using different life expectancies. Whether you live 5 years or 25 years can have a dramatic effect on the amount of money you receive as well as what your heirs receive depending on your relative payout selection. If you are wanting to leave something behind, you will want to explore the different strategies you can use to replace lost income.
Lastly, you and your advisor can see how the different payout options affect your financial plan. This decision shouldn’t be made in a vacuum and with all things financial, context matters. Thinking of your financial goals, your payout decision becomes easier to make once you understand how taking an annuity vs lump-sum will affect your lifestyle and goals. It will also help you prioritize what goals you deem most important which will help guide your decision.
As always, we are here to help. You can call us at (916) 924-7527 or complete our contact form to speak with an advisor about claiming your pension.