The Pension Payout Decision

Like many employers, NDC gives its workers just one chance to make this pension choice. Solomon has seven options to consider, each of which will result in different monthly payments for different periods of time. Naturally, since his pension will be a significant part of his retirement income, the Los Angeles resident would like to make the smartest decision. But that's surprisingly difficult.

"My son is a Stanford economics graduate. He came over here and did spreadsheets and his own analysis of this thing," Solomon says. "I think it took him five hours and we were still not sure what's best."

About 38 million Americans are active participants in defined-benefit plans, which pay a set monthly stipend for life. Almost all of these plans require prospective retirees to make irrevocable choices on the eve of their retirement.

Traditionally, these choices have boiled down to whether retirees want the pension payments to last for their lifetimes alone or to continue throughout their spouses' lives. The first choice provides a bigger monthly stipend, but it could land your spouse in the poorhouse if you haven't planned carefully.

Companies increasingly are offering additional choices, including allowing retirees to take a lump sum in lieu of monthly payments, take a set number of guaranteed payments or choose from a variety of options that pay both the retiree and the spouse throughout their lifetimes. (Guaranteed equal payment plans generally pay a monthly benefit for the employee's lifetime or for a set number of months--such as 60, 120 or 180--whichever is longer.)

Between the complex choices and the legalese, many pre-retirees do not understand the implications of these choices.

"A lot of times, people see the forms and get confused because of all the technical language," says Karen Ferguson, director of the Pension Rights Center in Washington. "The result is people don't always understand what they are signing up for. The consequences can be devastating."

Ferguson has heard hundreds of horror stories--women left destitute because their husbands chose payments that stopped when they died; couples who thought they'd be wise to take a lump sum--but realized too late that they were such poor investors that they quickly lost a significant amount of the money.

"How you take your pension benefits is such an important decision," Ferguson says. "It's generally irrevocable, so if you mess up, you can't go back."

So how do you choose wisely?

First, realize that there are always two choices: to collect benefits for the employee's lifetime alone or to accept a reduced amount during the employee's lifetime in exchange for benefits continuing throughout the spouse's life.

Many plans offer other choices as well. For example, more companies now allow workers to take a lump-sum payment in lieu of a monthly benefit.

Solomon's plan offers seven payment choices, including 60 guaranteed monthly payments; 120 monthly payments; 180 monthly payments; or various joint-and-survivor options that would pay one monthly amount now and a smaller amount to his spouse if he dies first.

Notably, as Solomon learned through his son's calculations, all of the payment options are "actuarially equivalent." What that means is that if you live the life span of the average American--about age 79 for a woman and 72 for a man--you will get about the same amount from the company pension regardless of which option you choose.

Consequently, the question of which option is best is a personal one. To decide, you have to look at your own circumstances, such as your ability to invest a lump sum wisely; your other retirement income and savings; and your chances of living longer--or shorter--than the average American. You may also want to consider the strength of your pension plan and whether it is backed by the Pension Benefit Guaranty Corp.

The PBGC ensures benefits up to $3,051 a month for workers in covered plans. Most plans offered by private industry--with the exception of those offered by small personal service companies such as doctors' and lawyers' offices, and by churches and other nonprofits--are PBGC-insured. (If you are uncertain whether your plan is insured by the PBGC, ask your employer.)

When might you opt for a lump sum? If your employer's plan does not have the PBGC insurance and you're uncertain about the pension's continuing viability, you may want to take the money and run.

You also might choose the lump sum when you are highly confident of your ability to invest the money profitably, or when you think your chances of dying much sooner than the average person--perhaps because of poor health or a family history of early mortality--is exceptionally high.

Monthly benefits are the wisest option for those who are not comfortable with their investing skills, and they make sense for those with a family history of longevity.

However, Ferguson counsels married couples against selecting the simple lifetime benefit option--even though it's likely to pay the most per month. That's because it leaves your spouse in the lurch if you die first.

On the other hand, joint-and-survivor benefits pay less per month but provide continuing income to the surviving spouse. With a simple lifetime benefit, the spouse gets nothing after the death of the retiree.

Who might choose monthly payments for a set period, such as 60 or 120 months? Those who have other pension income that kicks in later in their retirement. For instance, early retirees, who figure they'll collect Social Security at age 65, might opt for the higher monthly pension until then. People who have substantial retirement accounts, such as IRAs and 401(k)s, might also choose this option, since they know they must start taking distributions from those plans at age 70 1/2. So if their pension income evaporates at the same time, it won't cause hardship.

For Solomon, the decision came down to health. He could have elected to get as much as $788 a month by choosing a simple lifetime benefit. But his wife, Judie, is a few years younger than he, and he doesn't want to leave her strapped should he die first. So he opted for a 100% joint-and-survivor plan that will pay $616 per month for as long as either he or Judie is alive.

"I chose the lowest monthly payment, but I plan to live forever, so I'll get my money's worth," he says.