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Retirement: Lump sum or annuity?

Texas retirees, and those approaching retirement age, have a big choice to make when it comes to their financial future: Do they take a lump-sum payout from their pension or 401(k), or do they opt for monthly payments?

It isn't a decision to be taken lightly, says CNN Money. And taking a year before retirement age to explore all the options is a wise move because choosing the wrong path can have long-lasting financial repercussions.

Actuarial tables

Life expectancy is one of the key elements to determining whether a lump sum or monthly annuity payments are right for the retiree. According to the Social Security Administration website's 2009 figures, a 65-year-old man could expect to live another 15½ years; for a woman, it was 20 years. http://tinyurl.com/4c7rb78

As the Dallas Morning News says, no one can know precisely how long they'll live, but looking at a family's health history - especially parents' longevity - can give retirees an idea of how much longer they have.

For those in good health with a family history of longevity, taking the annuity might make the best sense. That way they would be guaranteed a monthly payment for the rest of their lives, be it 20 or 30 years. In short, they wouldn't outlive their money.

For those in poor health with a family history of dying young, the one-time payout might be the better option. That way they could use the money to pay expected medical bills, treat themselves to things a monthly payment wouldn't allow, and they might be able to leave money to their heirs.

Another consideration, the Dallas Morning News says, is how much the retiree would earn in investments if they took the lump sum. If the market is right and it's a considerable sum, the lump sum could be right for all retirees.

But, advises AARP, if the retiree is highly dependent on the money and doesn't know much about investing, she should take the pension. The guaranteed nature of a monthly check can bring peace of mind that the money won't be outlived and the retiree won't be poorer as she ages.

Other considerations

There are more things to consider, however, before deciding on the right path.

Beyond the pension, CNN Money asks, does the retiree have any other retirement savings or sources of income? If the answer is yes and this other money will cover monthly living expenses, taking the lump sum and letting it grow is a good option. If the answer is no, taking the one-time payment and rolling it into an IRA can be risky; if the market tanks, the retiree could lose some or all of her money.

Second, CNN Money says retirees should look at their pension plan's financial health. Request a copy of the plan's annual report, which is called form 5500, and look at the firm's funding ratio to future obligations. A healthy pension will have a ratio of at least 80 percent set aside.

If the plan becomes insolvent, the Pension Benefit Guaranty Corp. - which insures private pension plans - will pay benefits. The catch, though, is that in 2014 the annual limit is $60,000 for a single-employer plan.

However, if your company doesn't offer pensions, AARP reports, a person can buy one for herself. After rolling a 401(k) or other retirement money into an IRA, the retiree could use part of the money to buy an immediate-pay annuity.

The annuity option

There are at least three annuity options a retiree can consider, reports the Dallas Morning News.

First is the life annuity. This makes monthly payments for as long as the plan participant lives - but it stops when he dies.

Second is a life annuity with survivor benefits. This plan continues to make payments to a survivor after the plan participant dies.

Finally, there is an annuity with period certainty. This type pays for as long as the retiree lives or for a set period of time, whichever is longer. For example, life and 15 years would pay for the retiree's lifetime or 15 years, whichever is longer. If the participant dies in the first 15 years, the remaining payments would go to a designated beneficiary.

Consider this, says Tom Murphy, a certified financial planer at Murphy & Sylvest LLC in Dallas. Life-only plans pay the most per month, and amounts decrease as survivor and period certainty options are added.

If you have questions about this retirement planning or related issues, contact our office for a consultation.

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