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  • Kyle Rolek, Retirement Planning Specialist

Should I Take the Lump Sum? An Article For PSERS Employees



When handled correctly, the monthly income and lump sum pension benefits can be a powerful combination to protect the long-term financial security of PSERS employees who are nearing retirement.


The monthly income lasts for life, and potentially a survivor's life if one of the survivor options is selected. While the monthly income provides the benefit of consistent, predictable lifetime income, the income does not increase with inflation.


This article discusses:


1 - The impact of inflation on your pension benefit and retirement expenses


2 - Protecting your long-term retirement planning from inflation risk


3 - What to do with the PSERS lump sum pension benefit


4 - A word of caution about financial salespeople and annuities for PSERS employees


5 - PSERS lump sum beneficiary flexibility


What is Inflation?


Inflation is price increases over time. For example, a gallon of gasoline cost an average of $0.36 in 1970. As of this writing, the national average is about $2.16.


From the early 1900s to the time this article was written, inflation has averaged about 3% per year. During periods like the 1970s, it's been higher than 10% per year. It's been lower than 3% per year recently, but that could change in the future at the rate our national debt is expanding.


Inflation can be a real threat to your long-term financial security during retirement. During your working years, salaries often get a "cost of living increase" to help offset the effects of inflation. In retirement, however, if you're living primarily on a fixed pension, your income will not go up.


Retirement may be the first time you'll feel the full force of inflation.


How Can Inflation Impact Expenses In Retirement? See Table Below


To summarize the data from the table below...


At age 65 when they retire, this family needs about $5,000 per month, or $60,000 per year.


At age 75, they'll need about $80,000 per year to maintain the same standard of living, assuming 3% inflation (more if inflation is higher, less if inflation is lower). To translate this, retirement got about $20,000 per year more expensive in just 10 short years, assuming only 3% inflation.


At age 85, it would take about $108,000 per year to maintain the standard of living that $60,000 per year provided at age 65, assuming 3% inflation. Retirement got about $48,000 per year more expensive over 20 years.


At age 95, it would take about $145,000 per year to buy what $60,000 per year bought at age 65 assuming 3% inflation. Retirement got about $85,000 per year more expensive over 30 years.

True, it's possible you may spend less on certain activities as you can get older. However, here are two related points to consider...


1 - I see clients today in there 80s who are just as active, in some cases more so, than they were in there 60s. Not having full-time employment opens up a lot more free time, and more free time can lead to more expenses. Also, on average, people are leading healthier lives and staying active longer during retirement today than in years' past.


2 - Depending on the specific expense, you don't always have a choice to spend less. For example, property taxes generally go up over time, and they may go up faster than they have in the past in a very inflationary environment. Also, healthcare costs have been increasing at an annual rate that exceeds 5% per year. The more of your budget that goes to healthcare costs, the higher the rate of inflation you may experience in retirement.


What Can You Do To Protect Yourself From Inflation?


Own assets that increase in value over time.


For one, your home may be a good source of inflation protection.


Second and more relevant to this article, your PSERS pension lump sum can provide inflation protection if it's moved by "direct rollover" into your own Traditional IRA. As long as the "direct rollover" is performed correctly, it is not taxable.


The money in your Traditional IRA can then be invested, responsibly, for growth to help protect your long-term retirement planning from inflation risk.


Stock vs. Bond vs. Inflation: 1928 - 2019


To summarize the data from the table below...


1- Returns on the S&P 500 have averaged about 11% per year from 1928 - 2019


2 - Returns of US Treasury Bonds have averaged about 5% per year.


3 - Inflation has averaged about 3% per year.


4 - Stock of large US companies has beaten inflation by a wide margin over the long term.

*Full data set from NYU Stern School of Business linked here: Data Set


Although stock has beaten inflation by a wide margin over time, it's very important to invest retirement money, including the PSERS lump sum, responsibly to protect from the risk of long-term loss.


Here's two comments about protecting from the risk of long-term loss...


1 - Establish a well-organized investment plan for your retirement. Retirement-specific investment planning is discussed in detail in Chapter 4 of my book Rolek Retirement Planning.


2 - Choose high-quality investments. This generally includes high-quality US stocks and investment-grade bonds. The specific percentage to allocate to each depends on your unique cash flow needs and personal preferences.


A Word of Caution About Annuities


Many financial salespeople, who sometimes use titles like "advisor", get paid commissions to sell financial products to you. They often love annuities because annuities usually pay big commissions to them. However, they might not make sense for you at all, especially because you'll already have consistent lifetime income from your PSERS pension.


Here are two related comments...


1 - Avoid taking advice from people who get paid commissions to sell products to you. This creates a clear conflict of interest between what's financially best for you and what's best for the financial salesperson. How do you know if someone gets paid commissions? This article discusses it: How to Find a Fiduciary


2 - We discussed inflation risk above. As a PSERS employee, the monthly income component of your pension provides consistent lifetime income, but it's subject to inflation risk. Buying an annuity is kind of like buying more pension. You already have a pension. If you buy an annuity, you're taking money away from growth and adding to your long-term inflation risk. Each situation is unique, but it's usually better to have the lump sum invested for growth to hedge against inflation risk, especially because you already have a pension*.


*A related comment: Some financial salespeople will tell you they have annuities with a "cost of living increase". That sounds great conceptually, but you pay a hefty price for this "benefit".


For example, Hypothetical Annuity #1 pays $1,000 per month with no cost of living increase. Hypothetical Annuity #2 pays $700 per month with a 2% annual cost of living increase. It would take over 18 years for the $700 per month, increasing at 2% per year, to be greater than $1,000 per month. You miss out on 18 years of larger payments and interest earned on those payments during the first 18 years. When the time value of money is considered, this is very unlikely to work out in your best interest over the long term.


The conceptual sales pitch of "guaranteed lifetime income with a cost of living increase" sounds great. Who wouldn't want that? But when you analyze the real numbers, you'll likely find these products are not in your best interest.


Another Benefit of Lump Sum: Beneficiary Flexibility


Once the lump sum is successfully moved by "direct rollover" into your own Traditional IRA, you have a lot of flexibility with setting up beneficiaries. You can also change your beneficiaries at any time if your preferences change later.


"Primary beneficiaries" will get the money when you die. For married couples, it's common to name the spouse as the "100% primary beneficiary", but it doesn't necessarily have to be that way.


You can name multiple beneficiaries.


You can choose the specific percentage to allocate to each individual beneficiary.


You can add "Contingent Beneficiaries". Contingent beneficiaries will get the money if there are no living primary beneficiaries at your death.


Here's a fairly common planning scenario that I'll often discuss with married clients regarding the lump sum...


PSERS participants can select a monthly income option with a survivor benefit. This means that either some or all of the monthly income will continue for a survivor's life if the PSERS participant pre-deceases the survivor.


Here's a hypothetical example...


Jane, a PSERS participant, would get $3,000 per month if no survivor benefit is elected.


If Jane selects the 100% survivor benefit option, then her benefit is reduced to $2,500 per month for as long as she's alive. In exchange, 100% of her benefit continues for her spouse's life. There's a cost of $500 per month ($3,000 vs $2,500) for as long as Jane's alive. If Jane lives for 30 years, this $500 per month reduction adds up to $180,000 in reduced benefits ($500 x 12 x 30).


If Jane selects 75% of her benefit to continue for her spouse, then the monthly benefit is $2,750 per month. Compared to the 100% survivor option, the survivor gets less if Jane dies first. However, for as long as Jane is alive, Jane gets more income each month ($2,750 vs. $2,500). If Jane lives for 30 years, this extra $250 per month adds up to $90,000 ($250 x 12 x 30). Keep in mind that Jane's spouse will likely benefit from this additional income too because it's increasing the family's monthly cash flow for as long as Jane's alive.


The numbers above are hypothetical only. Generally, the larger the survivor benefit percentage selected and the younger the survivor, the larger the reduction in monthly income while the PSERS participant is alive.


In this example, it's very important to Jane to make sure her spouse is financially secure if she dies unexpectedly early on in retirement.


By developing a comprehensive plan that carefully considers her overall situation including other assets, debts, income sources, and expenses, she determines that taking the lump sum would allow her to select the 75% survivor option instead of the 100% survivor option and her spouse will still be in great shape financially.


After rolling her PSERS pension lump sum into her Traditional IRA, Jane will name her spouse as the 100% primary beneficiary of the account. Her spouse will get 100% of this IRA account if Jane dies first, and also 75% of Jane's monthly income pension. With these two items combined, Jane's spouse will be financially secure if Jane dies first (this determination can only be made when all aspects of their unique financial situation are considered).


Equally as important, for as long as Jane is alive, they'll receive more monthly income by having selected the 75% survivor option instead of the 100% survivor option. Depending on how long Jane lives, it's possible that electing the 75% option is better for the survivor too because they are both getting more income while Jane is alive.


This hypothetical example was included to illustrate a thought process in a common planning scenario, but it is not intended as advice and will absolutely not be appropriate or applicable in all cases.


Speak with a fiduciary advisor, one who does not get paid commissions to sell products, to determine which option makes the most sense within the context of your own unique big picture retirement planning. This article, also linked above, discusses how to identify a fiduciary: How to Find a Fiduciary


Should I Take the Lump Sum? In Summary...


In most cases, yes.


The monthly income provides you with consistent lifetime income. This is a great benefit, but it's subject to inflation risk.


Taking the lump sum, rolling it over to a Traditional IRA, and investing it responsibly for growth (not into an annuity, you already have a pension and don't need more inflation risk), helps protect you from inflation risk.


The lump sum also has beneficiary flexibility, which has benefits discussed above.


When handled correctly, the monthly income and lump sum can work very well together to provide you with consistent lifetime income, inflation protection, and a solid foundation for your long-term financial security.




Want a 1-on-1 retirement planning session? Fill out the form on our website, call us at 267-427-5667, or email kyle.rolek@rolekretirement.com







Disclosures:

This article is not intended as personal advice in any capacity. For a full list of disclosures, see this page: Disclosures


This article uses information believed to be accurate on the date it was written. It is not intended to provide information or advice about what benefits are available in your specific situation. Speak with your employer for more information regarding your benefits. For example, newer employees may not have these benefit options available to them.


We are a Pennsylvania Registered Investment Adviser. We are not affiliated with or endorsed by your employer, PSERS, or the state of Pennsylvania.

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