After 30 years at the Ford Motor Company, Walter Murdoch* is one of the lucky ones. He’s already set to retire at age 56. His long career as a receiving clerk, plus a prudent habit of putting money aside, means Walter has all three legs of the proverbial retirement stool to support him: Social Security, a company pension, and savings in a 401(k) account. His wife, Susan, has these, too.
But like many folks getting ready to retire, Walter has a decision to make. Should he take his pension in one lump sum right away or opt for lifelong monthly payments? Specifically, he must choose between $265,000 now and monthly checks of $1,670.
For most people the decision is straightforward—the relative safety of unending support makes more sense than seizing a pile of cash in hopes of investing it at a superior rate of return. Census Bureau data shows that seven of eight retirees do take monthly checks. But at a time when pension obligations weigh on many companies, including Ford, the choice requires extra care. To make a sound decision, Walter needs to answer the following questions:
1. Is your health a concern? Here’s one clear exception to the preference for monthly payouts. If family history or a medical problem leads you to believe you may not have long to live, taking a lump sum and investing it yourself makes sense. It puts more money at your disposal and allows you to leave any remainder to your heirs. (Monthly checks last as long as you do or, at a reduced rate, as long as your spouse does.) In Walter and Susan’s case, health isn’t an issue.
2. Do you need the cash? Debt prompts people to take lump sums, but do this as a last resort. You may be better served by the discipline of monthly payouts. And never raid a pension to pay off your mortgage—think about moving to a cheaper place instead. Fortunately for Walter and Susan, they own their ranch home and have little debt.
3. Can you stomach greater risk? If stock market fluctuations make you nervous, a monthly check is the logical choice. That puts the investment risk where you want it—with a pension professional. Of course, brokers may advise you to cash out a pension and let them handle it—Walter’s did—but the risk is still yours, permanently. Walter said, “No thanks.”
4. Is your pension fully insured? Finally, consider the source of those checks. When a company defaults on its pension plan, its best-paid employees lose out, because the government agency that insures pensions caps coverage. Worse, the earlier you retire, the lower the cap. Walter will join a growing army of retirees depending on Ford, which, according to its 2005 annual report, had a whopping $11 billion in unfunded obligations. But Ford hasn’t defaulted, and if it did, Walter is insured for up to $1,819 a month—more than enough. To see what you’d get if your pension fund defaulted, go to the website of the Pension Benefit Guaranty Corporation.
