Over the years one common choice individuals are faced with is how to receive their pension benefit when it is offered to them at retirement. There are more routinely numerous options available, such as a single life payment, joint life payment or even more common in recent years, the lump sum option. Let’s first start by pointing out that for individuals who are employees of a government agency, a lump sum option is typically not a choice you will be offered.
The lump sum option has become more common for those in the private sector that have worked for large multinational corporations, and even some mid-sized businesses. This is largely due to the longer than expected life expectancies we are facing, as well as other demographic changes that can impact the actuarial projections of a pension fund. It is very difficult to predict in a pension fund what these legacy costs will be due to a variety of reasons. Companies may have a smaller number of employees in the future contributing to the fund. They may have slower than expected business cycles that force layoffs and reduce staff. As a result, there is and will continue to be more of a push towards defined contribution plans (401k/profit sharing) in the future. The largest challenge is the substantial increase in life expectancies since many of these pension funds were initiated many decades ago.
Let’s first address the lump sum option. In the majority of cases, the lump sum option is the most prudent choice. Pension funds are using the same actuarial data to make projections about life expectancy to determine their liabilities as an insurance company that sells an immediate fixed annuity. An immediate fixed annuity bought privately has the same characteristics to the individual as a private pension benefit once the receipt of income begins. The distribution rate is typically very similar. However, in some cases the entirety of the pension benefit offered as an income is not needed at the moment the individual retires.