Pension choices just got harder

The difficult retirement choice of whether to take a lump-sum distribution from your company’s pension or a lifetime monthly annuity is getting more complex.

The recently enacted pension legislation is going to change the formulas for calculating lump-sum distributions from corporate pensions, substituting a new benchmark interest rate and adjusting mortality tables as well.

Even before the change, choosing between a lump sum and an annuity meant guessing about your life expectancy, future interest rates, stock returns and inflation — all factors that affect the choice. The longer you live, for instance, the more attractive a lifetime annuity becomes.

“It’s a really tough decision,” said Martha Priddy Patterson, a director at Deloitte Consulting LLP’s Human Capital Practice. “If you have a terminal disease and you’re going to retire, take the lump sum, but beyond this dramatic situation, there is no easy answer.”

For private-sector employees retiring with pensions, there are some rules of thumb that can help guide a decision. Early retirees, for example, may find that an annuity is a better option for various reasons. Individuals who don’t immediately need a monthly income or who expect to receive a large pension from a company at risk of bankruptcy should consider taking a lump sum.

Currently, the lump sum is calculated using the yield of the 30-year Treasury bond, which was set at 5.13 percent in July, the most recent rate. Beginning in 2008, that number will be calculated using 80 percent of the Treasury rate and 20 percent of the corporate bond rate. Each year, the corporate bond rate will increase by 20 percentage points until it is 100 percent in 2012.

Under the new law, the lump sum is expected to be lower because the corporate bond rate is higher than the Treasury rate, said Chet Andrzejewski, vice chairman of the pension committee for the American Academy of Actuaries. The new legislation also will require the Internal Revenue Service to update the mortality tables by 2008.

“The net effect should be a drop” in the lump sum, Andrzejewski said.

No one should make any decision without getting estimates of lump sums and monthly annuity payments from plan providers. Retirees also should consider their personal circumstances, including their health, investment style, financial obligations and other assets.

Some pensions pay early retirees substantially smaller lump sums relative to annuities, according to the Pension Rights Center in Washington.

For many people, an annuity is often the safest bet.

“If you don’t know what to do, take the annuity,” advised Dallas Salisbury, president of the Employee Benefit Research Institute in Washington. “The last thing in the world you should do is deny yourself that paycheck in retirement.”

Workers, he said, are often tempted by the lump sum, especially if they’re among the 65 percent of Americans who are living from paycheck to paycheck.

“The lump sum looks like a lot of money, and the annuity doesn’t look like much,” Salisbury said.

He said about half of those with pensions are offered the lump sum, but as many as 85 percent to 95 percent of those offered take it. Some people haven’t worked for an employer for long and the lump sum is small. Others are tempted to spend the cash immediately or want to invest it themselves.

The argument for taking a lump sum “is it gives you more control over your assets,” said Bob Leone, a principal at Hewitt. “A lot of people feel they want control over their assets. They feel they could a better job investing it.”

Retirees also need to find out whether their annuity provides spousal benefits, which could make a big difference to their families when they die.

But someone thinking about an annuity should shop around before foregoing the company policy, which often provides a better deal.