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Retirement Savings: Should You Opt for a Pension or a Lump Sum

Let’s say you’ve been working for around 20 to 30 years and are finally reaching your retirement age. Now you have a big decision to make – should you opt for pension or a lump sum?

In most cases, pension plans give workers the choice to either opt to take a lump sum from time to time, or monthly check payments throughout their lives from then onwards. Most workers prefer to choose lump sum benefits. However, with the new policies being imposed, it is very likely that this option will lose its charm in the near future.
Beware on Interest Rates

In order to calculate lump sums, you will need to calculate your prevailing rates and life expectancy. If the interest rates are less, it will take a bigger amount of lump sum to be equivalent to your future pay offs. On the contrary, if the interest rates are on the higher side, the smaller the lump sum amount. However, the changes in policy over the years have led to a change in the way lump sum rates are determined.

A few years back, pension plans used the 30 years treasury bond system to calculate lump sums. However, as compared to other interest rates, treasury bonds are usually lower these days. Consequently, this has led to much larger lump sum amounts. This encourages people to opt for lump sums.

Four years back, a new formula was imposed in 2008, which was aimed at changing the interest rates. This means that the rates will progressively turn away from treasury bonds to higher bond rates. This is due to take complete effect in 5 years of its implementation, which means that we can expect to see results in 2013. So, this implies that as interest rates go higher, the lower the lump sum payment you will receive.

The Choice is Yours

Now there’s one question most people ask at this point: will there be an effect on the monthly pension payments, if you decide to go with monthly payments instead of lump sum amounts? The answer is no, not at all. In fact, as the lump sum amounts get smaller (due of the change in interest rates), the better the monthly benefits that will be offered to you.

If you’re at the verge of retirement, get the HR department of your workplace to estimate lump sum benefits you’ll likely receive under both the current and probable future rates. See if there’s a difference that will help you decide precisely when will be the best time to retire. But if you’ve already retired, it will be a good idea to consider the fact that it is a lot better to be receiving monthly pension payments, rather than lump sum payments. That won’t be a bad thing at all. Moreover, you’ll have a guaranteed inflow of income for the rest of your days.

Allan enjoys blogging about personal finance and retirement planning in particular. Allan has published articles on smsf, pension plans and estate planning in various online and offline publications.