Can I tell you a story? It’s a true one, and – unfortunately – it’s happened more than once. Way more than once. It may even be your story. Here goes:
Sam is leaving his job, and with it his defined benefit plan. He gets a small sheaf of paper from his company, asking him to choose between getting a lifetime monthly pension at retirement, or taking a lump sum now, transferable (at least in part) to a locked in retirement savings plan.
Pension vs. Lump Sum
Over the next few weeks, Sam vacillates between the two choices. The monthly amount seems small compared to the commuted value, and he doesn’t have a lot of faith in management to take care of him for the rest of his life. On the other hand, he’s never paid much attention to investing before, and can’t imagine what he’d do with that much money.
Related: Decoding Your Company Pension Plan
Sixty days is beginning to seem way too short, and with the deadline looming, Sam calls the investment advisor his brother-in-law told him about, figuring that – since he’s a professional – he’ll be able to explain the pros and cons of both options and help Sam weigh them rationally against each other. Plus, he’ll come right to Sam’s house to do it.
The advisor tells Sam to take the lump sum and invest it with him. He has charts that show the growth of an investment over the amount of time Sam has left until he retires, charts that show how much money Sam will be able to withdraw every year based on that growth, and charts that show that the mutual funds he’s recommending have a four or five star rating.
Sam is impressed. Seeing the growth of the lump sum made the lifetime pension seem even smaller by comparison, and being in control of his own retirement money – with the help of his advisor – sounds better than leaving it in the hands of his old company. He decides to take the commuted value.
This is where a better storyteller would insert a tidy ending that illustrates how the advisor only cared about earning his commission, and how Sam made a huge mistake that he regretted for the rest of his life.
Related: Fun With Retirement Calculators
I can’t write an ending like that because bashing the advisor isn’t the point of my story.
Know Your Options
The point is this: investment advisors exist to sell you investments, not to weigh the relative merits of a lifetime pension vs. a lump sum. There’s no shame in consulting a professional to make the choice between your options, but the right way is to do most of the work yourself, and only then – if you must – seek help, like so:
Step One: Read the paperwork. Every word, more than once. Make notes.
If there’s anything you don’t understand, like how much your surviving spouse would get if you were to pass away before or after you retire, or how much your monthly benefit will increase with inflation – if it will – write down the specific answers you’re looking for.
Step Two: Call HR. Be persistent.
The package always has a phone number on it. The people you speak to don’t know much about how well the pension fund is managed, but they do know the precise details of your entitlement. Ask specific questions and stay on the phone (or make multiple calls) until you know as much as you can.
Step Three: Know what you’re comparing.
Comparing a monthly benefit amount to a lump sum is useless. What you have to calculate is the amount your lump sum will have to grow in order to provide the same monthly benefit without running out before you die. This means the advisor’s job is to talk about probabilities, safe withdrawal rates, and worst-case market returns, as well as the cost to invest, often buried deep in disclosure documents and expressed as a percentage instead of real dollars.
Step Four: Understand the risks.
The risk when you opt for a lifetime pension is that the company paying the pension won’t have enough money to pay you your full entitlement when you retire. The risk when you opt for the commuted value is that your investments won’t perform well enough to provide you with sufficient money to replace the pension for your entire retirement.
There you have it folks. Is it an exhaustive list of questions to consider? No. But it’s a place to start, and a framework that will relegate any advisor you consult to his proper role: information provider instead of salesman.
Sandi Martin is an ex-banker who left the dark side to start Spring Personal Finance, a one woman fee only financial planning practice based in Gravenhurst, Ontario. She and her husband have three kids under five, none of whom are learning the words to “Fidelity Fiduciary Bank” quickly enough. She takes her clients seriously, but not much else.