# Lump Sum vs Monthly Payments



## Alaric (Dec 23, 2009)

Hello all

My parent will be retiring and are trying to decide between taking an upfront lump sum payment versus monthly pension payments. My parent is part of a defined benefit pension plan, so the monthly payments would be guaranteed to remain at that level for life. 

Stats: mid 50s, this is an earlier retirement. The lump sum payment would be ~$250K, versus the monthly payment of $850.

A few questions:
1) If a lump sum payment is taken, how can they generate a monthly income stream from there? Ie. what investment vehicle would they need to use?
2) What are the tax implications of either routes - lump sum versus monthly?
3) Is the LIF (Life Income Fund) a recommended vehicle?

Thanks in advance,


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## OptsyEagle (Nov 29, 2009)

You also need to find out if the pension is indexed with inflation. That has a considerable value and needs to be taken into account. Also, is the pension payable now, when they are in their mid 50s (you should give actual ages) or do they need to wait until they are 60 or 65. Lastly what is the survivorship benefit if the owner of the pension dies.


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## twa2w (Mar 5, 2016)

Optsyeagle has some good questions.

To give a more complete answer. would need your parents age, marital status (single, married, separated, divorced), expected longevity, does he/she have other sources of income, do they need these funds before age 60.65 or 71. Is the pension under federal or provincial rules.

But I will try to answer some of your questions generally.
#1 lump sum. If your parent opts for the lump sum, they cannot take it in cash but must use it to buy an annuity or roll it into a LIF (aka LRSP, LRIF, LIRA). 

#2 tax. Your parent will pay tax on the monthly stream of income generated. Depending on the pension and the legislation they may be able to take a small portion of the lump sum as a cash payment and this would be taxed in the year rec'd.

#3 LIF. A LIF has advantages and disadvantages. Essentially your parent would be responsible for the investment decisions and the returns generated. Payments from a LIF cannot usually be taken before age 55 and must start no later the year following turning 71. There is a minimum payment that must be taken once started and there is a maximum payment you cannot exceed. Once the money runs out in a RIF it is gone. But it will allow you to take more money out earlier than say the pension. This may prove useful for travel and extras now if the desire is there and there is enough other income to fund basic lifestyle later.
On the other hand if there is money left when the parent dies, the funds will go tot the estate. A LIF may be advantages if there is very short life expectancy, or your parent has a strong track record of investing, or they do not need the money until a later age or have other funds and don`t need these funds. They can then defer taking payments until a later age.
With a pension or annuity , once the payments start, they are guaranteed for life (unless the insurance company or the pension plan go insolvent) however once the parent dies the money is gone even if only one or two payments are made. (annuities or pensions can be paid to a spousal survivor and both can have guarantee periods where the pymts are guaranteed for a minimum period such as 5 or 10 years.

Not sure hw familiar you are with pensions but usually they work roughly like this (depends on legislation -provincial or federal - and the terms of the pension)
Usually if your parent is over 55 and pension is vested, they will have to take the pension at retirement but they may have the option to defer it to a later age usually not later than 65.(unless they opt to transfer the lump sum to a LIF or annuity but that is a one time offer at time of retirement usually)
So assume they decide to take the pension now.
If they are single or spouse signs a waiver they would get the 850.00 per month for life
If they are married, they would pick a survivor option. That might be take a pension of 750 a month and once they die, the survivor would get 50%of the monthly pymt. Another option may be to take 500 a month which would continue to survivor. There are usually about 6 to 10 different options. The choice you pick will depend on a number of factors depending on other income, life expectancy etc.
If separated or divorced, there may be a clause in the agreement that he or she is responsible for a continuing support which may place an onus on the estate to provide for the separated spouse which could affect pension choices. It can get messy.

FWIW most planners recommend you take a lump sum to transfer to a LIF because, of course, they earn a commission on investing the money. This is often not the right choice in the long run. Of course lots of factors come in to play.

You of course never know if you made the right decision until well after the fact. Did you live longer or shorter than expected. did your spouse outlive or die earlier etc etc.

Hope this helps but more info will certainly be more helpful.

Just an FYI if you want a simple approach. 850 X 12 is 10,200 a year. That is 4.08% annual return on the capital of 250,000.

my apologies if I oversimplified this. Not sure what your knowledge level is.

cheers


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## Alaric (Dec 23, 2009)

Thanks for the responses guys. I appreciate the walk through. 

To clarify my mom's situation. She is 56 and married. There is a survivorship benefit at 60% to her spouse. There is no cost of living adjustment, so the $850 is constant in perpetuity. 

She lives in Ontario and works for a big 5 bank. How would she know if federal or provincial rules apply? 

Also, would she be taxed on the lump sum payment option? 

What performance rate would she need to generate to beat the monthly payments option? 

Thanks again.


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## Rusty O'Toole (Feb 1, 2012)

Take the monthly payments. Unless you are an expert investor you will be better off. And if you were, you wouldn't need to ask. At their time of life they can't afford to take chances.


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## indexxx (Oct 31, 2011)

Actually, I disagree with taking the monthly payments as there is no indexing to inflation- I would take the lump sum.


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## sags (May 15, 2010)

I think the decision has to be made within the total family income picture. One DB pension for fixed monthly income is essential, but two DB pensions may change the equation in favor of commuting the value of one of them.

Another consideration is ancillary benefits attached to the pension. When you take a commuted value, you sever all ties to the employer and most often any benefits are lost. (Group life insurance, health benefits, employee discounts)

The commuted value is supposed to represent the monetary value of the benefits, but nevertheless they are gone.


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## twa2w (Mar 5, 2016)

Ok so bank pensions are under federal legislation.

She cannot take a lump sum as cash AFAIK. She has to move it to a LIF or buy an annuity. The money moves tax free to a LIF or annuity.
She would then be taxed on the income stream - either from the LIF or annuity.

Performance rate to beat pension? A little oversimplfied but
850 a month is 10,200 a year. That would be just over 4% based on a lump sum of 250,000. Payments are monthly so return would be a little higher to meet 850 monthly but not much. Say 5% 

Is her spouse older, younger, is he retiring as well. What other pensions or income do they have. Does she need this to survive.

I don't beleve she can defer it and take a larger pendion later so if she wants to do thst she would heve to look at the LIF / annuity option.

Usually these pensions are linked to CPP and at age 65, when CPP kicks in, the pension is reduced. Not sure if this is the case for your mother. Based on the pymt amount I would say not.

What sort of benefits will she get in retirement. Will she lose them if she takes the commuted value( lump sum).

I think she won't get much other than free checking account and maybe a small amount towards a health plan.


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## Beaver101 (Nov 14, 2011)

Since the parent works for a bank, surely there is a financial advisor or planner she can ask on these questions. Also, does the bank not have an HR department? 

First stats to take note is that she will get $850 per month only at normal retirement age, standardly age 65. That amount will reduce at "early" retirement.


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## GreatLaker (Mar 23, 2014)

Here are some resources they can use to analyze the decision:

http://www.advisor.ca/images/other/ae/ae_0706_pensionpaths.pdf

https://repsourcepublic.manulife.co...168b37985f10c7/inv_trs_mk1982.pdf?MOD=AJPERES

http://www.avrexmoney.com/retirement/locked-in-retirement-accounts-a-pension-road-map/

Taking the monthly pension is the simple decision. A bank pension is likely to be stable, minimal worries about pension solvency or financial condition of the bank / sponsor. 

If they are considering taking the commuted (lump sum) value here are some things to consider:

how familiar are they with investing?
do they already manage their own money? If not, why start now?
what is their investing strategy and plan?
if the market plunged >40 % like in 2008 what would they do? Taking a monthly pension they don't need to worry
Do they have a low cost investment plan? A lot of mutual fund investments have MERs of 2+ %, which is way higher than a pension's costs and will slowly siphon off a lot of the returns. Pension funds have a long term view and can invest at very low cost. 
if they are not self directed investors, do they have an advisor they trust (really trust) and know exactly what fees are charged?
how well do they understand locked-in retirement accounts like LIRAs and LIFs and the associated tax rules and withdrawal rules?

That's a long list that should have them thinking carefully before commuting their pension. If they dont have answers readily available then why take on the added risk and stress? Don't get me wrong, lots of of people successfully manage their own pension money but doing so requires a plan and knowledge, including answering tough questions like the ones I posed above.

My mom is 90, and my dad passed away 20+ years ago. She is glad to have a monthly pension and not worry about investing pension money.


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## OptsyEagle (Nov 29, 2009)

Just so you and everyone else knows: When it comes to the two options of monthly pension or commuted lump sum value, it is not that one is mathematically better then the other. It is that *the options are exactly the same*. The pension plan intends to pay out all of its assets to its members. It does not benefit, one way or the other on the decision you make. We have a forum of some pretty smart people but they are at best, equal to the mathematical actuarial skills of the people who designed the pension plan.

The only difference your parents will generate is if they feel they have better skills at investing then what the mandate for the pension plan offers. In my opinion, the only benefit obtained will most definitely come at the cost of additional risk. So, since the options are the same, mathematically, I would weigh on what they think is the best. Is having another $850 per month of guaranteed income better then having $250,000 in a locked in plan where the owner does not even have the right to take a lump sum withdrawal and now is tasked with managing it through the ups and downs of the world we live in.

I would take the monthly pension, but as another poster indicated, quite wisely, if your parents already have enough guaranteed income to cover their basic expenses, then the risk of the lump sum would be reduced to whatever degree that exists. If not, the monthly pension is by far the winner, in my opinion.


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## Beaver101 (Nov 14, 2011)

OptsyEagle said:


> ...
> I would take the monthly pension, but as another poster indicated, quite wisely, if your parents already have enough guaranteed income to cover their basic expenses, then the risk of the lump sum would be reduced to whatever degree that exists. If not, *the monthly pension is by far the winner*, in my opinion.


 ... depends on one's health and family history of longevity.


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## birdman (Feb 12, 2013)

With a defined benefit plan the benefits are pre determined for life and investment decisions are made by the pension fund as opposed to yourself. I would take the pension.


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## Daniel A. (Mar 20, 2011)

I would also go with the monthly pension, there is no reason to take on the risk.


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## twa2w (Mar 5, 2016)

Just to clarify. Your mother is planning on retiring now at age 56. Her monthly pension, starting now, would be 850 per month but if she elects to commute her pension she would get 250k to move to LIF or annuity.
These numbers do not sound entirely correct. The monthly pension sounds a little low compared to the commuted value unless the pension is indexed.

She could move the 250k to a LIF and buy say 250k in Scotiabank stock. It currently yields a dividend of 4.62%.
This would give her 11,550 per year in dividends which is more than the monthly pymts on the pension. Note the dividends are quarterly not monthly so she would have to adjust to this.
She could withdraw this amount each year as it is between the min/max LID pymts.
In fact this amount would not run afoul of the min/max rule until age 68 assuming of course there was bot a big change in value of bns stock. By age 68 hopefully the dividend rate would have increased.
By age 70 withdrawal rates start increasing more dramatically and she would begin esting into principal and if she lives long enough would eventually drain the LIF.
Here is the min max. Paymt % for LIF.
klsfinancial.ca › resources › lif-payments

Note well. I am not suggesting this. Just illustrating a point on amount of return needed to match return on a pension.
With dividends at current levels it would be relatively easy with a small portfolio of dividend stocks to exceed the pensions return but there are very real risks.

Cheers


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## fraser (May 15, 2010)

One thing to keep in mind is that NOW is the perfect time for taking the cash. Interest rates are at an all time low. This translates into an all time high for commuted values. It is the opposite of of annuity purchases.

So, if someone thinks that interest rates will increase substantially over the next few years one strategy might be to take the commuted pension value while it is at it's highest, invest safely for a few years, and then purchase an annuity when interest rates are higher and annuity costs are less.

Not suggesting this. Just something to consider. I know a few who have/going this route. It is so dependent on your own financial situation, health, and personality.

You also need to be aware that sometimes only a portion of the commuted value can be rolled over and tax sheltered. Sometimes there is a portion that must be taken into income. This can be covered off if you have any RSP room. In my case the employer provided me with the total commuted value of my DB pension and the indicated how much could be tax sheltered and how much had to be taken into income immediately. This will vary with each person, each DB plan.


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## Alaric (Dec 23, 2009)

Thanks to everyone so far on their contributions and feedback. She will be meeting with an advisory to clarify a lot of the great points raised. 

To confirm a few facts, yes the $850 monthly is what she would get today at this age. Her spouse is also on a defined benefit plan, but he would get substantially less per month. 

The benefits remain the same with either option selected. Also, they technically would not require the funds immediately, as they have savings they can access first for the first 2 years. 

Is it true that you can transfer a LIF up to 50% into a Rrsp, subject to Rrsp room availability? Also, the age to start withdrawing in a LIF is 55? Subject to the government's formula of course. 

Thanks again.


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## sags (May 15, 2010)

Information on unlocking a LIF.

https://www.fsco.gov.on.ca/en/pensions/lockedin/lif/Pages/lifunlocking.aspx


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## twa2w (Mar 5, 2016)

sags said:


> Information on unlocking a LIF.
> 
> https://www.fsco.gov.on.ca/en/pensions/lockedin/lif/Pages/lifunlocking.aspx


I believe this link applies to pensions and LIFs governed under Ontario pension rules. The OP's mothers pension is under federal pension rules

Similar but slightly different

http://www.osfi-bsif.gc.ca/Eng/pp-rr/faq/Pages/ulk-dbc.aspx


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