Reuters Money

When it comes to pensions, the advice of playwrights George S. Kaufman and Moss Hart doesn’t apply – you can, in fact, take it with you.

About one-third of private sector workers who have traditional defined benefit pensions are given a choice at retirement between a monthly annuity-style payment or a lump sum. Most retirees choose the lump sum – even though it’s rarely the smartest move.

Most retirees will come out ahead over the course of retirement with an annuity. And, lump sums are getting to be an even worse deal due to recent pension reform legislation that mandates changes in the way lump sum payments are calculated.

Under federal law, pension plan sponsors calculate lump sums using longevity and interest-rate statistics, aiming to match the amount you’d need to invest to match the annuity-style checks you’d receive from your normal retirement age. In that sense, the choice between lump sum and annuity should be neutral, producing the same result over time.

But that’s not the case. While the outcome depends on a number of factors —how you invest the money, whether you’re a male or female, and whether you’re married—most people will come out ahead with an annuitized pension. Here’s why:

Lower lifetime income.
Say you’re entitled to a monthly pension of $1,000 at age 65, payable for life. That converts to a lump sum of about $140,000. Of course, that sounds like a lot more than $1,000 – and that’s why so many retirees take the lump sum if they’re offered a choice. But the $1,000 comes every month of your life, in good times or bad.  And if you’re married, you could elect a joint-and-survivor benefit with a slightly lower monthly payment around $850. If you go first, that payment continues until the death of your spouse.

The lump sum? You’ll need to invest it to generate lifetime retirement income, and you run the risk that you’ll withdraw too much, suffer market setbacks or live much longer than average – creating the need to stretch your nest egg much further. Actuaries say the odds of success with a monthly payment are much higher.

Pension reform is cutting lump sum payouts.
Plan sponsors lobbied successfully for a change in the benchmark interest rate used to calculate lump sums in the Pension Protection Act of 2006 (PPA). They argued that lump sum payments were being inflated artificially by ultra-low 30-year Treasury rates, which was the benchmark rate. The PPA replaced the Treasury rate with a higher composite corporate bond rate that will be phased in fully in 2012. The corporate rate is a little over 100 basis points higher than current 30-year Treasury rates.

“All other things being equal, it means a lower lump sum,” says Alan Glickstein, a senior consultant and pensions expert at Towers Watson. “For someone close to retirement age, it works out roughly to to a 10 percent change in value for every one percentage difference in interest rates.”

Women get an especially bad deal.
The actuarial tables governing lump sum calculations are unisex, but women outlive men, on average, by about four years. That means female workers who take lump sums get shortchanged by unisex longevity assumptions.

Early retirement can be a pothole.
Many employers offer older workers pension incentives to retire early, but aren’t required by law to include those sweeteners in lump sums.

“Let’s say you’re on track to receive a $1,000 pension at age 65,” says Glickstein. “If you took early retirement at 55 it might be worth only $400 a month. Your employer might offer $600 to encourage you to retire — that’s a fairly common design. But that extra amount might not be included in the lump sum calculation.  Be sure to ask your employer how it’s calculated, and take the annuity if it’s not included.”

A lump sum can make sense in some situations, Glickstein says. “The key factors are how long you’re likely to live, and what you plan to do with the money. For example, say you’re married and your spouse receives a monthly pension—you might want to take the lump sum to invest in a business or travel. Look at the whole family’s circumstance.”

“But if the pension in question will be your primary source of income in retirement alongside Social Security, consider taking the annuity.”

PHOTO: Alan Glickstein, Towers Watson pictured in an undated handout photo.REUTERS/Handout