What to Do With a Lump Sum Pension Payment?

When you choose to accept the balance of your pension as a lump sum, you can choose between using the proceeds to cover short-term needs or reinvest the funds in a vessel designed to provide you with income during your retirement years. Funds held in a pension plan grow tax-deferred, so you must consider both your current financial needs and your tax situation before deciding on how to use the funds.

Paying Off Debts

Many retirees find that their income drops considerably during their retirement years because Social Security combined with other retirement income does not amount to as much as the salary they enjoyed during their working years. However, aside from trying to increase your income by reinvesting your pension, you could cut your long-term costs by paying off your debt. If you pay off your mortgage, car loan and credit card debt, you greatly reduce your monthly expenses. Depending on how much debt you owe, using your pension to pay off some debt might make sense.

Immediate Income Annuity

Many companies offer their employees the choice of a lump sum payment or a lifetime income stream. You may have declined the lifetime payments offered by your employer, but if you are still in need of income, you could invest in an immediate income annuity. You invest a lump sum premium and then receive payments for either a certain number of years or for life. Some people turn a lump sum payout into a short-term immediate income annuity in order to generate income for the gap years between retirement age and the year in which Social Security benefits begin.

Individual Retirement Account

You can maintain the tax-deferred status of your pension money by rolling it into an Individual Retirement Aaccount. You can invest IRA funds into almost any kind of investment ranging from stock purchases to certificates of deposit. Many people opt to invest in income-generating bond mutual funds when close to retirement because these funds tend to outperform CDs but are less risky than stocks or mutual funds consisting of mostly stocks. You can establish periodic withdrawals from your IRA to supplement your income. You can also buy a variable annuity where your funds are invested for between four and 10 years before annuitization at which point you start to receive lifetime income payments. However, you must ensure you have sufficient income during the intervening years.

Considerations

If you opt to use pension funds to settle your debts, you must first pay taxes on the entire amount withdrawn. The lump sum adds to your tax burden for the year in which you access the funds and could cause you to move into a higher overall bracket. You may pay less in taxes by keeping the funds in an IRA and taking withdrawals periodically over many years. Many investors choose to split their lump sum up and keep some funds on hand for emergencies, pay off debts with a portion of the proceeds and keep the rest in an IRA for the long term.

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