Should You Cash in Your Pension?

Things to consider before making permanent decisions about your pension

Life—and especially retirement—can be riddled with tough choices. Some pension plans will allow you to take a lump sum distribution rather than lifelong payments, and it can be tempting to it in if this option is available. But it's not always the best thing to do.

Don't cash in your pension or make any other permanent decisions about it without doing a thoughtful analysis first. Here are some issues you might want to consider.

Lump Sum or Annuity

Woman holding money
K. Miller Photographs/Moment?Getty Images

If you take the lump sum, the money can usually be rolled right over into an IRA account so taxes wouldn't be a big factor. Some people do this because a financial planner has convinced them that he can do better with the money. Or you might do it just because you like the comfort of knowing that all that money is available to you if you need it.

In reality, there are very few good reasons to cash out your pension as a lump sum. More often than not, other payout options will offer a better deal when they're viewed over your entire life expectancy. You should always analyze the consequences of the lump sum or annuity pension option over your life expectancy to see which is the best deal for you. The lump sum option might be good in the short-term, but you could run out of money if you make bad decisions with the funds. An annuity protects you against this outcome.

Joint Life Pension Payouts

Couple looking at a photo album

You'll have to decide what pension distribution option is best for both you and your spouse if you're married. Maybe you're comfortable with cashing in your pension and managing the investments, but would your spouse be able to manage the money as well if you pass away? What if your spouse has a much longer life expectancy than you?

This could make a  joint life pension annuity payout far more attractive than a lump sum distribution. Joint life payouts are usually available in many versions, such as 100 percent to a spouse, 75 percent to a spouse, or 50 percent to a spouse. Remember, your household will lose some Social Security income when the first spouse passes away, so having pension income available to the survivor can be quite important.

When to Start Your Pension

Man using a calculator
Image Source/Getty Images

You may be able to retire at age 60, but that doesn't mean you have to start your pension at 60. Many pensions—although not all—offer substantially higher payouts if you begin benefits at a later age. You might be leaving money on the table if you haven't analyzed the payout options and you start your pension early.

Even if you have to withdraw from your savings a little to make up for the delay, waiting might still be the more attractive option. The right decision as to when to start your pension can help reduce your risk of running out of money in retirement. 

How Much in Taxes to Withhold on Your Pension

Taxes due in April sign
Richard Goerg/Photographers Choice RF/Getty Images

The last thing you want in retirement is to find out that you owe unexpected taxes. Sometimes retirees start their pension benefits and have no taxes withheld because they think they won't owe any. Then, later, they start Social Security or they take IRA withdrawals. Surprise! The IRS wants a share of this income.

You can adjust the tax withholding on your pension benefits so you come out pretty close to a breakeven point on any taxes you might owe or on an expected refund. It's best to project your taxable income before you begin your pension so you can set your tax withholding accordingly. For example, if you project that you'll be in the 25-percent marginal tax bracket but will have itemized deductions, you might set federal withholding on your pension at 20 percent.