Should You Cash In Your Pension?

Run an analysis before making pension decisions that have life-long consequences

Some pensions allow you to take a lump sum distribution instead of life-long pension payments. It can be tempting to cash in your pension if this option is available. This is not always the best thing to do. This decision has life-long consequences. Do not cash in your pension, or make any decisions about it, without first doing a thoughtful analysis. The articles below cover the main items you need to consider before making any decisions about how to take out your pension.

Lump Sum or Annuity?

Woman holding what is left of her pension in her hands.
Cashing in your pension could leave you with less. K. Miller Photographs/Moment?Getty Images

Some pension plans allow you to take your money all at once in a lump sum. This lump sum can usually be rolled over right into an IRA account, so taxes are not a big factor. Many people take a lump sum when they should not. Sometimes a financial planner convinces you that they can do better with the money. Sometimes you just think it would be better if it was all available to you. I have looked at a lot of pension plans; there are a few times where cashing it in as a lump sum was the right choice, but more often than not, other payout options offered a better deal when viewed over your entire life expectancy. You should always analyze the consequences of the lump sum or annuity pension option over life expectancy to see which one would be the best deal for you. The lump sum could be good in the short-term, but if you make bad decisions, you could run out of money. The annuity protects you against this outcome.

Joint Life Pension Payouts

Couple looking at a photo album.
A join life option can protect income for a spouse. AlistrairBerg/DigitalVision/GettyImages

If you are married, you will need to decide what pension distribution option is best for you and your spouse. Maybe you are comfortable cashing in your pension and managing the investments, but if you pass early, would your spouse manage the money as well? 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 often come in many versions, such as 100% to spouse, 75% to spouse, or 50% to spouse. Remember, your household will lose some Social Security income when the first spouse passes, so having pension income available to the survivor can be quite important.

When should I start my pension?

Man using a calculator to evaluate pension payouts.
Some times it pays to start your pension at a later age. Image Source/Getty Images

You may be able to retire at 60, but that may not mean you have to start your pension at 60. Many pensions (but not all) offer substantially higher payouts if you start benefits at a later age. If you have not analyzed the payout options and you start your pension early, you may be leaving money on the table. Even when we consider that you may have to withdraw from your own savings to make up for delaying the start of the pension, some delayed starts still look more attractive. 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 should I withhold on my pension?

Taxes due in April sign.
Most pension benefits are taxable. Richard Goerg/Photographers Choice RF/Getty Images

The last thing you want in retirement is to find out you owe unexpected taxes. Sometimes retirees start their pension benefits and have no taxes withheld because they think they will owe no taxes in retirement. Then later they start Social Security, or take an IRA withdrawal, and surprise - they find they owe taxes. You can adjust the tax withholding on your pension benefits so you come out pretty close to break even on taxes owed or a refund due. It is best to project your taxable income before you begin your pension, and set your tax withholding accordingly. For example, if you project that you will be in the 25% marginal tax bracket, but will have itemized deductions, you might set federal withholding on your pension at 20%.