Employer-sponsored defined-benefit pension plans are quickly becoming a thing of the past, at least in the private sector. Most public employees are still covered by such plans, although a lump-sum option generally is not available.

For private-sector retirees who still have traditional pensions, many have the option of choosing 1) a lifetime stream of income or 2) a lump-sum payment which is intended to represent the present value of that income stream, based on life expectancy and a factor related to the time-value of money.

Making that decision is a huge one. Once made, it cannot be reversed. The decision impacts the retiree’s financial picture for the rest of his/her life.

Close to home, Kodak announced in January 2012 that it was suspending the lump-sum option for its defined-benefit pension plan, pending the outcome of the Chapter 11 bankruptcy process.

Vested plan participants leaving the company were allowed to check a box if they wished to retain their rights to a lump sum if restored in the future.

Kodak indeed did restore the lump-sum pension option this past September, opening the door for many retirees and downsized former employees to now be faced with the big decision.

What to do?

In working with clients, we take a number of factors into account to help them choose the lump-sum vs. lifetime-annuity option that is best suited for their circumstances. Each situation is unique and requires a careful analysis. Some of the factors impacting the decision include:

• The time-value-of-money factor that equates the lump sum with a straight-life annuity stream. 
• Other income sources, including Social Security benefits, other pensions, and income from continued full or part-time employment. 
• After-tax spending goals/needs during retirement. 
• Health and family health history. 
• Existing investment accounts, IRAs, 401(k) plans, savings, CDs, etc. 
• Anticipated inheritances – ballpark amounts and timeframes. 

Funding level of the employer’s pension plan and long-term financial strength and viability of the employer. Shaky plans would tilt the decision toward lump sum.

One important consideration is that pension income generally is constant. The income stream does not change to keep pace with inflation. Pension-income spending power will likely drop in half over a 20-25-year timeframe.

If the lump-sum option is chosen, the money must be removed from the plan. Here are some choices, similar to options available with a 401(k) plan:

Take the money and run.

Unless you are facing a catastrophic financial emergency, don’t even think of this option! This is clearly a last resort.

First, these assets are a key piece of your retirement nest egg. Second, if you take the cash outright, the distribution will be subject to income taxes at ordinary rates. Additionally, if you are under the age of 59-1/2, distributions generally are subject to a 10% early-withdrawal penalty, although the penalty is waived for distributions made to an employee who attained the age of 55 before leaving the company.

Roll over to a Traditional IRA.

This generally is the most attractive option.

Rolling over to an IRA carries with it no tax consequences if transferred directly from the pension plan to your IRA trustee. An IRA will offer you a wide choice of investments. But be sure to select your advisor and associated financial firm carefully. Doing so will make all the difference in the world to your financial health over the subsequent years.

Choosing the lump sum and subsequent IRA rollover does not prevent you from later electing a lifetime income option, perhaps at a higher income than offered initially by the employer pension plan, anticipating higher interest rates in the future.

How – by purchasing an immediate fixed annuity within the IRA. This is not to suggest that this option is ideal. But it does allow one to access the income option later through a commercial insurance company vs. the original employer pension plan.

Roll over to a Roth IRA.

This also can be an attractive option for the lump sum, depending on circumstances.

As with any conversion of pre-tax money into a Roth IRA, income taxes are payable on the conversion amount in the year of transfer. So, be mindful that such a rollover will have tax consequences. But once the money is in the Roth IRA, all income and appreciation are tax-free for life as long as certain conditions are met.

Choices are always good, but be sure to seek competent financial guidance before making your choice.