March 13, 2007

More American workers are facing a critical question as they reach retirement: whether to take pension benefits as a single one-time cash payout, or as a lifetime stream of monthly payments.

Companies are increasingly giving retiring employees that choice, and pension consultants say that most retirees take the lump sum when they can. For many, however, a lump sum may not be the wisest choice. People may spend down the money or invest it poorly. And depending on their life expectancy, they may well reap a greater benefit by opting for lifetime monthly payments

Historically, pensions have been paid out as a fixed sum each month until the retiree dies, with the option to take a reduced payment that continues for a spouse's lifetime as well. But today, some 50% of the 22 million Americans with a private-sector pension have the lump-sum option, up from about 15% in 1995, with more getting it every year. Over the past decade, such companies as Eastman Chemical Co., Cooper Tire & Rubber Co. and Citigroup Inc. have added the option as, in many cases, they switch to "cash balance" or other cost-saving plans.

Last year's sweeping pension legislation may further complicate the lump-sum calculation for some retirees. It allows employers with cash-balance pension plans -- in which workers accumulate a hypothetical account balance based on their annual pay -- to use the account value when calculating a lump-sum payout, instead of recalculating it using average life expectancies, as was previously required. It could lead to a bigger difference in the value of the traditional and lump-sum options.

If your financial adviser encourages you to take a lump sum, be wary. "They stand to make a substantial amount of money" earning commissions or fees on the assets you invest, says Gary Schatsky, a financial adviser in New York, who also receives fees on lump sums he invests for clients.

Financial advisers may also be unaware of other reasons why lump sums may be a bad deal. Here are five more things to consider before taking a lump sum:

• Your company's health may not matter as much as you think. Many people think a lump sum is safer, thanks to all the bad news in the pension world. That includes ailing airlines that have dumped pensions onto the Pension Benefit Guaranty Corp., leaving pilots with a fraction of the retirement income they were entitled to.

But the federal pension insurer guarantees payouts up to $49,500 a year at age 65. So only retirees who are eligible for bigger pensions would lose out if their company goes under. (The guarantee is lower for those retiring before 65.) Taking a lump sum may make sense if your company is teetering on bankruptcy and you're expecting a large pension, but most companies and people aren't in this situation.

• Your own health may matter a lot. In a nutshell, if you're in poor health, it may be advisable to take the lump sum if you have a choice. But if you expect to live a long time, the lifetime payments are probably a better deal.

Here's why: The monthly checks retirees traditionally receive from a pension (called an annuity) are typically based on each retiree's pay and years of work. But when employers pay out lump sums, they must convert the future monthly payments into a cash-out value. To do this, they estimate how many years of checks the person is likely to receive, using national average life expectancies, which were last updated in 2002.

So if you have a chronic disease, or a family history of early deaths from heart attacks, or for some reason you don't think you'll outlive the national average, you may be better off taking a lump sum. But if you expect to live longer than average, you may be shortchanging yourself.

"Most people greatly underestimate what their life expectancy is," says Heidi Rackley, an actuary at Mercer Human Resources Consulting. A man turning 65 in 2008 can expect to live an additional 19 years, on average, recent industry estimates suggest, while a woman is likely to live 21 more years. "A key thing people forget about 'average life expectancy' is that half the population will live longer than that," Ms. Rackley says.

Companies understand this dynamic well. Blue-collar workers tend to have shorter life spans than the national average -- and companies with mostly blue-collar workers are less likely to offer lump sums. By offering only monthly checks until the employee's death, the company ends up paying out less in total pensions. General Motors Corp., for instance, doesn't allow most of its workers to take a lump-sum payout.

Employers with mostly white-collar and female workers -- those most likely to live longer than average -- are most likely to offer lump sums. International Business Machines Corp. is one. GM allows its white-collar workers to take a lump sum if they leave before retirement age.

Companies, including GM and IBM , say mortality factors don't play a role in their decision about offering lump sums. But government data show a strong correlation between longevity and payout options. About 31% of blue-collar workers had a lump-sum option in their pension plans, while 59% of white-collar workers did, according to a 2005 Bureau of Labor Statistics report.

• Keep in mind the age and health of your spouse, and any dependents. Married couples may also be better off taking the monthly payments. By law, married retirees may take monthly checks over their lifetime -- with nothing for a surviving spouse -- or instead opt for a smaller monthly check that will continue to be paid as long as a surviving spouse lives. (The size of the reduced check is determined largely by the spouse's age.) Life expectancy for couples can be longer than for individuals, Ms. Rackley cautions. "There's a good 25% chance one of them is going to live to 90."

Bedda and Paul D'Angelo each opted for monthly payments from their previous employers, figuring they'd end up with more money in the long run. In fact, Ms. D'Angelo, 60, now a financial adviser in Durham, N.C., says she often advises clients to avoid taking a lump sum. "I have always preferred to bet that people are going to live than that they are going to die" early, Ms. D'Angelo says.

Other factors can complicate the decision, however. Albert Van Lund, who retired as head of human resources for a California utility company, seemed a shoo-in for taking monthly payments: He and his wife were in good health, and his father had lived to 103. He took a lump sum instead. Now 82, Mr. Van Lund says he preferred investing the money himself, and wanted to provide for his disabled son; the monthly payments would have ended once he and his wife died.

• Retiring early can cost you 20% of your pension or more. In a bid to encourage older workers to retire, many large companies offer an early-retirement subsidy, effectively paying out a full pension as much as a decade before normal retirement age.

But the law doesn't require employers to take these subsidies into account when converting a monthly benefit into a lump sum. That alone can cost retirees 20% of the value of their pensions or more, with longtime workers in their 40s to mid-50s losing the most.

While employers are required by law to show workers what they would lose by taking a lump sum, retirement experts say their information isn't always clear, and retirees don't always realize what's at stake.

• Know the quirks of your pension plan. Some pension plans have rules that help them win the payout roulette. Consider the multi-employer pension plan sponsored by the Marine Engineers' Beneficial Association, which covers ship engineers and deck officers. It requires workers to meet health standards, and potentially submit to a medical exam, before being eligible for a lump sum.

Retirees in good health can take a lump sum, but those in poor health may not be allowed to, according to participants, plan documents and former plan officials. Current plan officials didn't return calls seeking comment.

The provision saves the plan money because those most likely to die early will receive only a few years' worth of pension checks, instead of a more valuable lump sum. Those likely to live a long time, but who take the lump sum based on average life expectancy, end up getting less than they would have with monthly checks. The pension plan wins either way.

Less-healthy participants in the MEBA plan have an out: By requesting a lump sum at least two years before retiring, they may take it regardless of their health. Several plan participants said they and co-workers try to make sure to ask for the lump sum in advance.

Write to Theo Francis at theo.francis@wsj.com