PENSION PAYOUT: MAKING THE RIGHT DECISION?

First published in UNICEF Staff News, December 2001

When you retire from UNICEF, it is critical to make smart decisions about your finances, as this process defines almost all other aspects of your life. One of the first choices you will encounter is how you withdraw your pension. There are three options: a full pension, a lump sum with a reduced pension, or a withdrawal settlement.

Under the full pension option, you receive a guaranteed annual amount until you die. With the lump sum, you withdraw up to a third of the entire pension entitlement as a lump sum, and then receive an annual payout calculated from the amount of money remaining with the UN Joint Staff Pension Fund (UNJSPF). For example, if your full pension would have been US $40,000 a year, but you decide to withdraw a one-third lump sum of $175,000 upon retirement, you would then receive a reduced annual pension equal to two-thirds of the full pension, or $26,670. A third option is to withdraw your entire pension entitlement upon retirement. The suitability of this choice rests on whether you can turn the settlement into a series of monthly payments that add up to more than the full pension that you would get from the UNJSPF.

Most retirees select either the full or lump sum payout plans. Your choice depends in part on two questions: First, can you invest the lump sum properly to receive an appropriate return? Second, can you manage the lump sum well enough so that it yields more than the difference between the full and the reduced pension? In the example above, taking the lumpsum means receiving $13,330 less per year than you would with a full pension. You must then consider how to turn the lump sum of $175,000 into a series of payments that will equal or exceed the present value of $13,330 a year for the rest of your life. Present value includes inflation. With a rate of 2.1 per cent (more accurate calculations should be based on historical average pension increases), you will need to earn at least $14,485 per year by the fifth year after your retirement.

Whether the lump sum makes sense depends partly on your skills as an investor or your access to reliable professional advice (see box below). It also relates to life span. If a retiree dies within five years of retirement, the lump sum would have been a distinct advantage for the family wealth, as much of the amount would not have been spent, or may even have been invested to earn more money. However, life expectancy is increasing. Some retirees must be prepared to plan for 35 or 40 years.

With either the lump sum or full pension, if you die before your spouse, then the survivor benefit is one-half of the full pension. However, differences between the two options may result from your life span. If a retiree who opted for a full pension of $40,000 a year, adjusted for a 2.1 per cent inflation rate, dies after five years, he/she would have collected $208,578. The surviving spouse will continue to receive $20,000 a year, again adjusted for inflation. Under the lump sum, the retiree would have taken in $139,070 in annual payments plus the original lump sum of $175,000. If this had been invested in a safe investment option such as a certificate of deposit, at 4.6 per cent, the total would have grown to $219,127.

In this case, choosing the full pension would result in receiving $149,619 less than the lump sum option. Either way, the surviving spouse would continue to receive an annual income of $20,000, adjusted for inflation. But under the lump sum, he or she would also continue receiving additional income from either the lump sum itself or investments of the money.

Making the final decision on your pension payout depends on a range of considerations. These include taxation, which may have a greater impact on single large withdrawals than on smaller amounts dispersed over the years; the fear of a spendthrift spouse who might squander a lump sum; and your expectations for standard of living. If you can live with a reduced pension, then the lump sum could be used to pay off a mortgage or other debt.

Remember to weigh all of these issues seriously. You will not have a full pay check coming in, and your pension may be only 40 to 60 per cent of your salary. If you take the lump sum, keep in mind that it is not Monopoly money, but real cash that must sustain you for two or three decades.

And no matter how good your planning, you may face barriers you never anticipated. Start by doing a reality check on your finances. Don’t be surprised if you anticipate spending as much or more than in pre-retirement years. What if you have a gap between your dream finances and your real finances? This will require some thoughtful adjusting and perhaps even some lifestyle changes. You should also consider the status of your physical health, and other financial factors such as accrued savings, investments, life insurance, annuities and inheritance.

However you approach it, retirement is a major transition in a person’s life. Different circumstances guide the choices for each individual. While the UN Pre-Retirement Programme is helpful, it would assist the UN community if such a programme were held many years prior to retirement so that the process can be planned in advance.

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Mr./Ms. Investor Extraordinaire

Some UN retirees seem to have adopted a risky past-time in their retirement years—Mr./Ms. Investor Extraordinaire. For some, this hobby has left a big dent in their personal fortunes, particularly as the stock market overall has declined. One recent retiree took a lump sum and invested it in technology stocks on the advice of her broker. When these stocks later collapsed, she lost over 40 per cent of her money. It is true historically that returns on stock investments have been higher over the long term than those on investments in more conservative categories such as certificates of deposit. But whether stock market losses can be replaced in an individual lifetime depends on the age and health of the person concerned. In some cases, if stocks were purchased at their highest price and then the market falls, it may take many years before the stocks again reach a comparable value. Retirees have to weigh the fact that their pension may be their only source of income. A smaller but guaranteed sum may make more sense than the kind of high-return, high-risk investing that is often suggested for those who are still in their earning years and have a chance to replace their losses. Be particularly careful not to fall prey to unscrupulous offers or investment scams that offer quick and high returns. Investing is a process that requires knowledge, sound judgement and patience. If you decide to hire a financial adviser, exercise caution that the advice is not linked to pushing products or earning commissions. And whatever you decide to do, it makes sense to start by educating yourself, perhaps by taking some introductory university courses in investments and financial planning.

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