[Excerpt] For those workers who participate in a traditional pension plan—15 percent of private sector workers and 75 percent State and local government workers—the math exercise doesn’t end once you figure out your monthly benefit (often based on earnings and years of service). No matter how the plan calculates your benefit, retirees must have the opportunity to receive periodic payments for life and may be offered alternative forms of payment.
Sound confusing? It gets worse. To really understand the options, you need to remember those “time value of money” calculations if you’ve ever taken a finance class. In a nutshell, the plan is required to have sufficient assets to be able to pay you the required benefits for your lifetime. The various forms of payment in most cases simply distribute those funds differently. In its simplest form, a plan might have $200,000 in assets designated for your pension. You might be offered a lump sum of $200,000 or monthly payments of $1,050 for life. It may not seem like it, but these two payments are equivalent. Investing $200,000 at 4 percent interest provides a $1,050 monthly payment for about 25 years.
Because the options are designed to be roughly equivalent (more formally, the “actuarial equivalent”), your decision to choose one form of payment over another is not about the monetary value; other factors come into play, such as the need to provide benefits for survivors. This issue of Beyond the Numbers looks at the various payment options and what factors you need to take into account when making a decision. The accompanying charts provide a visual representation of different payment options.