Making the decision between a lump sum pension and other retirement options can feel overwhelming. Depending on your financial situation, you may have more options, but also more complex considerations. As a Certified Financial Planner, I’ve seen clients face both successes and regrets with their previous choices. 

Let’s explore the top five mistakes to avoid when considering a lump sum pension. A thoughtful approach can help protect your financial future.

Mistake 1: Underestimating Longevity Risk

One of the most common mistakes is underestimating how long you’ll live. It’s natural to think you won’t live to 100, but I’ve worked with enough clients to know it’s possible to live far beyond what you thought was possible! 

Opting for a lump sum without accounting for your potential lifespan can lead to running out of money during retirement.

Why It Matters

People are living longer than ever before, and for high earners who are accustomed to a certain standard of living, the risk of outliving their wealth is real. The lump sum might look large today, but what about 20 or 30 years from now?

Action Plan:
To mitigate this risk, consider blending your strategies. A portion of your lump sum could go into an annuity to provide guaranteed income. 

This ensures that no matter how long you live, a steady income stream is there for you. For more on how to balance lump sum vs. annuity, check out Navigating Your Pension: Lump Sum vs. Annuity—What’s Right for You?.

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Mistake 2: Ignoring the Impact of Inflation

When you receive a lump sum, it’s tempting to focus on the amount you have today. However, inflation slowly erodes the purchasing power of money. Over time, the cost of living will rise, and your lump sum may not stretch as far as it does now.

Lump sum pension example

Let’s consider someone who thought a $1 million lump sum would last their entire retirement. Fifteen years later, rising healthcare costs and inflation caught them off guard, forcing a reduction in their lifestyle. 

High net worth individuals often face higher living expenses, which makes this risk even greater.

Protecting Against Inflation

To combat inflation, consider investing a portion of your lump sum in diversified assets that can pace (outpace) inflation. Real estate, equities, and inflation protected securities can help your money grow. 

For more investment options tailored to sudden wealth, visit What Are the Best Investments for Sudden Wealth?.

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Mistake 3: Overlooking Tax Consequences

One major pitfall is overlooking the tax consequences of taking a lump sum. A large distribution could bump you into a higher tax bracket, resulting in a hefty tax bill. 

It’s not just about what you get, it’s about what you keep after taxes.

Smart Tax Planning

By rolling your lump sum into an IRA or other tax-deferred account, you can avoid immediate taxes and give your money more time to grow. High earners especially need to be cautious, as they are already in higher tax brackets.

Advanced Tax Strategies

I’ve worked with several clients who chose to roll over their lump sums and saw a significant reduction in taxes. Explore advanced strategies for maximizing your after-tax returns in this helpful article: Maximizing Your After-Tax Returns: Advanced Strategies for High Earners.

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Mistake 4: Failing to Consider Your Spouse or Beneficiaries

For high-net-worth families, estate planning and protecting your spouse or beneficiaries should be top priorities. Many people don’t consider how a lump sum decision will affect their spouse or heirs. 

Will your spouse have enough if something happens to you? What about estate taxes?

Joint Pension Options vs. Lump Sum

If you’re married, choosing a lump sum might seem like a good option, but you could also be giving up guaranteed joint survivor benefits. Weigh the pros and cons carefully. For example, consider partners who prefer a balance between a lump sum and guaranteed income to ensure their spouses are protected.

Tip: Protect your loved ones by incorporating life insurance or joint survivor annuities into your retirement strategy. Learn more about strategies for protecting your wealth from unforeseen risks in How to Protect Your Wealth From Unforeseen Risks.

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Mistake 5: Making the Decision Without a Comprehensive Financial Plan

Finally, the biggest mistake I see is making the lump sum decision without a comprehensive financial plan. It’s tempting to cash out because of the immediate access to a large sum of money, but this decision needs to fit within your broader financial goals.

Your Overall Financial Picture

Consider how this lump sum will impact your retirement income, taxes, and overall estate plan. High earners tend to have more complex finances, and making a decision in isolation can lead to inefficiencies. A proper financial plan will take into account all your assets, income sources, and future needs.

Work With a Planner

I always recommend working with a financial planner to help guide this decision. Your lump sum is just one piece of your financial puzzle. You can get more insight on how to evaluate your lump sum options in 7 Steps to Evaluate Your Lump Sum Pension Options.

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What’s Next, Make a Thoughtful Decision

Choosing a lump sum pension is a significant decision, especially for high net worth individuals. Avoiding these five common mistakes will help you make a more informed choice. 

From understanding the impact of longevity and inflation to considering taxes and loved ones, this decision isn’t one to take lightly. Take the time to align it with your overall financial goals.

For more in-depth advice and strategies, reach out for a personalized consultation. You can also explore additional resources and insights by visiting our Insights page.