Are Lump Sums Running Short Too Soon?

Working Americans appear to still be taking their lump (sums), but liking them less, according to a new survey.

The “Paycheck or Pot of Gold Study” by MetLife, based on a Summer 2016 survey by Harris Poll, found that one in five individuals (21%) who took a lump sum either from a defined benefit plan or defined contribution plan depleted their lump sum, on average, in 5½ years. Among the 26 respondents (yes, that’s just 26 people) who withdrew money from their DC plans and were not also receiving separate DB pension income, the money was depleted in just 4 years.

Spend ‘Thrifts?’

On the other hand, a lot of the lump sum depletion has a manageable explanation. Among those DB and DC plan participants who took a lump sum, nearly two-thirds (63%) reported that they had major purchases or spending within the first year, including vacations, home improvements and luxury purchases. Moreover, also during the first year, 30% of these individuals also used the money for expenses or debt, including 27% who paid down debt (e.g., credit card), 4% who paid medical/long-term care expenses, and 4% who paid education expenses.

And more than one in five individuals who took a lump sum from their DB or DC plan (22%) report that they gave away a significant portion of this money to an individual and/or a group (e.g., friends, family, charity). Needless to say, nearly one-third (31%) have regrets about major spending in the first year, and nearly a quarter (23%) of those who gave money away regret doing so.

Risk ‘Factors’

The report found some relationships between whether an individual considered themselves to be a “risk-taker” and their likelihood of selecting a lump sum. Of the DB and DC plan participants who selected a lump sum, 46% said they were risk-takers, compared with 36% of those who selected a guaranteed annuity; and 64% of DB and DC plan participants who took the annuity (vs. 54% who took the lump sum) described themselves as “risk-averse.”

The study also looked at the kind of information participants received about making a distribution election. It found that DC plan participants who selected an annuity were more likely than those who selected a lump sum to have been provided with a paper statement illustrating how much income their DC plan would provide in retirement (55% vs. 28%). Additionally, 39% of DC plan participants who chose an annuity say they received a projection estimating how many years the money in their DC plan would last, compared to 30% who chose a lump sum.

About 8 out of 10 DB and DC plan participants (79%) said they consulted with someone and/or conducted online research when choosing between accepting a lump sum and annuity payments, or what to do with the balance in their DC plans. Nearly half of DB and DC plan participants who took a lump sum (46%) say they consulted with a financial planner, compared to 35% of those who took an annuity; 25% who took an annuity spoke with their employer, compared to 10% who chose a lump sum.

Decision Drivers

The primary drivers of the decision-making process cited by both DB and DC plan participants included:

  • their financial circumstances at the time (58%);
  • the tax treatment of the payment options (42)%;
  • the total value of the lump sum or account balance compared to the total value of annuity payments they would receive (38%);
  • their health (27%); and
  • family history of longevity (20%).

The point, according to the report’s authors, is that the factors that dominated the decision were relatively short-term, “here and now” considerations.

The report’s authors conclude that behavioral economics has shown that the “lottery effect” — the idea of an individual suddenly being offered what is perceived as a large sum of money — is tempting, and can “cloud” decision-making. They note that research has also shown that the way in which the choice between a paycheck (i.e., monthly annuity payments) or a perceived “pot of gold” (i.e., a lump sum) is framed or presented influences an individual’s decision. For example, if an annuity is viewed through a “consumption frame” (i.e., one which encourages individuals to “focus on the end result of what they will be able to spend over time”), it is viewed as valuable insurance, but when it is framed in terms of investment risk and return, an annuity is viewed as a “risky asset” because the individual’s exact life expectancy is unknown.

The survey found that nearly all of those who took an annuity (96%) — 97% of DB plan participants and 94% of DC plan participants — were happy they chose the guaranteed monthly annuity payments rather than a lump sum (or, in the case of DC plan participants, a lump sum or periodic withdrawal payments). Most also think they are better off financially and more financially secure, feel that the annuity payments make budgeting more predictable and say it is easier for them to pay for the basic necessities of life.

The survey’s authors — who arguably have a vested interest in annuity adoption rates — note the important role that employers can play in designing retirement plans to help ensure lifetime income is “easily understandable and accessible directly from the plan,” though a number of obstacles remain (for a list, see “5 Reasons Why More Plans Don’t Offer Retirement Income Options.”) The report also notes that while policymakers can help to ensure that participants in workplace retirement plans are able to achieve successful retirement outcomes, the “…regulatory infrastructure to support and enable income options for DC plan participants is still a work in progress.”

Note: The average age of the DB plan participants in the survey was 65 and, of those who are retired, the average age they retired was 58. The average age of the DC plan participants was 67, and the average age at which they retired was 61. The average lump sum amount for those who took a lump sum from their DB plans was approximately $192,357 ($232,507 for men and $144,793 for women), while the average DC plan balance at retirement was approximately $239,792 ($274,859 for men and $188,178 for women).

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