Selecting a pension payout plan for when you retire is an important, and often difficult, decision.
Most plans within the United States allow you one opportunity to select either a lump sum (a one-time cash payout that you receive upon retiring) or an annuity (monthly payments until a retiree’s passing — though some plans offer survivor benefits for their spouse).
“We often make this decision based on our expectations for the next 10, 20, or 30 years,” says Jessica Zhai, Ph.D., an assistant professor within Bryant’s Mathematics and Economics department.
Zhai — alongside Bryant’s Assistant Professor of Mathematics Yvette Feng, Ph.D., Mathematics and Economics Department Chair Gao Niu, Ph.D., Mathematics Professor James Bishop, Ph.D., and Mathematics Professor John Quinn, Ph.D. — co-authored a study exploring lump sum, annuity, and joint annuity and how an individual’s health status plays a role in the payout option they select. Their findings were published earlier this year in the Journal of Risk and Financial Management.
“If the retiree is very healthy, then they may want to choose annuity. Otherwise, if the retiree is unhealthy, then they may want to choose a lump sum,” Zhai explains, suggesting that this is how retirees can receive the greatest value from their pensions.
The study notes that most pension calculations are based on average life expectancy and don’t take into account individuals with serious health conditions, who often have shorter lifespans. To address this gap, Bryant researchers followed a method that adjusts standard pension mortality tables by leveraging medical research on common morbidity conditions such as diabetes, chronic obstructive pulmonary disease, and congestive heart failure.
In addition to finding that healthier individuals get more value out of annuities and less healthy individuals get more value out of lump sums, the co-authors' research also suggests that the more severe a person’s illness is, the lower the value of their life annuity will be. For instance, the study calculated that a 65-year-old retiree with congestive heart failure will realize, on average, only about 45.5 percent of the value of a single life annuity relative to a healthy individual.
As for joint-life annuities, the study found that a person’s payout selection will also depend on their spouse’s health. For example, if the retiree isn’t healthy, but their spouse is, then it may be more beneficial to select a high survivor benefit since it could significantly increase the value of the annuity; however, if both individuals are unhealthy, then they should take a lump sum. Furthermore, when considering gender, women will generally receive more value from annuities because they tend to live longer.
Looking at future areas of study, researchers are already working on another paper related to pension payments and tax. Specifically, they are focusing on how lump sum payouts can trigger larger and more immediate tax bills while annuity payments spread tax obligations over many years; they're also considering how different state and federal tax structures as well as life expectancies influence payout selections.
“When we make this decision, a lot of factors are very important to consider,” Zhai says.