Ready, Set, Go! When To Start A Pension Payout?

The question comes up often: I’m ready to retire at age 55, and I can begin collecting my pension right away. Should I? The amount of the pension increases to almost double if I wait to start collecting at age 62, and two-and-a-half times if I wait until age 65. What’s the best way to do this?

Obviously, there are a lot of factors that will go into the answer to such a question, so right off, it’s hard to say for sure, but here are the basics of making this decision:

These types of pensions are based on the employer’s assumption about your life expectancy. If you live to exactly the expected age, the cost to the employer will be roughly the same no matter which option you choose. You just need to do the math – bigger payments later are made for (expected) fewer years.

It goes without saying that if you were sure you’d die at age 60, you would be much better off starting your pension payout as early as possible. On the other hand, if you live longer than expected, starting your payout as late as possible will likely make up for the late start. But at what projected life span does this make sense?

An Example To Consider

Let’s start with an example: Say at age 55 you could begin a pension paying $700 per month, or at age 62, $1,303 per month, or you could begin receiving $1,737 per month if you wait to age 65 to begin collecting. For the purpose of simplicity, the example will not factor in taxes or any cost-of-living adjustments.

At age 70, your first option is still ahead of the other two. So, if you were to die before age 71, the first option, collecting at age 55, works the best, because you would have collected a total of $126,000 by that point, versus $125,095 for the age 62 option and only $104,225 with the age 65 option.

However (and isn’t there always a however in life?) – if you lived beyond that age, the other options begin to take the lead. If you lived to at least 72 but not to age 75, the age 62 option would work out the best. Anything from age 75 on up, you’re best off to wait until age 65 to get started.

Throw in a Wrench Or Two

This has been a very simplistic look at the arithmetic behind this question – but there is more. Remember when I mentioned above that if you live to the expected age, the cost to your employer is roughly the same no matter which option you choose? How can this be, you might ask…? Well, during the time that you’re not taking your pension payments, your employer has control over the money in the pension fund, and they’ve got it invested, so it’s growing over that 7 or 10 years (between age 55 and either 62 or 65). The returns that your employer achieves over that time helps to balance out whichever choice you make.

Why is this important? Consider it this way: Instead of spending the money when you receive each pension payment, what would your results be if you invested them? If you took your pension of $700 at age 55 and invested each payment for a conservative return of 6%, by age 62 you would have amassed $72,852 in savings, a gain of more than $14,000 over the total of your payments. Using this strategy, you remain in the driver’s seat until age 78 with the age 55 option, when the age 62 option takes over until age 80, at which point the age 65 option is the clear winner.

Okay, Maybe a Third Wrench in the Works

Now – the problem with that last calculation is that it assumes you have the wherewithal to get by without spending your pension money… which isn’t out of the question for the earlier years, you’d still be plenty young and spry enough to earn a part-time living that could make up the difference and allow you to continue your lifestyle, but at some point you’d probably like to stop working altogether.

Back to our example, if we make the assumption that at age 65 you begin spending your pension and savings, at the rate of $1,737 per month (the amount of your pension if you started drawing at age 65). Oddly enough, using this strategy, you start running out of money in your surplus fund at approximately the same crossover point as in the earlier strategy: if you used the age 55 option you’d have used up your surplus by age 78; while with the age 62 option, your surplus would be gone by age 80. At those ages, you would have to get by on the $700 or $1,303 of your original pension, plus any social security and other retirement savings.

And The Point of This Is...?

The point of all this, well actually there are two points: First – the answer to the question of when to take the pension depends on what you’ll do with it, and whether or not you need those funds right away. Couple those factors with how long you’ll live. If you’ll need a larger amount to live on, such as if you don't have any other retirement savings, the longer you can wait before starting your pension payouts, the better, especially if you’re in good health and expect to live beyond age 80.

The second point is that, even if you have a pension available to you, it is definitely in your best interest to develop a savings strategy in addition to the pension. And this is doubly important if your pension is fixed (no cost-of-living adjustments) as in our example.

The best way to answer this question is to gather all of these factors, along with considerations regarding investment risk tolerance, tax implications, family longevity and your own health, as well as your lifestyle costs, healthcare costs, and propensity to continue working after your official “retirement” – at whatever age that might be – and then run the calculations.

As you might have guessed, this is just the sort of thing that I do, and I’d be happy to help you get an understanding of the numbers as they relate to your situation. Just give me a call.

That’s all for now – until next month…