For most future pensioners, the most important financial decision of their lives is the choice between drawing their pension fund assets as a pension or as a lump sum. It is therefore important to carefully weigh up the advantages and disadvantages.
Many prospective pensioners are unaware that the majority of their assets are held by the pension fund. The decision whether to draw your retirement assets a pension or as a lump sum has far-reaching consequences: once taken, it cannot be reversed. Not only will the decision be valid for the next 25 years or more, it will also affect family members, since the impact on inheritances varies considerably.
Rising numbers of prospective pensioners are opting for the middle way and withdrawing only part of their retirement assets. If you combine a partial lump-sum withdrawal with a pension, you can have your cake and eat it too: you receive a secure income to meet your basic needs and capital to dispose of as and when needed. According to the law, members may draw at least one quarter of their retirement assets as a lump sum. However, many pension funds go further and permit withdrawals of half or even the entire assets.
The following overview compares the pension option with the lump-sum withdrawal option:
Yes, guaranteed for life
Investment and longevity risk
Yes (monthly pension)
According to chosen investment strategy
Investment experience required?
100% as income
Lump-sum withdrawal is tax-privileged, thereafter income and property taxes
Heirs / surviving dependents?
60% widow’s / widower’s pension, no transfer of the unused assets
No widow’s / widower’s pension, unused assets transferred to heirs, prenuptial agreement and testamentary contract / will recommended
At present, one in two pensioners opt for the pension. One in three take the financial market route, withdrawing their entire assets and securing their pension through capital consumption and the chosen investment strategy. The remainder take the middle way and combine the withdrawal of a portion of their retirement assets with a reduced pension for life. All three approaches have advantages and disadvantages.
The main argument in favour of the pension is that it is paid out reliably month after month – for life. Pension recipients do not have to worry about investment and can devote themselves to other things. On top of this, it is entirely feasible that they will live longer than the actuarial life expectancy, in which case the pension has a clear advantage. However, there are also risks involved. In the past, few pension funds have compensated for inflation, or have done so only to a limited extent. This is not likely to change in the future. As a consequence, inflation may reduce purchasing power and pensioners can afford less although their pension remains the same.
By contrast, the lump-sum withdrawal presents the opportunity to preserve the retirement assets in real terms through investment. However, it may not be that easy to exceed the 2.5–3% annual return generated by pension funds over the last ten years with individual investments. On top of this, psychology tends to work against the lump-sum withdrawal. Most people find it difficult to gradually consume the capital they have saved up over the course of their entire lives.
The following tips will help you to make the right decision:
Tip 1: Ask your pension fund
Consult your pension fund about the different options. This information is free of charge. As a next step, it may be worth consulting a financial planning expert. The basis for the decision is your income and asset situation as well as your financial obligations. Your health condition may also play a role.
Tip 2: Check the registration deadline
Lump-sum withdrawals must be registered with the pension fund. Depending on the specific fund, registration periods range from a few days to several months. Keep in mind that, once the deadline for the lump-sum withdrawal has expired, your decision can no longer be reversed!
Tip 3: Choose the more appropriate pot
In the case of married couples, it may be advisable for one partner to draw the pension and the other to draw a lump-sum. Compare the terms of the two pension funds, such as conversion rate, coverage ratio and amount of widows' and widowers' pensions.