The news media has been flooded with stories revealing pension buyout initiatives from major corporations. Once perceived as the stable, secure constant of the large employer-employee relationship, pensions, under increasing pressure, continue their transition into near extinction. As a result, many Americans who expected to receive a monthly fixed income from an employer during retirement are now asking, “What do I do if the company I work for, or retired from, suddenly offers a lump-sum option?”
Lump-sum offerings can drastically alter original retirement plans that otherwise had been based on receiving traditional monthly pension payments. However, that does not mean you can’t still come out ahead. Changes in a company’s pension plan call for a thorough analysis of which option is right for each individual based on a number of different factors.
What are your options? There are essentially two options when considering a pension buyout:
- Keep the pension the same. At a high level, keeping the pension from your employer may produce the most immediate gain in terms of income, given today’s current interest rate environment. There is a potential downside, however, in terms of personal factors, such as health, risk tolerance and estate-related goals, among others.
- Take the lump-sum payment. In this option, you are effectively relieving your former employer of any future liability owed by taking the “full” amount now, in exchange for a discount. Seeing the actual lump-sum dollar amount can be quite startling. Many people become either mesmerized or terrified. If you determine taking the lump-sum payment makes the most sense for you, the second step is to decide what type of investment vehicle will be most effective.
There are five major factors to consider when analyzing whether you should keep the pension, or accept the lump sum.
- The long-term financial stability of your company. Why is the future financial stability of the company an important factor when considering the lump-sum option? Your company is the party responsible for paying you. Although it is natural to focus on the present, you must also consider what the landscape will look like in 10, 15 or 20 years, or perhaps even longer. Ask yourself the question, “What if something happens to my company, and it can no longer pay out my pension benefit?” If this were to come true, the Pension Benefit Guaranty Corporation, or PBGC, would step in. Although some people are comforted by the PBGC’s presence, others are uncertain of the actual protection it provides. Created by the Employee Retirement Income Security Act of 1974, or ERISA, the PBGC was designed to serve as a safety net to employees and retirees on the chance an employer’s defined-benefit retirement plan ended, and did not have sufficient assets to pay out its benefit obligations.
- Your available savings outside of the pension plan. Ultimately, every individual has a certain monthly dollar amount he or she requires as a standard of living during retirement. When you keep the pension, your employer is responsible for investing the money, and paying you what you are owed on a monthly basis. When you take the lump sum, you accept the sum of all future payments owed to you (in today’s dollars), and bear responsibility for investing the assets and paying yourself what is needed to continue your standard of living.
- Your personal legacy goals. Passing funds remaining from the pension on to children or charity is a benefit not possible with the traditional pension plan. Once you and your spouse have passed, the payment stream ends. With the lump sum, the funds belong to you. Therefore, those funds may be left to a spouse, other loved ones or charity after your death. Simply put, the lump sum permits you the freedom, not only to direct where the money will go while you are living, but also where it goes after your death.
- Your desire to “own” the money. The greatest and potentially most stressful consideration of taking the lump-sum option which keeping the pension does not provide, is the freedom to do whatever you want with the money. This can be a benefit because investing wisely can potentially yield greater returns than your original projected payout balance. This can also be a negative, however, because depending on how you invest, the money is subject to gains and losses in the market. For those who are not reliant on the monthly pension payments, the option to take part of the lump sum in cash and roll the rest over into an individual retirement account is available as well. This could be an opportunity to pay off debts, send children to college, travel and more, because the lump-sum option grants you the liberty to control the money.
- Personal factors. As mentioned earlier, although it is true that keeping the pension may reflect a gain in terms of immediate income, the downside of keeping a pension is realized in the future, rather than the present. However, the same could be said for taking the lump sum
Here is a list of other personal factors that may influence your decision:
The obvious choice for some is to take the money and run, whether for emotional reasons or a variety of other temptations. However, some individuals may instinctively want to play it safe.
Regardless of your predisposition:
- Weigh your options as objectively as you can.
- Resolve to make your decision based on what is the right personal choice for both today and tomorrow.
- Review your choice within the context of your entire financial picture. This decision should not be made in a vacuum.
- Seek out a professional. An experienced, credentialed retirement advisor can be the key to helping you sleep better at night.
*Published here (Previously appeared on US News & World Report and has been updated for clarity)
Gregory S. Ostrowski, CFP, CRPC, is a managing partner of Scarborough Capital Management in Annapolis, Maryland.
Contact Gregory:firstname.lastname@example.org 410-573-5700 or 800-835-4015
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