You are a retiree receiving a monthly pension. Your former employer has offered you a large sum of money to take instead of your monthly pension. It sure looks tempting. What should you do?
Paying out monthly pensions as lump-sums seems to be all the rage today. In April, Ford Motor Co. announced that it will offer 90,000 of its retirees a lump-sum instead of their monthly pensions. GM recently announced a similar option for 42,000 of its retirees. And there are other companies doing the same.
Why are all these companies handing out such huge amounts of money instead of much smaller pension payments? The answer is pretty simple: it is saving them money. They are not doing it out of generosity toward you and other retirees. They are trying to save a buck or two or three, or billions.
By paying out these lump-sums, these companies have calculated that they are going to save substantial sums in the future on these upcoming pension benefit liabilities. This is especially true now, as you and other retirees are much healthier than your predecessors and are living much longer lives.
So if the company is saving money, who is getting less money? You! Even though the buyout is going to be less money than your pension, there may be some situations in which it would be better for you to take the buyout. First, we will cover a few reasons to keep your pension, in addition to you getting more money:
Need Income. If you need as much income as possible for your entire lifetime, you may want to keep your pension. The lump-sum will not likely be able to sustain the same income stream payout. Also, you may want to or have already elected a spousal continuation pension benefit after your death, which you want to last the rest of your spouse’s lifetime. There are no guarantees that a lump-sum will last. Once it’s gone, it’s gone.
Don’t Need the Income. If you do not need the income to live on and are just banking your pension, you may be better off keeping your pension. The overall rate of return could be substantially more with your monthly pension if you live to your life expectancy because you have more principal with which to earn income.
Lack of Investment Skills. Another reason to keep your pension is if you have little experience in investments or lack the discipline for investing. You have probably heard stories about the lottery winners or heirs receiving large sums of money and blowing through it quickly. It is estimated that most people who receive large sums of money, such as through inheritance or lottery winnings, generally go through those windfalls in less than three years.
Sometimes such a large sum of money all at once is just too tempting for some people to pass up or leave invested. I have seen people just spend the money as they wanted to, without any budgeting. They often run out of money long before their retirements end and then they are only left with Social Security and monthly expenses that are much bigger than their Social Security. I even saw one case in which the buyout was spent before the retiree reached age 62 and was eligible for Social Security, with no pension, no savings and no job.
You Want Government Protections. Most monthly pensions are guaranteed by the Federal Pension Benefit Guarantee Corporation (“PBGC”). If you take the lump-sum option, you would no longer have that PBGC protection for your pension. You may have some protections either under the FDIC, SIPC or state insurance programs. If you take the lump-sum and the financial institution goes belly up, how much of your lump-sum do you get to keep?
Here are some reasons you may want to take the lump-sum distribution:
Poor Health. If you are not too healthy and do not expect to live your life expectancy under the IRS tables, you might be better off taking a lump-sum. Then you would be able to leave the large sum to your loved ones.
Unmarried Partner. If you are not married to your partner, you may also want to take a lump-sum distribution. Most pensions do not allow a spousal pension continuation election for unmarried domestic partners, only for spouses. In such situations, when you are gone, so goes your pension. With a lump-sum option, you can leave the lump-sum distribution to your domestic partner.
Do Not Need Income, Have Investment Skills and Are Under Age 70½. If you have a ways to go before reaching age 70½, have investment skills and do not need the income, you may want to take the lump-sum distribution. In such cases, if you just are going to invest the money anyway, it might make sense to take the dough as a lump-sum even though it is less than your pension payments. You could deposit your pension lump-sum payment into a rollover IRA and wouldn’t have to start taking any withdrawals until you reach age 70½. Until age 70½ your investment would be compounding tax free inside of your IRA. There would be no paying of any income taxes on the gains until it is withdrawn from your IRA.
So what should you do? It all depends on your situation. Once you get the offer from your former employer, review it closely. Talk to your financial advisor. Run the numbers. Does it make sense for you to take the lump-sum distribution? If it does, go for it. If it doesn’t, do not hesitate to stay with your pension.
Do not rush to make a decision, but also do not drag your feet. There are many deadlines by which you have to make decisions. For example, GM retirees have until July 20, 2012 to make their decision. When you do get advice from one financial advisor, you may also want get a second opinion from another advisor. Different people have different philosophies and different ideas. It doesn’t hurt to get more than one opinion.
By Matthew M. Wallace CPA, JD
Published edited July 1, 2012 in The Times Herald newspaper, Port Huron, Michigan as: Pension distributions- monthly or lump-sum?