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Latest Newsletter: What should you do if your employer offers a lump-sum cash payout?
What happens when you combine a rising stock market with falling interest rates? You get a favorable environment for companies offering a lump-sum cash payout for employees vested in terminated pension plans. Plans generally may offer this type of program only if their IRS funded percentage is at least 80%. The rising stock market may have helped underfunded plans reach the 80% level. General Electric is the latest company to offer a pension buyout to former employees as it tries to shore up its pension plans. The company is offering lump-sum payments to 100,000 former employees.
Pension plans must pay premiums to the Pension Benefit Guaranty Corporation (PBGC) to insure benefits. PBGC participant flat premium rate for plan years beginning in 2019 is $80 for single-employer plans (up from a 2018 rate of $74). The premium savings would amount to $8 million per year if all of General Electric’s former employees would take the lump-sum payment.
Before you accept a lump-sum offer, you should make sure the pension calculations are correct. How would you know if there was an error which had been compounding for many years? How can you ensure that you’ll get what’s rightfully yours when retirement arrives? It’s up to you to keep track of your own pension.
A good place to start is to educate yourself about how your plan works. Contact your company’s benefits officer and ask for a summary plan description. This will show how your pension is calculated. Request a personal statement of benefits which will tell you what your benefits are currently worth and how many years you’ve been in the plan. It may even include a projection of your monthly check.
Finally, you should create a “pension file” where you keep all your documents from your employer. Also keep records of the dates you worked and your salary since this type of data is used by your employer to calculate the value of your pension. Ask for professional help if you still think something might be wrong. The American Academy of Actuaries Pension Assistance List program offers up to four hours of free help from a volunteer. The U.S. Department of Health and Human Services, Administration for Community Living’s Pension Counseling and Information Program may also be helpful.
Once you are confident the amount calculated is correct, take your time to consider the options. Maybe you want to grab the cash now while it is available and roll it over to an IRA. Perhaps the idea of “guaranteed” income for life sounds better. Here are some key factors to consider:
Age & Health – Pension benefits are generally calculated based on a combination of years of service and final average salary. Also, average life expectancy is used rather than your individual life expectancy in determining lump-sum amounts. A lump sum could be attractive for someone in poor health because the whole remaining amount could be passed to beneficiaries. Mathematically, it may make more sense for a person with a high likelihood of living a long time to remain in the pension plan.
Spouse’s Resources – If your spouse already has a pension and you don’t have much saved in a 401(k), you might prefer having money to invest with a lump sum. However, if your spouse has no assets, it might be comforting to have a fixed pension income for the rest of both of your lives by electing a joint and survivor annuity option.
Risk Tolerance – Many risk-averse investors prefer a monthly annuity and those with greater investing experience and risk tolerance prefer a lump sum. Another important factor to consider is when you will need the money. A younger person with an aggressive risk tolerance may be more likely to invest a lump sum and generate more future income than they would get from the pension plan.
Other Income & Taxes – Probably the most often missed – yet key factor – is other sources of income and the rate of tax paid on the pension funds. Does it make sense to pay tax on monthly annuity payments if you don’t need the money for several years? A pension would be stacked on top of other income such as wages or self-employment income and could end up costing a lot in taxes each year.
Inflation – Pension payments are nearly always fixed for life. Even at low rates of inflation, the cost of goods and services will double about every 20 years. A lump- sum payment could be invested in inflation fighting investments, which have the potential to keep pace with rising cost-of-living.
Financial Stability – If the employer were to default on its pension obligations, the plan will be supported by the PBGC. However, retirees may get only a portion of the benefits they’d previously been promised. The maximum pension benefit guaranteed by PBGC is set by law and adjusted yearly. For plans that end in 2019, workers who retire at age 65 can receive up to $5,607.95 per month (or $67,295 per year) under PBGC’s insurance program for single-employer plans. Those with pension benefits greater than the insured amount may be better off taking a lump sum.
Make sure you carefully review the pros and cons of each pension option before making this important – and irrevocable – decision. Should you elect to take the lump sum offered, you can always choose to annuitize all or part of the lump sum later. A retiree could shop insurers who will guarantee a monthly income for life. Splitting the lump sum could provide some parts of the best from both options – guaranteed income from part of the lump sum plus a hedge against inflation through investing the remaining part. Talk to a knowledgeable adviser with retirement planning experience before making this important decision.
Lump-sum offers to buy out a pension should be verified for accuracy before being accepted.
Choosing a lump sum versus monthly pension payments is a decision which depends on the individual’s unique circumstances.
A split decision can be achieved by accepting the lump-sum offer and rolling it to an IRA. Then, you can use part of the lump sum to buy an investment that guarantees an income for life.
You’ve worked hard to save for retirement. How can you turn your wealth into an income that’s designed to last your lifetime?
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