If you’re entitled to a pension from a former employer, don't be surprised if you receive a letter offering you a lump sum payout. New rules that will take full effect next year allow plan administrators to calculate lifetime benefits assuming higher interest rates than were previously used. Plan sponsors have eagerly anticipated the rule changes, which allow them to offer smaller lump sum payouts. Some sponsors anxious to trim their pension obligations are expected to offer lump sums to vested former employees as well as current workers on the verge of retirement. (Employees who continue to work for a company that offers a pension are not eligible for a payout until they leave or retire.)
Even pension programs that have not offered lump sums in the past may amend their plans to take advantage of the new rules, says Philip Waldeck, senior vice-president of Pension Risk Management Solutions at Prudential Insurance. “Former employees are a hassle to track,” says Waldeck. Plus, the Pension Benefit Guaranty Corp., which protects workers’ benefits when employers declare bankruptcy, is expected to raise the insurance premiums that employers must pay for each plan participant. Paying out a lump sum removes a worker from the plan roster and reduces an employer’s future insurance costs. Plans must be at least 80% funded to offer lump sum payouts.
The rule changes make the termination of the plan an important consideration for sponsors who have already “frozen” their plans, says Evan Inglis, chief actuary at Vanguard. More than half of all private pension plans in the U.S. are either frozen (meaning workers retain benefits they have accrued but no longer earn more) or are closed to new employees, according to a Government Accountability Office report.
From just $107.88 $24.99 for Kiplinger Personal Finance
Become a smarter, better informed investor. Subscribe from just $107.88 $24.99, plus get up to 4 Special Issues
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
To terminate a pension plan, employers must be more than fully funded in order to cover the cost of payouts to participants who choose lump sums and the cost of annuities for employees who select lifetime monthly checks. Under the new rules, the annuity option is more expensive than a lump sum payout for employers, and that makes closing a plan more attractive for well-funded plan sponsors. The higher the interest rate, the cheaper it is to offer a lump sum, so some employers may wait until interest rates rise still further before deciding to terminate their plans.
Weighing your options. If you’re faced with deciding whether to take a lump sum, take your time. Once you’ve made up your mind, there’s no going back. Research shows that when given a choice between a lump sum and an annuity, about 70% of pension plan participants choose the wad of cash. But in the wake of the recent market meltdown, says Inglis, “individuals are less confident about managing money, and there is a greater desire for guaranteed income.” Plus, a lump sum payout may not include subsidized benefits that employers offer older workers as an incentive to retire early. Inglis speculates that only about half of employees who are offered a lump sum will take it.
Even if you are presented with a lump sum offer, a monthly annuity payable at your normal retirement age is always an option, says Rebecca Davis, of the Pension Rights Center, in Washington, D.C., and with an annuity you won't have to worry about how to invest your money or whether you will outlive your savings. However, you will face one potential risk: inflation. Most private pensions offer fixed payments for life, which means your monthly benefit will lose buying power over time. Even at a modest 3% rate of annual inflation, your purchasing power could be cut in half after 24 years; if inflation picks up, fixed payments will be even less attractive.
That makes managing a large payout on your own attractive, as long as you’re a skilled investor or you hire a financial adviser. Ann Sylvestro, a director with Horizon Blue Cross Blue Shield of New Jersey, decided to accelerate her retirement date and take a lump sum now to avoid the risk of a smaller payout in 2012. She and her husband, Anthony Granato, who is semi-retired after selling his auto-repair business, spent several years working with financial planner Doug Lockwood, of Harbor Lights Financial Group, in Manasquan, N.J., to prepare for this moment.
“The lump sum gives us the opportunity to better control our lifestyles,” says Sylvestro, 65. “If we were living on my fixed annuity payments, we would not have the ability to take additional income in years in which we want to travel or live a little better.” Says Lockwood, “A lump sum gives you the ability to control your income stream -- and your income taxes -- and also allows you to leave a legacy. But it's difficult to manage on your own.”
Help from the pros. Two major financial institutions -- Vanguard and Fidelity Investments -- are gearing up for the potential onslaught of pension-payout offers by offering free help to participants in the plans they administer. Such guidance may be crucial to individuals whose lump sum payouts are too small to satisfy the minimum asset requirements of many independent financial advisers. “This kind of counsel from a professional planner may mean the difference between jeopardizing their retirement security and helping to protect it," says Inglis.
Vanguard’s new Pension Reinvestment Services offers participants free phone access to certified financial planners, who do not receive commission on products they recommend, to guide them through their choices and explain the consequences of their decisions. For example, if you decide to forgo a monthly pension benefit, you may roll over the lump sum to an IRA or to your current employer’s 401(k) plan with no immediate tax consequences.
Future withdrawals will be taxed at your ordinary income tax rates. But if you decide to take the money and run, your employer is required to withhold 20% of the payout for federal income taxes, plus an additional 10% in early-withdrawal penalties if you are younger than 55 in the year you leave your job.
Fidelity’s new Collect Your Pension service includes online educational materials, a video on how to take a pension payout, and links to pension calculators and a retirement income planning tool. Gerald Foster of Seattle retired from Lafarge, a cement manufacturer, in June. He used Fidelity’s new online service and phone-based advice to decide how to collect his pension and to complete all the paperwork. A self-described computer nerd, Foster said the Web site was clearly laid out, and the phone counselor was helpful and knowledgeable.
Foster, 59, chose a partial lump sum distribution -- which he will use to pay down his mortgage -- and a $500-a-month benefit, which will supplement a pension he has from a previous employer. But before he could collect the lump sum, he had to supply a divorce decree to prove he did not have a spouse entitled to pension benefits. Normally, if a married employee selects a lump sum, the spouse must sign a document waiving the spouse’s right to a survivor benefit.
Married employees are always offered the choice of an annuity based solely on their own life or an annuity with a smaller monthly benefit that continues paying until the second spouse dies. In some cases, the surviving spouse is entitled to the full pension benefit; in other cases, the benefit may be just half of what the worker received. "It might make sense for a married couple to choose the single-life benefit and to purchase life insurance to provide for the surviving spouse tax-free,” says Robert Russell, a retirement income specialist and president of Russell & Co., a financial-planning firm in Fairborn, Ohio. That's just one example of the questions you need to ask a financial adviser before you sign off on a pension payout.
-
3 Ways to Stretch the 2026 Social Security COLA For Your BudgetThree steps retirees can take to stretch the Social Security COLA to fit their budgets.
-
How to Keep Your Charitable Giving Momentum Going All YearInstead of treating charity like a year-end rush for tax breaks, consider using smart tools like DAFs and recurring grants for maximum impact all the year.
-
Uber Takes Aim at the Bottom Lines of Billboard LawyersUber has filed lawsuits and proposed a ballot initiative, in California, to curb settlements it claims are falsely inflated by some personal injury lawyers.
-
What Does Medicare Not Cover? Eight Things You Should KnowMedicare Part A and Part B leave gaps in your healthcare coverage. But Medicare Advantage has problems, too.
-
15 Reasons You'll Regret an RV in RetirementMaking Your Money Last Here's why you might regret an RV in retirement. RV-savvy retirees talk about the downsides of spending retirement in a motorhome, travel trailer, fifth wheel, or other recreational vehicle.
-
457 Plan Contribution Limits for 2026Retirement plans There are higher 457 plan contribution limits in 2026. That's good news for state and local government employees.
-
Estate Planning Checklist: 13 Smart Movesretirement Follow this estate planning checklist for you (and your heirs) to hold on to more of your hard-earned money.
-
Medicare Basics: 12 Things You Need to KnowMedicare There's Medicare Part A, Part B, Part D, Medigap plans, Medicare Advantage plans and so on. We sort out the confusion about signing up for Medicare — and much more.
-
The Seven Worst Assets to Leave Your Kids or Grandkidsinheritance Leaving these assets to your loved ones may be more trouble than it’s worth. Here's how to avoid adding to their grief after you're gone.
-
SEP IRA Contribution Limits for 2026SEP IRA A good option for small business owners, SEP IRAs allow individual annual contributions of as much as $70,000 in 2025, and up to $72,000 in 2026.
-
Roth IRA Contribution Limits for 2026Roth IRAs Roth IRAs allow you to save for retirement with after-tax dollars while you're working, and then withdraw those contributions and earnings tax-free when you retire. Here's a look at 2026 limits and income-based phaseouts.
