The letter no doubt arrived unexpectedly.
A company you once worked for has an extraordinary proposal for you. You are due a monthly pension when you hit retirement age, but the company is offering to pay you a hefty lump sum right now to buy out your pension.
Do nothing, and your pension situation continues as is. Accept the buyout, and you'll have a large chunk of money to invest toward retirement. But you can no longer expect to get that monthly check the company had promised when you retire.
Sign up for Kiplinger’s Free E-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.
Suddenly, you have a major financial decision to make that could have a significant impact on your retirement.
Initially, you may even be puzzled about why that company you once worked for is so interested in buying out your pension.
Low interest rates represent one reason. Many of these pensions had anticipated that interest rates would be higher and that the money in the pension fund would be growing at a faster pace. These pension funds invest in equities and bonds just like you might in your 401(k)s and IRAs. According to Milliman 100 Pension Funding Index (PFI), as of April 2016, the 100 largest corporate defined benefit pension plans funding status dropped by $25 billion, leaving them underfunded by about 25%. With projected rates of return of more than 7% in order to succeed, you might see how this can become a problem.
Not to mention, people are living longer, too. That's great for you, but it means extra years of monthly payments that the pension folks hadn't counted on.
That combination has led most companies to try to get out of the pension game as quickly as possible. If every pensioner stays in in the plan, they are probably in trouble. They need to cut some costs and some liability.
So what should you do when that lump-sum offer arrives?
First, sit down with a trusted investment adviser who can provide you with some information and a consultation because there's no one-size-fits-all solution for everyone. The specific terms of the deal and your individual situation both play a role in whether you should accept the lump sum or hold steady and wait for that monthly pension check down the road. One of the most important things an adviser can do is provide you with the facts so that you can make your own decision. If an adviser simply tells you what you need to do, then they aren't doing their job, which should be to empower you to make your own decision. Otherwise, whose interests are they looking out for?
Take this example. Suppose your pension is set to be $2,000 a month. That might not sound like much, but it comes to $24,000 a year. Over 25 years of retirement, that's close to $600,000.
If you were going to take an annual withdrawal from your retirement savings you would need close to $400,000 at a 4% annual return to match the pension over 25 years.
So you need to take that kind of information into consideration as you weigh your decision. Is the lump sum large enough, or can it grow enough to provide you a similar annual return as those monthly pension payments would give you?
If it would take an 8% to 10% rate of return on the lump sum to give you a cash flow equal to the pension payments at your life expectancy, then you'll likely want to stick with the pension. On the other hand, if a low rate of return could provide that same cash flow, you might want to go with the lump sum.
Something else to factor into the decision is life expectancy. You can outlive a lump sum, but you don't outlive a pension. At the same time, you can't bequeath that pension payment to your children, but you could leave them the money in the lump sum.
For many people, the answer might be to take the lump sum and put it in an annuity with a guaranteed lifetime income benefit. That way they can guarantee themselves a steady income stream into their retirement years that could actually offer greater income than the pension, along with more flexibility and control over their money.
Another thing to keep in mind is the backing of the payments. While your pension is backed by the Pension Benefit Guaranty Corp. up to certain limits, your annuity guarantees are backed by the financial strength and claims-paying ability of the issuing insurer.
Regardless, when you're offered a lump sum, it's your responsibility to educate yourself about your options and evaluate your goals carefully.
Here are some good questions to ask yourself before making your decision:
- Do I have an emergency fund in case of the unexpected?
- How much income will I need to protect my spouse in case of death?
- Do I even need any more income from my investments?
- Do I need that income now or later?
- Are there concerns over the strength of my pension?
- Do I care what is left behind for my children or charity?
- And the most difficult of questions: How long will I live?
This could be one of the most important retirement decisions you make.
Don't take it lightly.
Casey B. Weade is an insurance professional and president of Howard Bailey Financial Inc. in Indiana and author of the book The Purpose-Based Retirement. Investment Advisory Services may be offered through Global Financial Private Capital, LLC, an SEC Registered Investment Advisor or Howard Bailey Securities, LLC, a Registered Investment Adviser.
Ronnie Blair contributed to this article.
-
Time to Spring-Clean Your Finances: A Financial Professional's Four Steps to Tidy Them UpA midyear review of everything from spending to saving, with adjustments as needed, can set you on track to financial security. Plus, don't forget to check in on your workplace benefits.
-
Why a Law Firm Secretly Recording Client Conversations Is Wrong (and Illegal)A law firm that has been recording client conversations without the clients' knowledge or permission and has threatened employees if they speak out faces legal and ethical challenges.
-
Donating Complex Assets Doesn't Have to Be ComplicatedIf you're looking to donate less-conventional assets but don't know where to start, this charity executive has answers, such as considering a donor-advised fund (DAF) for its tax benefits and ease of use.
-
Think a Repeal of the Estate Tax Wouldn't Affect You? WrongThe wording of any law that repeals or otherwise changes the federal estate tax could have an impact on all of us. Here's what you need to know, courtesy of an estate planning and tax attorney.
-
In Your 50s? We Need to Talk About Long-Term CareMany people don't like thinking about long-term care, but most people will need it. This financial professional recommends planning for these costs as early as possible to avoid stress later.
-
Social Security Pop Quiz: Are You Among the 89% of Americans Who'd Fail?Shockingly few people have any clue what their Social Security benefits could be. This financial adviser notes it's essential to understand that info and when it might be best to access your benefits.
-
Such Attractive Yields in High-Grade Munis Are Rare and May Not Last LongAccording to this munis expert, the last time munis were this cheap was a brief period in 2023. If you kicked yourself for missing out then, you have a second chance now.
-
Financial Analyst Sees a Bright Present for Municipal Bond InvestorsHigh-tax-bracket investors have an excellent opportunity to secure low-volatility, high-quality returns at yield levels rarely seen in over a decade.
