Recently, large companies have been offering to buyout employees and former employees from their company pension plans. This makes sense – the pension obligation is a liability for the company and one that is hard to quantify. How long will you live? What payment option will you choose? And at what age will you take the monthly pension payments? Also, companies have “promised” high returns for these pensions, returns that are increasingly difficult to achieve given low bond yields and low expected returns from global equities. A lump sum offer solves all these issues – if the employee accepts the buyout, the company’s liability goes away along with all the question marks.
But what about the employee? Is it a good deal for them (you)? Since a pension is considered “pre-tax” dollars, an individual can easily “roll over” the lump sum pension into an IRA and the monies will be able to grow tax-deferred. If you take the lump sum as a “distribution” however, the amount will be fully taxed as income in the year the distribution is made*. So you want to make sure you know what you are doing and fill out any paperwork carefully to avoid mistakes.
A good financial advisor should be able to help you make this decision (and fill out paperwork), as each individuals situation is unique. If you are contemplating this decision on your own, here a few things to consider:
The quick comparison should be between the expected returns of the pension versus expected returns of your lump sum rolled into an IRA. Most pension plans will “quote” you a monthly dollar amount they have “agreed” to pay you at some age in the future – say age 65. Some plans even give you a lump sum option at various ages so its easy to figure out what returns you would need to “beat” the pension numbers.
If the pension returns are greater than what you or your money manager can expect in a well diversified portfolio, there are a few other things to consider before you decide stick with the pension:
- Can the company actually earn the expected return of the pension? Many pension plans have large “expected” returns that seem unreasonable in the current market environment. If your pension payments are based on “expected” returns and the “actual” returns over the next few decades are lower, then the company may be forced to lower the pension payouts down the road.
- How well is the company pension currently funded? Having this information is very important. This can tell you if the company is doing a good job of funding its current and future pension obligations. If you work for a Fortune 500 company, a simple Google Search should get you this info. Ideally, you would like your company pension to be fully funded as of 2017. This article from Bloomberg does a great job of explaining the seriousness of underfunded pensions among major US corporations – https://www.bloomberg.com/graphics/2017-corporate-pensions. An underfunded pension today could lead to a cut in pension benefits down the road.
- Will the company offering the pension declare bankruptcy anytime between today and the day you die? Let’s say you are age 50. You plan to take your pension at age 65. Longevity runs in your family so you are expected to live to age 90. Will your company be in business for the next 40 years? If your company declares bankruptcy during that time frame, you will become a general creditor to that company in bankruptcy court. At that point, pension amounts may be cut significantly or entirely – a situation you do not want to be in.
- What if you die while taking your pension? A common payout option is to take a monthly payout from the pension for life. If you elect “single life payout” you get the highest monthly amount your company offers with one catch: when you die, the payouts stop and DO NOT pass to any beneficiaries. Think about that for a minute. Your pension offers you $3000 a month for life. Assuming you live 25 years, that’s an assumed value of about $900,000. After taking the pension for five years, you get sick and die – you collected $180,000 and possibly left $720,000 on the table – its gone. A way around this is to take a “joint payout” which pays a lower monthly amount but if you die, the payments will continue to your spouse. This works if both you and/or your spouse live a long time, but the risk is that you both die early in which case the payments are completely gone – they do not pass to the next generation.
Although taking the lump sum and investing it in an IRA may grow slower than your pension is “expected” to, the IRA structure can give you a larger amount of control over what happens to those funds. The IRA structure takes the funds out of the hands of the company and puts them in your hands.
Conversely, the monthly pension payout may be tough to beat in the real world if you live a long time AND if the payout does not get cut or go away for some reason. Those are big “ifs”. With the pension payments, you give up a good amount of control. Its a tough decision with no “right” answer, but a professional can help you figure out what is best for you.
* Author does not give tax advice. Please consult a CPA or accountant.
**The above article is informational in nature only and is not a recommendation to buy or sell securities. All information is gathered from sources believed to be reliable, but neither Charles Brown nor Ausdal Financial Partners, Inc guarantees the accuracy of the information. All investments carry a degree of risk. Individuals should consult with their tax and investment professionals before making changes to their investment portfolios.
***Securities and Investment Advisory services offered through Ausdal Financial Partners, Inc, 5187 Utica Ridge Road, Davenport, IA 52807 (563)326-2064. Member: FINRA/SIPC. M.Brown and Associates and Ausdal Financial Partners are independently owned and operated