Employer Pensions: Lump Sum or Take the Payments?

by Rob Phillips, CPA

A recent visitor to AnnuityAce called in with this exact question. He was retiring from Ford, and had the option to take a healthy lump sum or a decent monthly check. What is the right answer?

Unfortunately, like many things in life, there is no right answer. It just depends….

Reading the fine print of the monthly pension, this astute individual saw that there was absolutely no guarantee that Ford would make his monthly payment for life… No guarantee that he could count on it…. No guarantee that any other entity would back Ford up if they stiffed their retirees.

Last time I checked, Ford made great cars and trucks, and they were definitely NOT in the retirement income business… So he had to ask, should I take this lump sum and go into the market to get a better guarantee?

Well, unfortunately, this marketplace is not one that is conducive to excellent lifetime income returns. Ford probably has some good actuarial data on its employees and offered a monthly payout that could not be matched in the marketplace, and they also already had the money (I hope) and did not have any marketing/sales/administrative costs. All this translated into a more competitive return to the retiree, as it should.

We told this gentleman so, and said the only reason to consider the buyout was if he felt the credit risk was too great to bear, and if he could live with the close, but not quite as good, lifetime income we could generate from the lump sum. The ball is in his court to decide as there should never be pressure in a critical decision like this. It’s too important to push.

That’s where it depends- dig deep, be honest with yourself about your employer, your health, and your longevity, and ask….

I’m 65 now and retiring…. there’ve been ups and downs with my company… Am I confident they will be here in 20 years when I’m 85 and my spouse and I depend on this pension income and have nothing else to fall back on?”

If you can answer unequivocally yes, that your employer will stand behind you for 20-30 years, keep the pension. I can’t answer that question for you. But in case the turmoil of the last few years passed you by, with General Motors, Kodak, and other big names now totally reconstituted post bankruptcy, you might want to think long and hard about that lump sum.

Give us a call, let us give you some honest analysis. We won’t BS you and tell you we can beat the offer from your employer- rarely can we do so without some mitigating factors or deferral time on your side.

But we can probably get your income source coming from a company in the business of delivering safe and steady income checks…. and not one who’s in a totally different business like great cars and trucks, and operating a pension business on the side.

Sometimes that jump in credit quality is worth a slight haircut in the payout rate.

Trading In Your Pension

Others may succumb to the importuning of investment advisers eager to earn commissions and fees for managing the assets, or to the heady temptation of buying a sandwich franchise.

You can’t know what the future holds. But you can get a good idea of how well you’d be able to manage a lump sum by asking yourself the following questions. The more often you answer “yes,” the more likely you are to do better by sticking with your monthly pension plan.

Portfolio management. Can you say “no”? Choosing prudent investments is crucial. But if your investment portfolio contains variable annuities, life-insurance policies or investments you don’t understand, it demonstrates you can be talked into buying all sorts of potentially unsuitable, high-commission investments.

Any idea how much you pay in annual fees for your 401(k)? Probably not, and even if you do, you would be paying retail rates for investment management fees, not the institutional rates a pension plan would pay.

Asset preservation. A big part of managing your pension portfolio includes knowing how much you can withdraw each year and having the discipline to stick with the plan. Have you ever taken a loan from your 401(k), made a hardship withdrawal or withdrawn money from an IRA prematurely to pay for medical bills, tuition, a mortgage or a surprise expense?

Unexpected demands on your retirement income won’t vanish, and if you’ve always had trouble budgeting and have dipped into your retirement savings to pay current expenses, you’re going to find it even harder to stick with a budget when you don’t have the predictability of a monthly pension check.

Creating a legacy. Are you taking a lump sum because you want to leave money to your family? Perhaps you worry that if you elect a monthly pension and get hit by a meteorite the night of your retirement party, your family will get none of the pension money.

But don’t forget that, in most cases, your spouse will continue to receive the pension. What’s more, the odds of dying young are pretty slim, and the chances both you and your spouse will die prematurely are even longer. You’re far more likely to live too long and run out of money than you are to die young, and a monthly pension is insurance that you won’t end up sleeping in your kid’s dining room when you’re 92.

Protecting a spouse. Perhaps you are counting on your employer-provided life insurance to protect your spouse if you have taken a lump sum. Well, have you ever been surprised by your employer’s decision to cut benefits? If so, you may not see the blow coming when your employer rescinds its retiree life insurance, which most can do at will. In recent years, for example, GM has slashed both retiree health coverage and life-insurance benefits for white-collar retirees.

Self-defense. You might be inclined to take a lump sum because you don’t trust your employer. While it is common for companies to cut pension benefits while you’re working, they can’t cut them after you retire. Even if an employer goes bankrupt and dumps its obligations on the Pension Benefit Guaranty Corp., current retirees continue to receive their monthly payments, and most future retirees receive 100% of what they had earned.

After all this, if you’re still set on taking a lump sum, any attempt to dissuade you may be futile. But don’t say you weren’t warned

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