The recent pension buyout offered by General Motors sent many seniors and boomers on a mad hunt for information about the pros and cons of accepting a buyout offer in place of what was originally meant to be a lifetime payout.As with any financial decision, there are risks involved both in accepting a pension buyout offer and turning one down. Understanding these risks will help you make the decision that is least likely to damage your financial future, and may even result in an unexpected gain.
Money versus Income
One of the biggest factors in considering a pension buyout is how the lump sum stacks up against the total income that would otherwise bepaid annually throughout your retirement. If you’re in good health and you think you might live 20 years receiving pension payments, you must compare that total sum to the lump sum you’re being offered. If the lump sum is comparable to what you expect to be paid with periodic payments and you don’t think you can make up that difference with smart investing, then you may be better off in turning down the lump sum.
If you have a chronic condition or your health does not indicate that you’ll have a very long retirement, then you and your family might receive more value from accepting the lump sum payment.
Stress and Responsibility
It would be nice if the decision to take a pension buyout was as simple as comparing the buyout number with the amount you expect to receive over the course of your retirement, but it isn’t that easy. Some individuals who have a track record of being financially irresponsible may not feel confident taking on the entire lump sum of their pension. Instead, they may flourish under the forced restriction on spending that a regular pension payment creates.
Even if you have a great track record managing your money, the stress of taking on the entire lump sum and being responsible for investing it might be overwhelming. It’s not worth increasing your stress level in order to get a lump sum if you’re just going to be miserable throughout your retirement.
With that said, there are some who might feel stressed by not having control over their pension funds. For those individuals, a lump sum buyout offers a way to take control and feel more secure and less stressed—but the only way to really remove the stress is to make sure you choose an investment through which you can’t lose money. Sound impossible? Well, it isn’t. With a fixed, indexed or single premium immediate annuity, for instance, you won’t have to worry about your pension disappearing into the market.
The Value of a Windfall
There is a concept called the time value of money. This concept explores how the dollar is more valuable today than it will be tomorrow. The reason it’s more valuable today is twofold: first, it can be invested today, allowing it to grow between now and a future date; second, inflation cuts the buying power of the dollar over time. If you are a senior carrying any kind of debt, then I would propose that the third reason a dollar is more valuable today than it is tomorrow is because it can significantly reduce the total amount of interest that you pay on your debts.
The time value of money is an important concept to explore when considering a pension buyout. Receiving a lump sum today can help you pay off debt and reduce your overall spending on interest; it can pay for higher value goods and services today than it will at a future date when inflation has increased the price of everything; and, invested properly, you may be able to earn interest on the lump sum that increases its value. It’s always a good idea to speak to an advisor first, however, because if your debt is low interest, you may be better off keeping the debt and investing the lump sum into a secure product that outperforms your debt’s interest.
Company Trust
When a company declares bankruptcy and its underfunded pension is involuntarily terminated, the Pension Benefit Guarantee Corporation takes over both the plan’s assets and liabilities. They then payout a set amount to recipients, but that amount may be less than you were supposed to receive. Therefore, if you think that the company paying your pension is in a precarious financial position and could conceivably declare bankruptcy in the future, you may want to accept the lump sum offer as a way of securing what’s owed to you.
Consider Taxes and Your Estate
Most pensions stop making payments once the former employee and his or her spouse has passed away. Through accepting a pension buyout, however, you may be able to add that lump sum to your estate for the benefit of your heirs. However, that may not be a good thing for every senior. The lump sum will also be considered in your estate taxes, so if the amount is enough to push you over the estate tax exemption, it could be doing your legacy a disservice.
If you don’t have an IRA or 401(k) to roll the lump sum into, you could also be facing taxes during your lifetime. However, as long as you have one of these retirement accounts and you roll the lump sum into it, then you will only be taxed based on taxable distributions from the retirement accounts.
Accepting a pension buyout offer is not an easy decision. Between looking at the practicalities of the money involved, your personal traits and anxiety levels, and the use you have for the money, you should be able to come to a fairly solid decision. Most successful lump sum disbursements used a strategy of buying a fixed index annuity with a guaranteed income rider that maintained a continuous, monthly check to the retiree—just like their intact pension did. Unlike their pension, with an annuity retirees were able to secure a benefit for heirs through what was left in the annuity at the time of death and were able to maintain control over their funds.