Pensions buyouts and transfers are in the news (again). Corporate America is restructuring its growing underfunded pension commitments. Ford, GM, NCR, The New York Times, Visteon, Archer Daniels Midland, Thomson Reuters, Equifax, A.H. Belo, and Yum! Brands have all made buyout offers to tens of thousands of current and former employees vested in company pension plans in efforts to lighten their pension liabilities(1).

Some, like GM and Verizon, are also transferring pension obligations to group annuity deals with insurers like Prudential. AT&T is transferring $9.5 billion in preferred equity to its pension fund, to address its $10 billion unfunded liability, preserving its cash (and creating the kind of risk for all its pensioners that individuals should avoid by owning too much of their employer’s stock!).

The 401(k) do-it-yourself-retirement revolution is entering the home stretch. According to a Towers Watson report last week, only 30 of the Fortune 100 still offer pension plans to new hires. In 1985, the number was 90 out of 100, with only 10 offering 401(k) plans, which first went into effect in 1980.

Of course, the old Fortune 100, which was mostly Big Manufacturing, isn’t what it used to be either. The high tech companies who have supplanted the old rust-belt firms were never big on employee benefit plans, instead pushing perks like Friday beer parties and housecleaning for employees who slept under their desks like the young Steve Jobs. With a chance to win big in the tech startup lottery, who needed the old-fashioned security of a pension plan!

A Significant Role in Your Retirement Income Plan

Social Security and pensions are shrink-wrapped secure retirement income—bedrock income flooring—with lifetime benefits for you and, depending on the options available in your pension plan, possible continuing survivor benefits for your spouse.

Even if you don’t have a pension or are not offered a buyout, you will likely face the decision of whether to take a lump sum payment or opt for a lifetime stream of income from your 401(K) when you stop working—so pay attention!

Like the strategy for claiming Social Security benefits, the choice between a lump sum or lifetime income stream can make a critical difference to your lifestyle in retirement—tens of thousands of dollars over the years.

You need secure income flooring in retirement to at least cover your essential expenses such as housing, food, clothing, transportation, healthcare, and insurance. Your savings and investments, ideally, should be for emergencies and discretionary/legacy goals.

Almost everyone needs more secure income than they will receive from Social Security, and possibly even more than Social Security plus any pension, so be cautious about converting a pension to cash. You can find out more about retirement planning and determining how much secure income you need from my continuing series on Lifetime Financial Planning, available here (“What Is Retirement Income Planning?”).

Considerations For Taking Your Lump

Let’s start with the assumption that you need the pension income stream as part of your essential retirement income floor.

With that assumption, there are just a few reasons why you should consider the lump sum offer instead of regular pension payments:

1. You are in poor health and not expected to live much longer and you do not have a surviving spouse to provide for or your pension does not have survivor benefits
2. You have substantial assets with a very favorable coverage ratio for your expected retirement expenses, are an experienced investor, the loss of some or all of the principle from investing the lump sum would not impair your financial situation, and you prefer to manage the lump sum value of your pension yourself or are willing to pay an investment manager 1-2% a year to do it for you
3. Your pension significantly exceeds the $55,840 annual amount covered by the federal Pension Benefit Guaranty Corporation (PBGC), your company is likely to fail, and its pension plan is seriously underfunded and is also likely to fail
4. You can buy a larger secure income stream with the lump sum than your pension would pay; a number of companies have used new rules allowing a higher interest rate to calculate lower lump sums than previously allowed, so you should check this out, as explained below

The first reason, very poor health, either applies or it doesn’t. Same with the second, you either have more than enough or you don’t.

The third reason depends—no one can predict the future. If you fear that 20 years into retirement your ex-company will fail, its pension plan will fail, and the self-sustaining PBGC will be on its last legs and unable to make good on the $55,000 + increases that it insures for pensioners, then consider what might happen to the lump sum you take now because of this fear.

The lump sum is a large sum of money, so you will need to park it somewhere. If you invest the lump sum, it will be subject to an even larger set of investment risks than your pension plan during that same long-term time period—business risk, market risk, regulatory risk, credit risk, currency risk, interest rate risk, inflation risk, etc. You could lose some or all of it in the markets.

In other words, the pension is insured, and the lump sum, exposed to more risk, is not.

If you are nearing retirement, you should be de-risking, moving out of the markets, and increasing your secure income floor, not pulling it up to move cash into the markets. A pension or an annuity is secure, guaranteed income. Market returns are not.

That leaves the last of the four reasons as the main consideration for most of us.
Take the payout only if you can buy a bigger pension. Unless you are dying or so wealthy it really doesn’t matter, the main reason to take the lump sum instead of the pension is if you can use it to buy a larger, insured “pension” yourself, ie, a single-premium immediate annuity. The same thing GM, Verizon, and other large corporations are doing with their entire pension plans.

In part two, we'll look at a simple way to find out if you can buy a bigger pension with your lump sum, or if you should keep your pension income stream. Meanwhile, you can find more information at www.LonierFinancial.com.