Many companies who have formerly offered a pension are now “buying out” plan participants. General Electric is the most recent company to enact a pension freeze and to offer a buyout to all 100,000+ of their current pension benefit recipients. Fewer and fewer organizations now offer a pension to their employees for a variety of reasons. In their place, a 401(k), 403(b), or other employee-funded retirement savings vehicle is usually offered instead.
If you’re a pre-retiree or retiree who is being offered a pension buyout from your organization, you may be unsure about how to move forward. Let’s talk about what a buyout means for you, and what options are available.
If your company is offering to buy out your pension, they’re offering you an opportunity to take your pension value as of a certain date in exchange for relief from the company’s obligation to pay this in the future. It can take the form of an annuity, or more commonly, a one-time, lump-sum payment. This lump-sum usually is representative of the value of your future pension payments, or it may be slightly less. Many pension recipients push back against taking a lump-sum buyout because it feels as though they’re having some of their hard-earned benefit taken away. While this reasoning isn’t necessarily incorrect, there can also be several upsides to taking a buyout.
When your company offers you a pension buyout you may have the following options:
Taking the lump-sum payment from a pension buyout gives you the flexibility to leverage those funds in any way that fits your retirement plan best. Generally, in order to avoid paying taxes you would choose to move the funds into your own IRA account. Since pension funds are not taxed until received, the payment would be taxed unless moved into a tax-deferred account.
However, declining the lump sum, if this is an option, can also have some benefits. Getting your pension benefit distributed evenly month-to-month over the course of your retirement can prevent overspending, and offers some stability to your monthly cash flow during retirement.
Knowing whether you should take a pension buyout offer depends on several different factors. First and foremost, you need to understand how your company has calculated the lump-sum buyout of your pension. Most companies will calculate a buyout in a way that positively benefits them. So, although the figures are close to what you may have earned over the life of your pension, they’ll probably still be somewhat less. The present value of your future pension will typically be less than you would receive if you were to take pension payments over your lifetime. However, nothing is guaranteed, including your longevity. Changes in your own health may be a reason to choose the buyout.
You can always invest those funds to continually grow your wealth. In these situations, it’s wise to consult a financial advisor who can help you to determine how your company calculated your lump-sum payment, and whether or not that payment is a worthwhile substitute to your monthly pension.
That being said, there’s another key element to consider when debating a pension buyout offer: the health of your company. If your organization is offering a pension buyout, they may be doing so for financial reasons.
It may just be time for them to depart from their traditional pension plan. However, pension buyouts sometimes happen when a company needs to pay off debt, or right their financial ship in trying times. If this is the case, it’s possible that your company won’t be able to continue to fund your monthly benefit - in which case, a lump-sum buyout now would be the safer bet.
Have questions about your pension buyout? Worried that your company may freeze pension benefits? Reach out! We’d love to help answer any questions you may have.
Wood Smith Advisors, a woman-owned Registered Investment Advisor (RIA), is a fee-only financial services firm that partners with its clients to simplify their financial lives. We focus on women, entrepreneurs, and individuals with complex financial situations, providing objective and competent advice, education and services to help them develop and build their businesses and reach their financial goals. We can be reached by clicking here.
"Finance Made Simple" blog posts are intended for educational purposes and not for specific advice. Each person’s situation is different. Consult your financial advisor for advice relating to topics discussed.