If you’re currently in the workforce and you anticipate a company-sponsored pension when you retire, the odds are pretty good that you’ll be faced with a major decision before you actually retire.
The decision that you will likely face is whether you should continue to
receive a traditional pension or opt for a lump sum buyout. It
certainly appears to me the stars are aligned in such a manner that lump
sum buyouts will soon prove to be the norm rather than the exception.
There are a number reasons why plan sponsors might want to dissolve
their pension programs. One is the insurance premium imposed by the
Pension Benefit Guaranty Corporation.
The insurance premium per participant has jumped in recent years, and
currently stands at $49 per annum. By 2016, however, the cost of the
premium will jump by more than 30 percent, all the way up to $64.
To consider a lump sum buyout as an option, regulations mandate that the
pension program be funded above 80 percent. So, as a plan sponsor, if
your pension program is in relatively good shape and you can save
significant money on insurance costs, why wouldn’t you consider
terminating your pension?
In addition to no longer having to pay pension insurance premiums, even
more money is saved by eliminating the required administrative costs.
Another major reason why I think so many plans will be offering lump sum
options is the extremely low interest rate environment that we’re
currently experiencing. Simply stated, if a projected pension is $1,000
per month or $12,000 per year, consider how much capital the plan would
need to generate $12,000.
In other words, with interest rates so incredibly low, it would take a
lot of investment dollars to generate $1,000 per month. If interest
rates were to rise in the future, less money would be needed to generate
the $1,000, maybe a lot less.
A common question that I’ve been asked by many employees is why the lump
sum amount on their benefit projection statement is decreasing even
though they are continuing to work. The answer is a function of the
government rate for calculating how much the plan sponsor needs in
Currently, the rate is just over 1 percent. But in five years, it will
be 4 percent. Obviously, the plan sponsor would need less money to
generate your $1,000 per month at 4 percent rather than at 1 percent.
For the mathematically challenged, here’s a hypothetical example of what
a person might face in today’s pension environment and why a current
lump sum buyout might look fairly attractive from an employee’s point of
Retire now with a $12,000 annual pension or a lump sum payment of
$150,000. Or, retire in five years with the same $12,000 pension or a
$100,000 lump sum.
Of course, this is just hypothetical. Everybody’s situation is different
and there are pros and cons both ways. But what would you do?
If you’re approaching retirement, I strongly suggest you get an opinion
and analysis from a trusted financial adviser because there are a lot of
moving parts. It will probably be the most important financial decision
of a lifetime.
There is no one-size-fits-all answer because everyone’s circumstances
are unique. But to dismiss either option without doing your homework is
not a well-thought-out option.