Ready to take your lumps? A lump sum buyout, that is

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 reserve.

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 view.

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.