By Julian Guilfoyle
The belief that it is better to have a lesser certain benefit than the possibility of a greater one that may come to nothing is a decision increasing contemplated by today’s retiree. George Yacik outlines this decision that can have severe repercussions in the February issue of Financial Planning. In an article titled “Weighing a Pension Buyout”, Mr. Yacik discusses the complex decisions these retirees face when deciding between a lump sum disbursement versus a promised income stream for life.
Retirement in 1985 was a simpler endeavor than it is today. Yacik writes that back then, “some 89 of the Fortune 100 companies offered a traditional defined benefit (pension) to newly hired salaried employees.” Towers Watson, a human resources consulting firm, has found that these figures have “completely flipped. In the Fortune 100 of today, 89 companies now offer only account-based retirement plans (for example, a 401(k)) to new salaried hires.” The purpose of this shift was to save money as these companies and their defined benefit plans began to feel the strain of the baby boomers reaching retirement age. The shift in retirement benefits affects not only workers entering employment, it has expanded to current retirees already receiving their pension benefits. Yacik cites a recent study completed by Aon Hewitt. They found that some “35% of the more than 500 large American companies said they were likely or somewhat likely to offer a lump-sum payout to their retirees and employees in order to put a cap on their pension liabilities.” Even if one is already in retirement, they may be forced to revisit this crucial decision.
While it has made retirement a more treacherous undertaking, there are some benefits to the worker. First, the retiree doesn’t lose a substantial amount of money should they pass away before their life expectancy. For example, lets take a 65 year-old male with $250,000 in retirement benefits. If a pension option based solely on his life expectancy is elected, the retiree should receive around $1400 per month for the rest of their life. Should the retiree pass away at 70, he would lose $166,000 plus the interest this money could have generated during that period. If the retiree had elected a lump sum option of $250,000 (and withdrew $1400 per month), the $166,000 plus accrued interest would pass to the spouse as an IRA or to the children. This obviously works the other way as well. If the retiree lived past his life expectancy or if the lump sum saw a decline due to market losses, the retiree may outlive the lump sum disbursement.
The second benefit to retirees is that they control their own destinies. If the lump sum is rolled into an IRA the retiree has unlimited investment opportunities. The IRA can be transferred into whatever type of investments they desire. Depending on the size of the IRA and the investor’s goals, the IRA can also be split. A portion could be set aside to generate an income stream, another to provide for long-term care insurance, and the remainder to achieve long-term market growth. If the pension option is elected, the retiree is restricted to the pension fund manager’s investment ability. It is also subject to revisions made to retirement benefits by their previous employer, collective bargaining agreements, or bankruptcy proceedings.
Though the lump-sum option is becoming increasingly attractive to retirees, it is imperative that the transfer to an IRA is handled appropriately. If the retirement is not transferred correctly, the entire lump sum could be taxed as income, all in one year. This is one of the many reasons you should be working with both legal and financial advisors to guarantee a smooth transition from employment to retirement. If you are approaching retirement or if your former employer is considering modifying your existing pension, please feel free to call our office at 800-798-5297 to schedule a free consultation and discuss the options that are available to you.
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