Ask The CFP® Practitioner
“He who enjoys true leisure has time to improve his soul’s estate.”
~Henry David Thoreau
Question: My former employer is offering to buy out my pension plan. What should I consider before making a decision?
Answer: To help determine what’s best for you, there are a number of issues to consider. First, take into account other income sources, your health, age, family life expectancy, and future needs. If you’re married, do you want assets available for your spouse? If the primary objective is to create an income stream to replace the payout of the pension, you may not be able to do so because of today’s lower interest rates. Then again, this may not be your only goal.
Not many employers even offer pension plans any longer because they’ve become too expensive to maintain. This is because we’re living longer and the interest rate environment remains low. Companies aren’t interested in keeping these uncertain pension payout liabilities on their books.
For example, General Motors decided to “de-risk” its pension plan by offering buyouts to current retirees. Because of increased longevity, these recipients just happen to pose the greatest liability. More companies are opting to transfer the risk of indefinite income streams to retirees by offering lump-sum payouts.
Here are several important issues to consider when offered a payout:
1. Current income needs
Are your existing income sources such as savings, investments, IRA s, and Social Security benefits, adequate to meet your expected needs? If so, you may choose the lump sum and want to invest it at your discretion.
2. Tax implications
How would a lump sum buyout affect my taxes? Lump sum buyouts are taxed as ordinary income in the year received. To avoid unpleasant surprises, consult with your tax and financial advisor before taking any action.
3. Accessibility to cash
Is it important to have control and access to these assets? There may be greater flexibility and more choices with the payout option as opposed to the pension income stream.
4. Ability to grow assets and/or income over time
Do I want to choose how to invest retirement assets? The lump-sum payout provides more control in designing and monitoring your portfolio. Long-term inflation causes money to lose purchasing power over time. Pension payments generally don’t increase over time. Investing a portion of your assets may allow you to keep pace with inflation.
On the other hand, market risk could cause your principal and income stream to fluctuate based on market performance. In the worst case, you could completely run out of money if you live too long. With the pension, you could continue to receive the same benefit no matter what happens to the market.
5. Increasing medical and long-term care expenses
What is my current health status and life expectancy? Health care related expenses increase as we age while pension benefits do not. If you do have significant health issues, the lump sum may prove helpful. Also, consider the needs of a surviving spouse if applicable.
6. Your estate plan
Do I want to leave these assets to my heirs? Lump-sum payments are yours to do with as you see fit, giving you more flexibility when it comes to estate planning, liquidity or retirement income needs.
Knowledge is power. The combination of the low interest rate environment and longer life expectancies, it is likely that more employers will consider offering pension buyouts. Take the time to consider what’s best for your situation by weighing the pros and cons and taking into account cash flow requirements, risk-reward comfort levels, health, and longevity projections, along with the needs of your family. Stay focused and invest accordingly.
This information is general in nature, it is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or solicitation to buy or sell any particular investment. Investing involves risk and the possible loss of principal invested, investors may incur a profit or a loss. There is no guarantee any particular investment strategy will be successful. Opinions expressed herein are those of the author and subject to change at any time. Raymond James does not provide advice on tax, legal or mortgage issues.
This article provided by Darcie Guerin, CFP®, Associate Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041,firstname.lastname@example.org or www.raymondjames.com/Darcie. Please contact Darcie with any questions you would like to have answered in this column.