Those of you who are already retired and collecting a company-paid pension might receive a tempting offer from your former company. Many companies are giving their pensioners the option of trading in their guarantee of life-long pension payments for a one-time lump-sum payment.
The offer might look generous. Some people get buyouts of $300,000 or $400,000 or more. This sounds like a sizeable amount, but there is no assurance that the money will last for the rest of your life. This is unlike a pension, which keeps paying as long as you live. If you currently receive a company-paid pension, you should analyze the issue before you get an offer, so that you will not get caught up in the excitement of the dollar signs. Should you take a lump-sum pension payment?
What People Do with Their Lump-Sum Buyouts
A survey of retired people who took lump-sum buyouts, instead of a monthly pension check for life, revealed some disheartening news. More than 20 percent of those individuals spent all of the money in a little more than five years. Even those who did not spend all of their money in the first five years, had anxiety about whether they would have enough money for the rest of their lives.
The vast majority of people who take the lump-sum option, spend it on things that are not retirement needs. For example, nearly two-thirds of the people who got pension buyouts spend a portion of that money within one year on things like luxury items, home improvements and vacations. On the plus side, 30 percent of the people paid down debt or other expenses with some of their lump-sum funds. Paying off debt is usually wise financial management, but doing so with the lump-sum proceeds decreases the buyout money available for ongoing living expenses.
Who Benefits from a Lump-Sum Buyout
A buyout is seldom to the benefit of the retired employee. Let’s say that a 65-year-old retiree gets a company pension of $30,000 a year. If he accepts a $300,000 buyout and sticks it in the bank, it will be gone in 10 years at $30,000 a year. He could invest the money, but since conservative investments tend to produce low returns, he is unlikely to make enough investment earnings to keep the money paying him $30,000 a year for the rest of his life.
In some situations, it can benefit the retiree to accept a lump-sum buyout. If the retiree has a terminal illness with a very short life expectancy, for example, he could get more money through a buyout than with monthly payments for life. On the other hand, a medical prognosis is only a best guess, and not a guarantee.
Why Companies Switched from Pensions to 401(k) Plans
Companies bore all the risk of the market, when they provided private pensions for their retirees. Whether the market went up or down, and whether the cost of living went up or not, the companies still had to find a way to make their monthly pension payments. With 401(k) plans, the employer pays a specified percentage and has no further responsibility. If the account loses money, the employer does not have to come up with more funds for the retiree.
With 401(k) plans, employees also have to contribute much of the money to the plan. With company pensions, the employer had to fund the account. Finally, once a company pays its portion into a 401(k) account, the firm has completed its requirements. Maintaining pensions forces the employer into long-term financial commitments.
The upside of 401(k) accounts is that the employee has much more control over the management of the assets. The employee can direct how the money gets invested. Anyone who has worked for a mismanaged company knows how precarious it can be to stake your financial future on something over which you have little to no control.
AARP. “Treasury Department Oks More Lump-Sum Pension Payments.” (accessed March 23, 2019) https://www.aarp.org/retirement/planning-for-retirement/info-2019/lump-sum-payments-for-pensions.html