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Pension Plan Decision - Lump Sum Or Lifetime Payments?

Pension Plan
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EDITOR NOTE: A pension plan is a highly undiversified and long-term bet that an employee makes on his or her company. At most, an employee can get income to last throughout retirement. But that income won’t keep up with any loss in the dollar’s purchasing power over time. Also, betting that your company will last throughout your golden years is a highly speculative bet. Overall growth will likely remain low as compared with other assets. You’re probably better off taking retirement into your own hands and investing it yourself.

One of the risks that comes with pension plans may be looming larger than usual.

As many companies work to regain their financial footing in the midst of continuing economic uncertainty caused by the coronavirus pandemic, a retiring worker’s decision to take either a lump sum or lifetime payments from their pension could boil down to one factor: whether they think the employer will be able to meet its long-term commitments.

“That’s one of the biggest considerations that employees have when doing this kind of analysis,” said certified financial planner Leslie Beck, owner and principal of Compass Wealth Management in Rutherford, New Jersey. “Many have concerns about their company remaining viable.”

The number of private pension plans — which employers fund on behalf of workers — has been dwindling over time as companies have shifted the burden of retirement savings to employees through 401(k) plans or other defined-contribution plans. 

 In 1975, there were more than 103,000 pension plans in operation, according to the Labor Department. By 2017, that number had dropped to about 46,700. During the same time,  defined-contribution plans grew to 662,800, from 207,700.

In the airline industry — which has been hammered by the coronavirus crisis and the resulting drop in demand — a flurry of air carriers recently began offering early retirement or other separation packages to employees in an effort to cut costs by reducing headcount. And some experts anticipate that trend will spill over to other pension-providing companies if they, too, struggle financially.

One tricky part of making a decision about how to receive your pension benefits is that retirees generally like the idea of guaranteed income for the rest of their life, experts said. This often makes choosing the continuing payments more appealing than a lump sum.

“People look at the risk we’ve seen in the financial markets this year and say ’I don’t want risk, I want steady payments,” said CFP Chris Chen, wealth strategist with Insight Financial Strategists in Waltham, Massachusetts. “But pension payments depend on the solvency of the sponsor.”

If you want to remain a plan participant, be sure you have confidence in the company’s ability to make those future payments. Although the federal Pension Benefit Guaranty Corporation, or PBGC, would step in if the company could not meet its obligations, it may pay only a certain portion of promised benefits.

“If a company goes bankrupt or can’t meet its obligations, the last-ditch coverage is the PBGC, and everyone knows it is stretched to its limits,” Beck said. 

The PBGC’s multi-employer insurance program, which covers the pensions of 10.8 million Americans, is expected to become insolvent during fiscal year 2025, according to the agency’s most recent annual report. (Multiemployer pensions are those that serve multiple companies.) 

Already, the agency oversees or pays monthly retirement benefits, up to legal limits, to about 1 million retirees whose plans ended or failed. There also are some pensions not covered, including state-run or locally-run plans.

Opting for a lump sum

If you’re eyeing a lump sum due to fear of your employer going under or otherwise struggling to meet its pension obligations, be aware that the amount offered is generally lower in comparison to the amount you are promised to get, over time, if you were to stay in the plan.

However, because interest rates are generally low, lump sum offers have been bigger than they’d be if rates were high. Basically, when interest rates go up, the guaranteed-income option is higher and the lump sums go down.

Also, if you choose to remain in the pension plan instead of taking the lump sum, keep in mind that the amount you’ll receive may be fixed for life — pensions typically don’t have a cost-of-living adjustment.

“The amount wouldn’t go down in nominal dollars, but it goes down in purchasing power,” Chen said.

Originally posted on CNBC


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