By Brad Wright, CFP®
If you receive a letter from a former employer’s long-forgotten pension plan, offering to buy you out and send you a check, should you do it? As is typical with personal financial planning questions, the answer is “it depends.” Personal financial planning is exactly that, personal and variable, based on your situation and the current state of the former employer sending the letter.
Only about 10% of U.S. companies still offer any type of defined benefit (pension) plan. This type of plan is funded by the company and any benefit depends on salary, age, and number of years employed. In years past, it was common for our parents and grandparents to work for one company their entire careers. They would retire and begin to receive a monthly pension check for the rest of their lives.
Most companies have frozen their pension and shifted to an employee contribution plan, such as a 401(k) or 403(b). Organizations seek to get some of their pension liability off their books, so they can minimize funding the plan. Herein comes the offer letter to buy you out. Instead of waiting until retirement age to begin receiving monthly checks, they’ll send you the lump sum of what your future series of payments is worth today, according to their actuaries. This is the net present value of your account. A check for thousands of dollars now might seem like a decent offer but consider the following before making your decision to take that lump sum.
Reasons you may want to take the lump sum:
· Your Health: You have a terminal disease or another reason to think that you don’t have a long-time horizon to enjoy it.
· Health of the company: If the company doesn’t last, the pension funds may not either. The Pension Benefit Guaranty Corp (PBGC) would step in, but you may not receive your full amount.
· Other assets: You have plenty of other assets to provide a lifetime of income, or a spouse who does, and you would not be relying on this monthly check to survive.
· Relative size: It’s a small amount and wouldn’t amount to a significant check. This may be the case if you only worked for the company for a short amount of time.
Reasons you may want to defer taking the lump sum:
· Growth: Leaving the money where it is will allow it to continue to grow until you retire.
· Longevity risk: As people are living longer, more active lives, a monthly pension check could provide an income floor during retirement much like Social Security.
· Your fiscal habits: Would you spend it all? Twenty-one percent of people who cash out their pension spend the entire amount in just over five years, according to a 2017 MetLife survey. I know someone who has “blown through two pension lump sums already.”
· Taxes: Keep in mind that if you do take the offer and don’t roll the amount into a tax-deferred retirement account, the entire distribution will be subject to ordinary income tax in the year you receive it.
There are many large corporations making these buyout offers lately. There really is no general right or wrong answer on whether to take the offer. If you choose to take the lump sum, it’s important to remember that you can’t change your mind later. There is no going back if you run to Las Vegas and spend it all. Likewise if you wait and begin taking a monthly check – you won’t be able to go back and request a lump sum.
You may wish to seek out professional retirement and tax advice before making this decision. In doing so, it’s wise to search for a CERTIFIED FINANCIAL PLANNER™ professional (CFP®). A CFP® will act in a Fiduciary capacity and place your interests before his or hers and before the company they work for. You want to make sure you’re not being given advice to take the lump sum solely because someone thinks they can make money by suggesting that you use some of your pension to buy their product.
About the author: Brad Wright, CFP®
Brad Wright, CFP® is co-founder of Launch Financial Planning, LLC, a fee-only fiduciary firm located in Andover, MA. He is a frequent contributor to WCVB-TV and Mix 104-1 Radio. Brad is Chapter President of the Financial Planning Association of Massachusetts. Learn more about Brad at www.LaunchFP.com
The opinions penned here are for general information only and not intended to provide specific advice or recommendations for any individual.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. Any opinions are those of Brad Wright.