More companies are seeking to end their pension liabilities by extinguishing them with a buyout payment to those who were going to receive pension payments. Pension costs are rising which is spurring companies to get out of pensions. Two main costs are increasing: mandatory federal insurance on pensions and mandatory return assumptions are falling. When you receive a buyout offer from an employer, how do you decide what to do?
I recommend going through these five considerations for any buyout, each of which will tip toward or against accepting their offer.
- Are they offering you a good deal?
For example, if they are offering you $40,000 for your $350 monthly pension, you must evaluate if their offer is an appropriately high enough to replace it with an annuity. You do this by contacting a few insurance agents and ask how much it would cost you to purchase an annuity of $X, starting in X years (when the pension payments would begin). You will receive price quotes from the insurance companies but these are most likely to be higher than your employer’s offer. But how much lower is your employer’s offer, is the discount 5% or less (Ok, not too bad) or is the discount greater than 10-15% (a financially bad deal). You could also ask the agents to arrive at a comparison by going the other way, starting with your employer’s offer and then determining what their annuity payment would be.
- Is money in my hands a bad location for money?
Once you receive your payout, are you more likely to spend it all now or prudently buy an annuity that replaces it? If you might be tempted to spend it or invest it poorly, I recommend that you reject the buyout and keep the money out of your hands.
- How financially stable is my employer?
Has your company been around for 125 years or just 3 years? If your employer is not financially stable and may likely run into financial trouble in the future, your pension plan may be taken over by the federal pension system. If this occurs, you will likely face a reduction in benefits, sometimes it is a very severe reduction in your pension payments. If your employer is not long lasting or stable up to this point, I’d be far more likely to take any buyout offer to maximize the pension benefit before it shrinks. (A relative had his pension taken over by the federal government – they cut the payments in half and delayed the retirement date that he could start receiving it by an extra 5 years).
- Does your pension offer extra benefits?
For example, your employer’s pension may allow for early retirement or spousal benefits that make your employer’s pension far more valuable than a regular annuity. This makes a comparison more difficult but the more benefits your pension offers, the better it is to keep it.
- Taxes and penalties
When you receive a lump sum, you must immediately place it into an IRS qualified retirement account, such as a Roth IRA. If you do not, you’ll face a 10% penalty and ordinary federal and state income taxes on the entire amount. Are you prepared to move this money to an appropriate location before you receive it or will the payout be vaporized by taxes and penalties?
In general, it is my opinion that your money in someone else’s hands is always a highly risky location and should be avoided. So I would be inclined to accept the buyout payment unless some of these five considerations excessively tilted more toward leaving the pension money with my employer.