Wednesday, June 13, 2012
Should You Take a Lump-Sum Pension Payment?
by Emily Brandon
Thousands of General Motors and Ford retirees must soon decide whether to take their pensions as a single lump-sum payment and manage the money themselves or continue with monthly payments for life.
General Motors recently announced that it will end one of its pension plans. The company will offer 42,000 retirees currently receiving monthly pension payments the option to instead receive a single lump-sum payment. Those who don't take the pension buyout will have the option to continue with their current monthly benefit as an annuity paid out by The Prudential Insurance Company of America or select other annuity products from Prudential. These pension changes are expected to save General Motors $26 billion.
Ford announced in April that it will offer 90,000 retirees the option to receive a voluntary lump-sum pension payment instead of monthly payments. An Aon Hewitt survey of more than 500 human resources professionals in October 2011 found that 35 percent plan to offer lump sums to vested pension participants in 2012, and 19 percent say they are likely to add or liberalize a lump-sum option. However, only 6 percent of the companies surveyed plan to transfer pension plan assets and liabilities to another party to reduce risk exposure, as GM plans to. Chrysler representatives say the company has no plans to offer pension buyouts.
Retirees at GM and Ford must decide whether they want to manage their own retirement money or continue to receive steady monthly payments. "It's really giving an additional choice to existing retirees before the plan is terminated and goes to Prudential," says Preston Crabill, director of GM strategic benefit planning. Here's how to decide whether to take a lump-sum pension buyout:
The value of your lump sum. Exactly how your lump sum is calculated plays a big role in whether or not you should take it. Once you get your lump-sum offer, compare it to how much your monthly payments would be worth over a 30- or 40-year retirement or your estimated life expectancy. For example, if your pension payment is $1,500 per month and you receive that over 30 years, you will be paid $540,000, and that's not even counting the interest you will get if you save or invest a portion of each payment. If the lump sum you are offered and the interest you think it will generate is less than you expect your pension payments to be worth over your lifetime, it would be in your best financial interest to pass. Also consider whether the pension is payable to your spouse upon your death and the tax rate you would pay on your pension payments compared with investments you would buy with a lump sum.
Consider your health. If you have significant health problems or other reasons to believe that you won't live a long life, it makes sense to take the lump sum. "If you have poor health, you will be better off taking the lump sum," says Leon LaBrecque, a Troy, Mich.-based certified financial planner and managing partner of LJPR who works with many GM retirees. "If you are going to live a lot longer, you are going to be way better off taking the annuity."
Your investment skills. When you're in a pension or annuity fund, an investment professional makes long-term investment decisions for you. You get the same payment whether the stock market soars or tanks. Lump-sum payments give you an opportunity to invest the money yourself. You'll get to keep all your investment gains, but you could be forced to cut your standard of living if you suffer losses. "Lump sums have vastly more flexibility than annuities. You can take the lump sum, park it in an IRA, invest it, and then you have control over your income," says LaBrecque. "If you're savvy with investments and have the ability and expertise, you can probably make more money over the long haul investing it for yourself."
Your risk tolerance. If you are very conservative or uncomfortable with making investment decisions, an annuity is likely to provide more safety. "The pension is definitely a surer thing," says Christine Isham, a certified financial planner and president of Northern Financial Advisors in Franklin, Mich., who has some GM clients. "If you invest the lump sum, you still have the risk of the investments losing value. With the insurance company, you have a guarantee."
Government protections. Most private-sector traditional pension plans are insured by the Pension Benefit Guaranty Corporation, a government agency that will pay out benefits up to certain annual limits if the plan fails. However, GM retirees who select any of the Prudential annuity options will lose their PBGC protections. Private annuities are instead backed by State Guaranty Funds, which provide limited protections when insurance companies fail to pay out promised benefits. Check with your State Guaranty Association to see how much of your annuity will be replaced if the insurance company goes bankrupt.
Factor in inflation. Many pensions and annuities pay out the same amount every year and don't increase payouts to keep up with inflation. "You will have the opportunity to protect yourself against inflation if you take the lump sum," says LaBrecque. You could invest part of your lump sum in something guaranteed to keep up with inflation such as Treasury Inflation-Protected Securities or in asset classes that have historically kept pace with inflation such as stocks, commodities, or real estate.
Evaluate your spending habits. If you select the lump-sum option, you need to develop a spending plan that will make this one-time payment last the rest of your life--however long that is. Pensions and annuities can help prevent you from spending down your savings too quickly because you get a limited payment each month. They also ensure that you will still have money coming in if you end up living longer than expected. Richard Getman, a GM retiree and certified financial planner for Getman Financial Planning in Mount Pleasant, S.C., wasn't offered the lump-sum payment and isn't interested in one. "If I were offered a lump sum, I would pass it by," he says. "For me, a guaranteed monthly payment is easier and less stressful than trying to squeeze out a return to make the lump sum last a lifetime."
Don't miss the deadline. GM retirees have until July 20, 2012, to make their future payment decisions. "Get a second opinion and don't make a hasty decision," says LaBrecque. "Doing nothing will keep you where you are. If in doubt, stick with your annuity."
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