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Pension buyouts: Who wins and who loses?

(MoneyWatch) Why are employers offering pension buyouts to former employees who have a vested right to a future pension? This is something many readers are asking about the buyout offers they've been receiving lately.

This post follows up my previous two posts that showed a pension buyout is unlikely to produce a higher retirement income, compared to simply waiting and receiving a monthly check from your pension plan. While the amount of retirement income is certainly a critical consideration when you're deciding whether to accept a lump-sum buyout, there are other important considerations as well. This post addresses these issues and wraps up my series of posts on pension buyouts.

Employers are offering pension buyouts as part of a "pension de-risking" strategy. This means that they're concerned about continued exposure to stock market volatility, and they'd also like to reduce their ongoing plan administration costs.

If your employer offers you a lump-sum cash-out, it's really placing two bets:

  • That the assets in the pension trust will perform worse than the assumptions the IRS allows your employer to use when calculating lump-sum payments. Currently, the effective interest rates used for this purpose are around 4 percent to 5 percent per year. So employers are betting that their pension assets will consistently earn less than these percentages in future years.

  • That you and your co-workers will live longer as a group than the average life expectancy. Cashing you out now reduces their exposure should you live a long time. This is an important point -- lump-sum cash-outs are based on average life expectancy.

If you accept your employer's lump-sum offer, then you're on the other side of these bets. In other words, you're betting that you can invest the proceeds and consistently earn more than 4 or 5 percent per year. To achieve these results, you'll need to take some risk in the stock market, since interest rates on bonds and CDs are currently below these levels. You're also betting that you'll die before your average life expectancy; for the general population, there's about a 50-50 chance a person of that happening.

If you decline the lump-sum offer, then you're betting that you won't be able to invest the lump sum and consistently earn more than 4 or 5 percent per year, and that you'll live beyond your average life expectancy.

Are there other considerations?

Yes. Some people would rather have access to their money immediately, and maximizing their retirement income isn't a top priority. For these people, it might be more important for them to be able to leave their lump-sum payment as a legacy to their children or charities, an option that isn't possible if they choose to receive a monthly income from the plan.

If I decline the offer, can my employer decide not to pay my monthly income?

Federal law requires that your former employer pay your monthly income according to the terms of the pension plan. It can't change its mind and decide not to pay you. If another company acquires your former employer, the same rules apply.

What if I decline the buyout and my employer later goes bankrupt or is acquired?

Pension plan assets are held in a trust that is protected from creditors. Federal law requires that these assets be used to pay plan participants the pension that is owed them.

If your pension plan's assets are insufficient to meet its obligations, then the Pension Benefit Guaranty Corporation (PBGC) will pay your benefit, subject to certain limits. The PBGC is a federal agency that guarantees private pensions. Corporate pension plan sponsors are required by federal law to participate in the PBGC's pension insurance program.

In 2012, the maximum monthly pension payable at age 65 that the PBGC guarantees is $4,653 for a single life annuity and $4,188 for a 50-percent, joint-and-survivor annuity. Lower limits apply to pensions payable at earlier retirement ages. If your monthly pension is below these limits, then you don't need to worry about the bankruptcy of your former employer.

Once again, if another company acquires your former employer, that company is required by federal law to adequately fund the pension plan of the company it purchased and participate in the PBGC program.

What happens if I decline the lump sum offer and die before my monthly income starts?

If you're married when you die, then federal law requires that a monthly retirement income be paid to your surviving spouse when you would have been eligible to start payments. If you're not married, then there's no legal requirement for a death benefit, and any death benefit would depend on the specific terms of your pension plan.

If you're single and are in poor health, this could be one reason to elect the pension buyout. But don't let the lack of a death benefit influence you too much; if there's a good chance you'll survive until your retirement age, then the amount of monthly income could still be the deciding factor.

I've prepared a longer article on my website that goes into more details on the pros and cons of a lump-sum payment from a pension plan, including a checklist of reasons when it makes sense to elect a lump sum or the monthly income.

If you're offered a lump-sum buyout, your election is one of the most important financial decisions you'll ever make. It's well worth your time and effort to learn as much as you can in order to make the best decision for your circumstances. Good luck!

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