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Pension Buy-Outs Put Retirement Incomes at Risk

On the back of a recent pick up in performance in auto sales, auto makers are smartly looking to buy out workers’ pensions. Why is this smart? Let’s recap.

Pension obligations have grown far larger than most companies could afford with their cash flow. These companies, therefore, have relied upon market performance to make up for pension contributions. Unfortunately, stock markets haven’t complied with this plan over the past 10 years. At least the bull market in bonds has kept it from being a complete bloodbath. However, that run is coming to an end and due to central bank manipulation, we risk entering a period of deflating stock prices and bond prices.

In order to reduce the risk of pensions “blowing up” completely, some companies like GM and Ford have decided to try to buy out pensioners by giving them a one time lump sum instead of lifetime payments. This may seem like a bit of a lottery to some retirees receiving the offer though I assume many retirees will be a bit more wary.

You Should Be Wary

The lump sum (which typically gets rolled over to a “rollover IRA)”) can seem like a big chunk of money. And it can be a second chance to those who previously chose a “life only” pension option, to be able to leave something to a beneficiary. However, can retirees assure that they will get as generous a payout on their own as they would have received from the company? Also, a small but sizable minority has to ask themselves the question  – do they trust themselves with the cash? I have worked with a few people over the years who were better off with a pension or annuity payments because I know they would’ve blown any cash that they would have received.

The Company Pension Isn’t Always the Safest Place Either

Those who receive a monthly benefit that is higher than the PBGC guarantee amount do need to be wary of the financial strength of their pension provider. If a company defaults on their pension and the PBGC takes over, pension benefits are capped at the PBGC guarantee amount. Over the years, high pension earners like airline pilots have discovered just what that means. I have met with people who were in their sixties and their pension benefit was more than 10% of their buyout amount – an amazingly high yield in today’s interest rate environment with people living as long as they do. It makes me wonder just how safe that pension is.

If You Decide to Take the Cash

If you do decide to take the payout, what can you do? Some people might choose to shop for an annuity and take monthly checks. Some people might decide to invest the pension rollover in stocks and bonds and manage it just like a large pension. Some might just leave it in the bank and spend down principal. However, we won’t discuss those of you that choose to throw a big party with the cash! With that said, some points to consider:

  • If you choose an annuity, consider diversifying annuity companies, especially for amounts over $100,000 as many states’ insurance guarantee programs limit protection to $100,000
  • Also if you consider an annuity study the financial strength of the firm and try to mix mutual companies into your research as they don’t have the profit pressures that public insurance companies face
  • If you choose to invest yourself, you have effectively chosen to do just what your company pension is doing without the guarantee offered by the pension (pension shortfalls have to be made up by company cash flow, your potential portfolio losses do not).
  • Spending down principal might be ok if you’re over age 85 but you have to be very careful about factoring in inflation and living a long time.

Deciding

There are no easy choices here. Analyzing all options, on a spreadsheet where it’s laid out in unemotional terms is your best bet. If it helps, work with an advisor. Experienced advisors can analyze

Riding off into the sunset

the financial solvency of your company’s pension plan. They can also compare that to annuities and can analyze the financial strength of annuity companies. Furthermore, if you decide to manage the pension in stocks and bonds, an advisor can construct a portfolio with risk characteristics to match your wishes.  If you’d like to talk to someone, give our office a call. I’ll chat with you personally and answer your questions. Or if you like, send an online message to us  – click our Contact Page with all of our contact information. Thanks for reading.

Note: none of this is meant to be advice, and it certainly isn’t personalized to each reader (I don’t know you so I can’t advise you yet). Be careful about taking this information and making any rash decisions. Consult an advisor if you’re not sure about what you want to do, and consider having an advisor second check your idea if you are sure.

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