A pension roll-out lump sum should only be taken after the most deliberate study of the figures.
I’ve been getting a few inquiries lately about whether or not clients should take the lump sum pension roll-out benefit option from their employer pension. Before I get into analyzing that decision, let’s review how the offer comes along. We’ll use the most recent examples to come across my desk for purposes of this discussion. The people and companies involved will remain nameless.
Options Given When Presented with the Pension Roll-Out Lump Sum Choice
3 Options were offered:
1. Do nothing and keep current pension benefit
2. Roll out a lump sum
3. Roll out to a private annuity paying the same monthly benefit
Each option has it pros and cons and those depend on the size of the pension, the financial acumen of the participant, risk tolerance, and financial strength of the company running the pension. Also the financial strength of the annuity company (option 3) is very important.
1. Do Nothing – i.e. do not do a Pension Roll-Out
This means nothing will change. if you do nothing, you will get the pension declared. oftentimes, to select this option, you literally do “nothing” as the default activity is to keep things as is.
2. Pension Roll-out or rollover to a lump sum
This means that a designated lump sum of money can be rolled over to a retiree’s IRA account or even cashed out and taxed fully, whatever the retiree prefers. The benefits to this choice are – more control, and more safety in certain ways (see discussion below on PBGC) but also more risk. In this choice the retiree can access principal and spend as much or as little as he wants. Also, if the retiree is younger, taxes can be delayed if rolled to an IRA until required minimum distributions are due at age 70 1/2.
3. Pension Roll out to a pre-arranged annuity
Because this option was an annuity payment that exactly matched the “do nothing” pension payment, I can see only one (possibly large) advantage: need for more of a guarantee, especially on larger benefits. See discussion below for more on this. Effectively, the company offering the pension has contracted with a private insurer to issue an annuity (possibly a group annuity?) to the individual. Though this does not change the monthly benefit, the pension risk is off the books of the company offering the pension and is now the obligation of the insurance company.
Discussion and Analysis of Lump Sum vs Pension Payments
For many people under age 75, doing nothing (i.e. keeping current benefit) will fit the bill. Here’s why – unless you expect to die soon, the payouts on some pensions would be difficult to duplicate in the private market. Also, if you were to roll the money out and do it yourself, you could lose the PBGC guarantee and could possibly lose the full ERISA protection (that is if your pension is guaranteed by PBGC – see Table HERE for guarantee amounts). If you choose the annuity option, you also lose the PBGC guarantee and settle for an insurance company guarantee. The insurance company may have a lot of assets to back the pension, but the Federal government can print money so I’d side with the PBGC guarantee if you asked me what I’d do.
Why Are Companies Offering Lump Sum Distributions?
I can understand why a company would want to offer the annuity option – it gets that pension liability OFF THEIR BOOKS. And if you worked for a shaky company with no PBGC guarantee, you may want to consider it. You also may want to consider rolling over the lump sum but again, with pension payouts equating an 8-9% yield on the expected roll out sum on the last two clients that asked me to analyze this, it’s hard to justify rolling out. And both of these clients were age 64. I can not get an annuity on the private market that would pay 8-9% yield on the lump sum for life (at least not the companies I analyzed).
Are There Positives to a Pension Roll-Out?
Rolling out does have some pros in terms of control and freedom with the money. And if you are flush with cash, perhaps it could work for you. Also, if you are under age 70 1/2 and don’t need the money, you can hold off taxes until RMD (required minimum distribution) rules kick in. There is also the really neat opportunity, if it makes sense, to convert pension funds to a Roth IRA after rolling to a traditional IRA.
However, the other issue that arises with many folks is that something comes up that makes them do something silly with the cash. At least with the pension, if you mess up one month, another check is coming next month. Not so if one rolls out the cash and spends it. So for people with fewer assets, and for whom the pension is a major asset, getting that guarantee can be often very important.
Your Lump Sum Pension Roll-Out Due Diligence Points
So if you are confronted with the option of pension roll out, make sure you (among other things):
- Determine if your company participates in PBGC
- Determine the “yield’ of the pension -i.e. what is the monthly benefit x 12 months as a percentage of the lump sum rollout
- What is your overall financial picture?
- What other extraneous factors exist?
- Take the offer to an advisor to analyze on a spreadsheet for peace of mind (an advisor like us!)
Of course this is by no means an exhaustive list. But nonetheless, serious due diligence should be performed on this decision. if you have any questions, call our office (888.278.9433 x5) or drop us an email.
For further research, ask for our Top 5 IRA Tax Law Changes of 2016 when you contact us. It’s almost ready for publishing. In the meantime, download our 2014 version which I think highlighted some amazing tax benefits for higher income people. Request that HERE and we will send you the 2016 version as soon as it’ finalized.
Interesting read: Pension Advocacy Group Calls for halt to Pension Rollouts