Companies offer lump sum payouts for pensions to limit their long term liability. You may also have the ability to cash out your pension if your leave your job. If you remain in the pension, you will be paid for the rest of your (and perhaps also your beneficiary’s) life. If you accept a lump sum payment, the company buys out your future pension obligations in exchange for a large payment today.
If you receive a letter with an offer to buy out your pension, you are faced with a very important decision that once made, is irrevocable. It is tremendously important that you get help determining the impact that the decision will have on your retirement.
The recent rise in interest rates has led to a big increase in companies offering to buy out your pension with a lump sum payment. How do you know when an offer like this is once you should accept? Or, how do you know when you should keep your pension?
Pensions provide a safe, steady source of income for you for as long as you live. These can be great assets to have in retirement and should not be given up without considerable thought.
If the pension payment you would have would be absolutely vital for you to make ends meet in retirement, we would generally caution against taking an offer for a lump sum payment for your pension.
While it might be nice to look at a large lump sum payment, there are risks involved in investing and managing that money over time that should be considered. If you or your retirement plan does not have the ability to weather the periodic declines of the stock market, taking a buyout offer of your pension may be a poor decision.
It can make sense for some retirees to accept a lump sum payment for their pension. If you have a healthy amount of other fixed income in retirement, from Social Security, annuities, or other pensions. If you have sufficient sources of fixed income already, then the flexibility of having a lump sum payout and the potential for higher returns can be very beneficial for your retirement plan.
If you are willing to accept the ups and downs of the stock market. Taking a lump sum payment for your pension may provide you better inflation adjusted returns through your retirement. Remember, while a pension is a guaranteed payment, it likely does not adjust annually to inflation. Historically, a mix of stocks and bonds has returned a sum in excess of inflation and would allow you to adjust withdrawals up with inflation.
Ultimately you need to look at the amount of fixed income that you are comfortable with and that maximizes the success of your financial plan. If this pension is in excess of that amount, it may make sense to accept the lump sum payment.
Lastly, its important to understand your choices in accepting a lump sum payment and any subsequent tax consequences and potential penalties.
You have the option of taking this lump sum payout and rolling it into a traditional IRA. This results in no added tax liability for you right now, but it will be taxed whenever you withdrawal that money.
If you want to get the money outside of an IRA, there will be taxes that need to be paid. In general the amount will be taxed at your ordinary income tax rate. This may make sense depending on the size of your pension and if you have little to no other income. But for most, this is not a good idea.
You may also have the option in converting the proceeds into a Roth IRA. This results in taxes now, but the assets will grow tax free in a Roth for the rest of your life. This can be an incredibly beneficial strategy, but takes a lot of planning to ensure a Roth conversion strategy is right for you.
Since you have one chance to make the right decision – If you have an offer for a lump sum payment on your pension, its important to get help analyzing the impact of the choice on your financial plan. Please reach out and schedule a free meeting with us to see how we have helped other like yourself handle this decision.