Pension dilemma: lump sum now, or income stream later?

Companies are tossing a pension plan hot potato into employees laps

By Carla Fried

May 30, 2014 @ 5:22 pm EST

If you're lucky enough to have a claim on the $3 trillion-plus sitting in old-fashioned corporate pension plans, your retirement planning may soon get more complicated.

Companies eager to “de-risk” their long-term pension obligations are expected to increasingly offer voluntary one-time lump sum payments to former employees as an alternative to a pension's stream of lifetime income. A Towers Watson survey reports that nearly six in 10 companies with a defined-benefit plan either have offered a lump sum payment or plan to offer one.

The game of pension hot potato between corporations and former employees is partly due to a phased-in rule change that became fully effective in 2012. It centers on the interest rate and investment return assumptions companies use to calculate their future pension liabilities. Pension bean counters can now calculate lump sum obligations using a corporate bond yield for the discount rate, rather than a 30-year Treasury rate. Using that higher corporate bond rate in the calculation reduces the amount of the lump sum. Prudential Retirement estimates that this tweak could reduce corporate lump sum payouts by 5-25% depending on the recipient's age.

Offloading pension liability means the company doesn't have to worry about payments stretching on and on as people live longer. In February, the Society of Actuaries floated a new set of longevity tables that, if adopted, will extend the industry's base life expectancy for 65-year-olds by 10% for men and 11% for women, which means both genders would have a life expectancy into the late 80s. And if former employees take the lump sum option, companies can sidestep rising annual premiums collected by the Pension Benefit Guaranty Corp. (PBGC). Today's $49 per person flat-rate fee for single-employer plans is up from $35 in 2012 and is scheduled to rise at least 30% to $64 by 2016. After that, the premium will be adjusted for inflation.

Defined-benefit plan participants offered a lump sum payout don't have to take it. For someone with multiple retirement income sources who won't be solely reliant on a pension, and who is skilled at managing money or has a good adviser, taking the lump sum can work well, especially for heirs. For those who will rely primarily on pension income in retirement, the Pension Rights Center, a non-profit consumer advocacy group, suggests turning down the lump sum.

“A huge infusion of cash looks so tempting, but then you've got the responsibility and the risk of managing that money to make sure it lasts a lifetime,” says Nancy Hwa of the center.

The better move for those people, if offered, is to stick with the company's annuity or an annuity from a third-party insurer that buys out your employer's pension liability. The center offers a fact sheet to help with the lump sum/annuity decision. The deal you get from a pooled annuity is likely to be far better than what you can get on your own. That's particularly true of women, since annuity providers price in women's longer life expectancies on individual policies.

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