Needed: Better disclosures for pension cashouts
Are you eligible for a lump-sum pension cashout from your employer? Then you should be interested in the results of a recent report from the U.S. Government Accountability Office (GAO). The report's title, "Participants Need Better Information When Offered Lump Sums That Replace Their Lifetime Benefits," does a good job describing the GAO's conclusions.
If you're offered a lump-sum cashout of your pension benefit, you could benefit by studying the goals, implications and details of these offers. It may be one of the most important financial decisions you'll make regarding your retirement.
The basic advantage of a traditional defined-benefit pension plan is that your employer promises to pay you a monthly income for the rest of your life, no matter how long you live, and no matter what happens in investment markets. Employers are concluding that they don't want to bear the risk that you might live a long time, or that the stock market might crash in the future, so they want to transfer that risk to you through a pension buyout.
Lump-sum cashouts of lifetime monthly benefits for retired and terminated employees implemented by such employers as Ford Motor (F) and General Motors (GM) have become more prevalent in recent years. In pension lingo, this strategy is called "de-risking" or "pension risk transfer," meaning your employer is transferring the burden of managing your retirement benefits to you rather than managing them for you.
Do you really want to accept risks that your employer doesn't want? If you elect the lump-sum payment, you're betting that you can do a better job managing these risks than your employer can. In essence, accepting the buyout is a bet that you won't live longer than average or that you'll realize better-than-average returns by investing the money on your own. If you live longer than average or your retirement savings might be subject to stock market downturns, you might lose value by accepting a pension buyout.
For its study, the GAO reviewed the packets of informational material from 11 pension plan sponsors that recently offered lump-sum cashouts to retired and terminated employees, covering as many as 248,000 participants. The GAO concluded that while these packets typically complied with applicable pension regulatory requirements, they often fell short of delivering all the information a participant might need to make an informed decision regarding the value of the monthly pension check compared to the value of the lump-sum payment.
Pension buyout packages typically disclose the interest and mortality assumptions that go into the calculation of the lump-sum payment that's considered to be equivalent to the lifetime monthly income. If you get one of these informational packets, you'll see disclosures that say the actuaries are using something like the RP-2000 Mortality table, along with a string of interest rates used for various periods of your life.
Unless you're an actuary, this information might as well be describing the mathematics behind the theory of relativity or quantum mechanics. Most people simply don't understand the implications of the assumptions the plan sponsor uses to calculate the lump-sum payment.
The GAO identified situations where the cashout was less than market value of the pension, when that market value was estimated as the amount that an insurance company would charge to deliver an equivalent monthly pension. In addition, plan sponsors are allowed to ignore the value of certain ancillary benefits when calculating the lump-sum payment, such as early retirement or joint and survivor benefits that contain an employer subsidy.
The GAO report contains one example where the plan sponsor was allowed to pay a lump sum of $32,453 by assuming the participant would retire at age 65, but if the participant actually retired at age 60, the pension would be worth $54,301.
To assist you, the GAO report contains a list of eight key questions to ask when assessing a pension buyout. While this is certainly good advice, for a nonexpert the questions can be daunting, and pursuing the answers will take a determined and dedicated participant.
If you feel overwhelmed by the information, it's only natural that you might turn to a financial advisor for help with making this decision. If you do, be very careful who you hire. You can guess their answer if they want to invest your lump sum for you (and make money in the process). You'll want to make sure that any professional you hire isn't compensated depending on your investment decision and that they have the training in the special complexities of generating lifetime retirement income.
One reason some people accept the lump-sum payment is that they're worried their employer might go bankrupt and they'd lose their pension. To address this risk, the federal Pension Benefit Guaranty Corporation (PBGC) guarantees pensions sponsored by private businesses -- it's like the FDIC for pensions.
But only two of the 11 packets the GAO studied explained the role of the PBGC or provided information on the level of PBGC protections. This is one example of information the GAO would like to see provided to plan participants to help them make fully informed decisions.
If you're offered a pension buyout, carefully consider the pros and cons before taking the lump-sum payment. Calculate the market value of your annuity as measured by how much an insurance company would charge to pay your monthly benefit, or hire a skilled, unbiased advisor to help you with this analysis. Find out how much of your benefit the PBGC would guarantee.
The GAO report should serve as a warning to anybody who's offered a pension buyout. If you have any uncertainty regarding whether you should accept such an offer, your default decision should be to stick with the original intent of the plan, which is to pay you a monthly retirement income that lasts for the rest of your life, no matter how long you live.
You'll thank yourself when you reach your 80s, and that monthly check keeps getting deposited in your bank account automatically.
