Should you take a pension buyout?
A reader (age 62) recently asked me if he should take a lump-sum pension buyout from his retirement plan. He has two choices:
- Take a one-time, lump-sum payment of $78,000
- Immediately start a monthly payment of $460 that will last the rest of his life. If he dies first, his wife would then receive $230 per month for the rest of her life. (This is called a 50 percent joint and survivor annuity).
Thousands of workers are currently receiving such offers as many employers take steps to shed pension risk from their balance sheets.
Should he take the lump sum? The answer depends on a number of factors. Let's look at a checklist for both choices.
He might consider taking the lump sum if:
- he has other sources of lifetime retirement income that are adequate to cover his living expenses
- he has good uses for the payment other than generating retirement income, such as starting a business or paying off high-cost debt
- he has no other savings to access in case he has an emergency or a large unexpected expense
- he and his wife are in very poor health, and it's highly likely both will die before 20 years has passed
- he has the skills and expertise to invest and draw down his savings for the rest of his life.
He might consider taking the lifetime monthly payment if:
- he needs a regular retirement paycheck to help cover his living expenses for the rest of his life
- he or his wife are in average health or better, and it's likely that one of them will live for at least 20 years
- he has access to other savings in case he has an emergency or a large unexpected expense
- he isn't equipped to invest and manage a lump sum for the rest of his life, even when he's in his 80s or older.
If he's really focused on generating a lifetime retirement income, here's an important question: If he takes the lump sum payment of $78,000, can he generate a lifetime retirement income that's higher than $460 per month? One way to answer this question is to find out how much it would cost to buy a 50 percent joint and survivor annuity from an insurance company.
Please keep in mind that I'm not advocating that he buy such an annuity in this situation -- I'm merely using the cost of an annuity as a yardstick to measure whether the lump-sum payment offer is a good deal.
I priced this annuity with Income Solutions, a low-cost way to buy an annuity, and found that a policy paying $460 per month would cost between $93,000 and $96,000. That means he can't buy a lifetime monthly payment of $460 per month with $78,000. That amount could buy a 50 percent joint and survivor annuity providing only between $375 and $385 per month.
If he takes the $78,000 and asks a financial planner to generate a lifetime retirement income, many planners would recommend some variation of the 4 percent rule, which would generate an initial retirement income of about $260 per month (that's four percent of $78,000, divided by 12).
Some people might worry that they could lose their pension if their employer goes bankrupt. That shouldn't be a concern in this case. The Pension Benefit Guaranty Corp. (PBGC) is a federal agency that guarantees pensions from private employers in the event of bankruptcy, and it currently guarantees pensions up to $3,515 per month for a 62-year-old worker who elects a 50 percent joint and survivor annuity. My reader's benefit is well below the PBGC guaranty, so it would be fully covered.
So, my reader faces two choices. If he prefers having access to his money and is willing to pay the price of a smaller monthly retirement income, he would take the lump sum.
If he's really focused on maximizing his lifetime retirement income, the lifetime monthly payment is the better choice. In this case, all he has to do is turn down the offer of the lump-sum payment and allow his employer's retirement plan do what it's designed for: providing a secure, lifetime retirement paycheck.