What to Do With Your Lump-Sum Pension Buyout

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Have you recently received a lump sum pension offer?

Being located in the automotive capital of the world, we are at ground zero for a trend that is quickly catching on throughout corporate America. The lump sum pension buyout.

According to a recent report from H.S. Dent Publishing, Since 1998, the number of Fortune 100 companies that offer pensions to new employees has dropped by half. The fact is, pensions are just getting too expensive for companies to maintain. Not only are people living longer, but the two major stock market crashes since 2000, has left many plans underfunded. Companies whose pensions are underfunded, will be required to add money to bring it up to minimum funding levels. More and more companies are realizing that managing their employees retirement money is expensive and risky. Pension payouts can be a large unknown variable. In an effort to clean up their balance sheets many companies are offering their employees and retirees an option to take a one time lump sum pension buyout.

If you've received an offer from your company to buyout your pension you really need to do your homework. What you decide could be the most important financial decision of your life.

To explain how a lump sum buyout works, let me first start off my giving you a real basic overview of how a pension plan works.

There are many factors that go into managing a pension plan. One of those factors is an assumed life expectancy. Let's say for example that your company assumes that the average person in their pension plan will live to age 82. All of their calculations and payouts will be based off of this assumption. So if your company did their homework right, and keep in mind they probably spend millions of dollars every year on this, then on average, across the board the average life expectancy should be very close to age 82, what they predicted.

Now what we know, is that not everyone is going to live to exactly age 82. Some people are going to die younger, and some will live longer. The people that die early, help to pay for the benefits of people that live longer. One of the key benefits that the pension provides, is a guaranteed income stream for the rest of your life, no matter how long you live. Even if you live to be 95 or older, you continue to get those checks.

Let's talk about your package.

When you receive your lump sum pension buyout offer you will essentially have a choice between continuing with your regular monthly pension checks or taking a one time lump sum check in lieu of all future payments from your company's pension plan. If you take this option, you will be done with the pension for good. The amount of your lump sum, is going to be based primarily on your age and the amount of your monthly pension check.

The biggest question you probably have right now is, if you take the lump sum check, how you are going to replace the regular stream of income you currently get from the pension. Will this money last me for the rest of my life?

Let's talk about some of the advantages and disadvantages of taking the pension option versus the lump sum option.

The primary advantage of staying with the pension is the regular monthly income that is guaranteed for the rest of your life, and that's a big one!

The disadvantage, is that you don't have any control of the money. If you die prematurely the pension keeps your money to help pay for someone that lives longer. Also, the pension does not have any cost of living increases. You're stuck with the same amount for the rest of your life.

The primary advantage of taking the lump sum is that you control the money. Everyone's situation will be different, but it may be possible to fully replace the income that you currently get now from the pension. Depending on how the money is invested, you may also be able to grow your portfolio, and even grow the income that you get, to help keep up with inflation. Because the money is in your own account, your beneficiaries will get any remaining balances left at the end of your life.

If you rely on your monthly pension check to cover your living expenses, taking the lump sum will require you to make up that income on your own. With the pension, your checks continue for as long as you live, no matter how long. Now you bear all of the longevity risk. You will also need to plan for and be aware of how market risk and uncertainty could affect your ability for the money to last you for the rest of your life.

This is a big decision, it may be one of the most important financial decisions you will ever make.