Many companies are moving away from pension plans and choose to offer a 401(k), 403(b), or other employee-funded retirement savings plan instead. If a company already offers a pension, leadership may choose to buy out pension plan participants.
What is a pension buyout?
A pension buyout is when a company offers the employee the opportunity to take the pension value as of a specified date. The buyout relieves the company of any further obligation of the pension in the future. The pension buyout will commonly be in the form of a lump sum payment or an annuity. In some cases, you can decline the buyout option as well.
Lump sum option
The lump sum option is an estimated value of your future pension payments. The lump sum is the entire value is a single, one-time payment. Once taken, there are multiple ways to manage the money.
- Take the lump sum in cash. A lump sum in cash will be treated as ordinary income and taxed the year it is taken. If you are also under the retirement age of 59½, there is an additional penalty tax of 10%.
- Another option is to roll the lump sum into a qualified retirement account such as an IRA. Consider different strategies of different retirement account types, such as the difference between a traditional and a Roth IRA.
- Consider the risk of a lumpsum carefully since you will be responsible for managing and protecting your money. This can magnify your exposure to risks such as outliving your money due to spending it too quickly, poor stock market performance, bad investment advice, and fraud.
Annuity option
An annuity option is when an insurance company takes over the pension plan payments. Annuities provide a steady payment amount each month.
- Consider an annuity carefully and ensure there is a joint and survivor payout option to take care of your beneficiary.
- Also, consider if you and your beneficiary have a high probability of living long enough to get back what you have earned. An example is considering whether you and your beneficiary are in good health and have a family history of longevity.
Decline the buyout option
Sometimes there is the option to decline all or a portion of the pension buyout. This choice also comes with some specific risks.
- Ensure you are fully vested in your pension. If not fully vested, you could risk losing some or all of your pension funds if you are terminated or resign. Sometimes termination or resignation can still affect fully vested pensions. Review all your documentation.
- While most pensions are insured, there are limits to the insurance. The plan could still be at risk of underfunding, bankruptcy, and legal exemptions. While there are laws to protect participants from these, some laws protect better than others.
- Employers can update the plan. Always review disclosures.
Other considerations
When it comes to retirement planning, we all need to choose what type of and how much risk we are willing and able to manage. Review all the documentation and consider talking with financial advisors about each option. Consider your unique circumstances and what will work best for you.
Ensure there are no clerical errors in the paperwork by reviewing all the factors determining your unique payment amount. Review your age, how many years you have worked, your earnings history, and the terms of each plan. Below are additional questions that may help you decide whether taking a lump sum, annuity, or declining the buyout is best for you.
- Will you risk running out of money?
- How do your investment skills align with the option? An example is if choosing a lump sum, do you have the investing skills to manage a lump sum of money yourself? If not, do you understand the different types of financial advisors and know how to choose a cost-effective, qualified, and trusted advisor for your financial situation?
- How will your money be protected? Don’t be pressured to act before reading through all of the documentation. Get multiple opinions and understand your choices.
- What are the tax implications? How will each option affect your taxes now and in retirement?
- What are the fees? Are there additional hidden fees?
- How can inflation impact the option?
- How can market fluctuations impact the option?