Should you take your firm’s “Lump Sum” Pension Offer?

By: Kevin Dombrowksi

As previously published in the Delaware Business Times

November 30, 2017

As companies continue to move away from Defined Benefit pension plans to Defined Contribution plans, many active and retired employees are faced with decisions to take a lump sum payment today or to hold out for the promised periodic pension payment at some defined date in the future.  We have seen this happen countless times nationally as well as locally with DuPont and other companies in the area.  If you are faced with this choice, how can you make an educated decision?  Here are a few quick steps to help guide you.

Do the math.  When you are offered a lump sum payment, you can run the analysis quickly and compare the variables.  For example, if you are 50 years old and are offered a lump sum offer of $300,000 today or a monthly pension of $1,000 when you turn 65, you can quickly evaluate the present value of each.  Factoring in an estimate of inflation and a hypothetical expected rate of return on your investment –  which can vary quite a bit depending on the level of risk you are willing to take – you can compare the future potential value of the lump sum with the future periodic payments to see how the values stack up, given your time horizon and the number of anticipated years in retirement.  There are many online calculators that help you with present and future value calculations with the various configurable inputs.

When the dollars do not tell you everything.  There are many other variables to look at when making this decision, such as: Do you have other sources of retirement income or will this be your primary source?  Is there a cash flow need that cannot be met otherwise and will result in taking out a loan with interest?

Examine in the Tax Consequences.  If you take a lump sum payment, you should consider rolling over assets into a qualified investment such as an Individual Retirement Account (IRA) to postpone taxes and potentially avoid penalties.  If you do not roll these assets into a qualified investment you will be subject to regular federal income taxes on the entire amount.  Additionally, if you are younger than 59 ½ when you take the offer, you may also owe a 10% penalty to the IRS if you do not roll over the assets into a qualified investment.  One added advantage of the lump sum payment is the potential to convert the resulting IRA account to a Roth IRA account at an opportune time which may be a helpful retirement planning strategy since a Roth IRA does not have required minimum distributions during the owner’s lifetime. Tax laws and regulations are always subject to change, so know the rules and how they impact your particular situation.

Factor in the incentives.  Remember, most firms are offering this to reduce future pension obligations and to unload debt off their balance sheet.  Thus, they build the choice out in a way to entice some employees to take the lump sum payment today.  When things look too good to be true, take a step back and re-evaluate.

Consider the Risks.  When you take a lump sum, many invest the cash into the market so that inflation doesn’t erode the value of the account over time.  When you do this, you need to factor in the stock market risk as well as other types of investment related risks. If you do not take the lump sum, you may need to factor in the risks that the company will freeze their pension benefits or terminate the plan in the future.  There is no guarantee that what you are promised today will be there in the future and this risk needs to be considered when making your decision.

In the end, there is no perfect answer to this question. To adequately decide, you should consider the present value of your pension, your age and life expectancy, your risk tolerance, any tax consequences, and your retirement income needs and goals. You should consider consulting with a trusted financial and/or tax professional to help you run the numbers and consider all options side by side.


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