Category Archives: Employee benefits

Pension buyouts: Who wins and who loses?

May 7, 2013 7:06 pmLeave a Comment

Why are employers offering pension buyouts to former employees who have a vested right to a future pension? This is something many readers are asking about the buyout offers they’ve been receiving lately.

This post follows up my previous two posts that showed a pension buyout is unlikely to produce a higher retirement income, compared to simply waiting and receiving a monthly check from your pension plan. While the amount of retirement income is certainly a critical consideration when you’re deciding whether to accept a lump-sum buyout, there are other important considerations as well. This post addresses these issues and wraps up my series of posts on pension buyouts.

Employers are offering pension buyouts as part of a “pension de-risking” strategy. This means that they’re concerned about continued exposure to stock market volatility, and they’d also like to reduce their ongoing plan administration costs.

If your employer offers you a lump-sum cash-out, it’s really placing two bets:

    • That the assets in the pension trust will perform worse than the assumptions the IRS allows your employer to use when calculating lump-sum payments. Currently, the effective interest rates used for this purpose are around 4 percent to 5 percent per year. So employers are betting that their pension assets will consistently earn less than these percentages in future years.
  • That you and your co-workers will live longer as a group than the average life expectancy. Cashing you out now reduces their exposure should you live a long time. This is an important point — lump-sum cash-outs are based on average life expectancy.

If you accept your employer’s lump-sum offer, then you’re on the other side of these bets. In other words, you’re betting that you can invest the proceeds and consistently earn more than 4 or 5 percent per year. To achieve these results, you’ll need to take some risk in the stock market, since interest rates on bonds and CDs are currently below these levels. You’re also betting that you’ll die before your average life expectancy; for the general population, there’s about a 50-50 chance a person of that happening.

If you decline the lump-sum offer, then you’re betting that you won’t be able to invest the lump sum and consistently earn more than 4 or 5 percent per year, and that you’ll live beyond your average life expectancy.

Are there other considerations?

Yes. Some people would rather have access to their money immediately, and maximizing their retirement income isn’t a top priority. For these people, it might be more important for them to be able to leave their lump-sum payment as a legacy to their children or charities, an option that isn’t possible if they choose to receive a monthly income from the plan.

If I decline the offer, can my employer decide not to pay my monthly income?

Federal law requires that your former employer pay your monthly income according to the terms of the pension plan. It can’t change its mind and decide not to pay you. If another company acquires your former employer, the same rules apply.

What if I decline the buyout and my employer later goes bankrupt or is acquired?

Pension plan assets are held in a trust that is protected from creditors. Federal law requires that these assets be used to pay plan participants the pension that is owed them.

If your pension plan’s assets are insufficient to meet its obligations, then the Pension Benefit Guaranty Corporation (PBGC) will pay your benefit, subject to certain limits. The PBGC is a federal agency that guarantees private pensions. Corporate pension plan sponsors are required by federal law to participate in the PBGC’s pension insurance program.

In 2012, the maximum monthly pension payable at age 65 that the PBGC guarantees is $4,653 for a single life annuity and $4,188 for a 50-percent, joint-and-survivor annuity. Lower limits apply to pensions payable at earlier retirement ages. If your monthly pension is below these limits, then you don’t need to worry about the bankruptcy of your former employer.

Once again, if another company acquires your former employer, that company is required by federal law to adequately fund the pension plan of the company it purchased and participate in the PBGC program.

What happens if I decline the lump sum offer and die before my monthly income starts?

If you’re married when you die, then federal law requires that a monthly retirement income be paid to your surviving spouse when you would have been eligible to start payments. If you’re not married, then there’s no legal requirement for a death benefit, and any death benefit would depend on the specific terms of your pension plan.

If you’re single and are in poor health, this could be one reason to elect the pension buyout. But don’t let the lack of a death benefit influence you too much; if there’s a good chance you’ll survive until your retirement age, then the amount of monthly income could still be the deciding factor.

I’ve prepared a longer article on my website that goes into more details on the pros and cons of a lump-sum payment from a pension plan, including a checklist of reasons when it makes sense to elect a lump sum or the monthly income.

If you’re offered a lump-sum buyout, your election is one of the most important financial decisions you’ll ever make. It’s well worth your time and effort to learn as much as you can in order to make the best decision for your circumstances. Good luck!

Steve Vernon

 

Steve Vernon is a featured writer on the CBS MoneyWatch Retirement blog, a Research Fellow at the California Institute of Finance, and a Featured Contributor here on the CIF Blog

Posted in Employee Benefits, Featured Contributors, Retirement Income, Retirement Planning, Steve Vernon

Should you accept a pension buyout?

May 7, 2013 10:03 amLeave a Comment

Should you accept a lump sum cash-out of your pension from a former employer? A number of readers have received such an offer and have asked me whether this is a good idea. If you have a sizable pension, this is one of the most important financial decisions you’ll make, so it pays to carefully consider the pros and cons.

One of our readers sent me his cash-out election kit to analyze (To protect his privacy, I’ll call him “Jim” and refer to his former employer as XYZ Company.) Let’s take a detailed look at Jim’s offer. If you have a similar pension buyout offer, our considerations and conclusions for Jim will likely also apply to you.

Most Americans don’t have sufficient financial resources for a traditional retirement of “not working” starting in their mid-60s. As a result, they’ll need to squeeze the most reliable lifetime retirement income from their existing resources. So let’s take a look at Jim’s cash-out pension offer to see how he can maximize his retirement income.

Jim is 51 years old and is married to Jo, who’s 49. Jim worked for many years at XYZ Company, but he’s since terminated his employment with XYZ and now works for another company; in pension lingo, Jim is a “vested termination.” Most buyout offers made today are for former employees with a vested pension benefit who haven’t yet started their retirement income. These buyouts typically aren’t offered to retirees who’ve already started their pension, although Ford and GM made headlines earlier this year by offering buyouts to current retirees.

XYZ Company gave Jim a choice of one of the following options:

  • He can keep his lifetime monthly pension of $1,870 per month, starting at age 65
  • He can elect a lump sum of $126,000 that will be paid to him immediately
  • He can immediately start a lifetime monthly pension of $656 per month

If Jim elects the monthly pension, then he can also elect a joint-and-survivor annuity that would continue monthly income to his wife Jo after Jim passes away.

Because Jim is currently working, it makes no sense to start his pension immediately, so we’ll dismiss that option from the get-go.

So here’s the real question: If Jim takes the lump sum, can he generate a lifetime monthly income at age 65 that’s bigger than $1,870 per month? As it turns out, after working through the numbers, I determined that it will be hard for Jim to do this. I estimated Jim’s retirement income if he had elected the lump sum cash-out and used three different options to generate retirement income:

  • Option #1: Invest his lump sum now, and buy an immediate annuity at age 65
  • Option #2: Buy a deferred lifetime annuity from an insurance company that starts at age 65
  • Option #3: Invest his lump sum, and use systematic withdrawals at age 65 under the “4 percent rule”

The graph below compares the estimated retirement income under these three options to the retirement income he’ll get if he simply waits and takes the monthly retirement income from the XYZ Company Pension Plan.

The graph shows that it would be very unlikely for Jim to be able to generate a monthly income from his lump-sum payment that’s greater than simply taking the monthly retirement income from the XYZ Pension Plan.

Why does the XYZ Pension Plan generate more income than the three options? The answer depends on the specific option.

The first two options involve buying an annuity from a commercial insurance company. The IRS allows employer-sponsored pension plans to use actuarial assumptions for determining lump sum cash-outs that are more favorable than the assumptions that insurance companies use to price their annuities. In addition, insurance companies need to build in margins for profit and administrative expenses, while employers operate their pension plans on a nonprofit basis.

With the third option — systematic withdrawals — the so-called “safe” withdrawal rate is purposely set conservatively so the retirement savings can withstand “worst-case” scenarios (for example, the retiree living well beyond average life expectancies or experiencing poor investment returns).

Stay tuned for my next post on this topic, which explains my calculations in more detail. A third post will discuss considerations other than the amount of retirement income, and answers some questions that individuals commonly ask about these buyout offers.

Steve Vernon

 

Steve Vernon is a featured writer on the CBS MoneyWatch Retirement blog, a Research Fellow at the California Institute of Finance, and a Featured Contributor here on the CIF Blog

Posted in Employee Benefits, Featured Contributors, Retirement Income, Retirement Planning, Steve Vernon

What if your pension runs out of money?

March 8, 2013 9:35 amLeave a Comment

The zero-interest-rate policy in the U.S. continues to wreak havoc on those saving for retirement.

Case in point: Many companies are pouring cash into their defined benefit pension plans because of the low interest rates, according to a report this week in The Wall Street Journal. According to the report, companies are required to calculate the present value of the future pension liabilities—how much they need to pay out to retirees—by using a so-called discount rate, which based on corporate bond yields. As those rates fall, the liabilities rise. And as those liabilities increase, companies make up the difference by pouring cash into their plans.

So what does this trend portend for workers at the firms that have traditional defined benefit plans? What should workers do at firms where this might be happening or could happen? And what might small employers who have defined benefit plans consider doing to avoid problems?

Prepare for the worst

Not surprisingly, some experts say there’s plenty to worry about, others say this trend is much ado about nothing, and still others say workers with a defined benefit plan—funded or not—should be thankful for what they have.

At one extreme is Ary Rosenbaum, an ERISA/retirement plan attorney for his firm, The Rosenbaum Law Firm. He says workers ought to prepare for the possibility that their employer will freeze their pension benefit or terminate the plan.

And if that should happen, consider, at a minimum, increasing the amount of money you contribute to other retirement accounts, such as an IRA or 401(k) to make up for what you might lose in pension payments.

Others, meanwhile, say that workers whose employers have a well-funded pension plan need not worry as much about their plans being frozen or terminated. “Workers at healthy firms shouldn’t worry, because the company stands behind the promise,” said Ron Surz, president of Target Date Solutions. “That said, I don’t think there are many defined benefit corporate plans left. Defined benefit plans are now mostly union and government plans.”

Companies are pouring cash into pension plans

Some of America’s biggest companies are shifting cash that could be used for development or expansion into pension funds as low interest rates designed to spur the economy push up pension liabilities.

And still others remind us that there’s not much a worker can do whether a plan is funded or underfunded. “First, workers have very little influence over the actual funding requirements of true pension plans,” said Christine Russell, a retirement strategist for Christine Russell Retirement Consulting. “The amount a company must fund is determined through complicated formulas calculated by actuaries.”

So what can employee today do if they are covered by a pension? “Thank their employer for continuing the pension plan,” she said. “Many companies no longer offer such plans, so an employee covered by a pension is a lucky person, indeed.”

What’s more, she said employees should let the human resources/employee benefit department know that they value this benefit. “Often, it can seem like this substantial and important benefit is ignored by employees,” she said.

By way of background, there are more than 27,500 private-sector defined benefit plans covering more than 44 million American workers, according to the Pension Benefit Guaranty Corporation.

You can learn more about how employers can terminate a pension plan or how to check if your plan is underfunded at General FAQs about PBGC.

To be fair, it’s possible that this trend where firms pour cash into defined benefit plans may not continue, or at least it won’t at some of the country’s largest companies.

The aggregate deficit in pension plans sponsored by S&P 1500 companies decreased by $74 billion to $482 billion as of the end of January 2013, according to report released this week by Mercer. What’s more, Mercer said in its release that the funded ratio (assets divided by liabilities) improved 3%, up from 74% to 77% during the month. This deficit compares to an aggregate pension deficit of $557 billion on Dec. 31, 2012 and is a slight improvement over the $484 billion deficit and funded ratio of 75% at the end of 2011, the company said.

According to Mercer, the improvement of the past month was driven by strong equity markets, which gained more than 5% in the period, and an increase in interest rates of about 15 to 20 basis points, which reduces liabilities, the company said.

Still, the company cautioned defined-benefit pension watchers: “Before sponsors celebrate too much, it is important to realize we have had numerous examples over the past few years of funded status improvements quickly being wiped out by adverse market movements,” Jonathan Barry, a partner in Mercer’s retirement business, said in a release. “In both 2011 and 2012 there were monthly improvements in funded status early in the year, only to experience market conditions that saw year-end funding levels below the start of the year.”

Russell noted, for instance, that while funding amounts today seem substantial, during good performing years companies are permitted to fund less. “The market performance of the pension investments reduces the amount of cash the company needs to contribute to the pension,” she said. “And there are even some years where the company may not have to fund the plan at all.”

In addition, even during the best of times, some companies didn’t fund all of the pension contribution required, Russell said. “When that lack of full contribution is followed by a few years of market underperformance the required contribution to the pension goes up substantially,” she said. “As we know, there is usually a cost to procrastination; this is true especially where pension contributions are concerned.”

So what’s a worker with a defined benefit plan to do? Keep a close eye on the funded status of your plan, consult with a qualified expert about the health of your defined benefit, prepare for the possibility of your employer freezing or dropping your defined benefit plan, consider—regardless of the funded status of your plan—upping the amount you contribute to other retirement plans such as a 401(k) or IRA.

Small employers may have to freeze plans too

Meanwhile, small employers should consider freezing their plans at one extreme or, if nothing else, investing the assets in the plan differently.

Rosenbaum, for instance, said small employers that have a defined benefit pension may need to consider freezing their plans if they still accrue a benefit or develop a plan to terminate the plan. He noted that employers can amortize their underfunding over a seven-year period.

Others, meanwhile, suggest that small employers ought to consider shutting down their defined benefit plan and establishing a 401(k) plan. “Small corporate employers who have not yet established a defined contribution may want to do so, and if they do, they should plan on providing serious employee education,” said Surz.

By contrast, Russell doesn’t think small employers should shut down their pension plans. But they should make every effort to diversify their pool of pension assets appropriately. “When performance of the investments is greatly reduced, the company has to make up for it in larger out-of-pocket pension contributions,” Russell said. Relying on just a few asset classes in the plan might cause the pension portfolio to be too closely correlated with the stock market.”

The pension portfolio is then subject, she said, to the stock market‘s lack of performance. “Using some asset classes uncorrelated to the stock market, to broaden diversification can help with this problem,” Russell said.

In addition, some small employers may want to talk to their actuary about changing their funding formula, Russell said. “There are restrictions on what can be done, so keeping in communication with the actuary and exploring all options is important, especially if the portfolio has not performing as expected,” she said.

In addition, Russell said small employers should review their pension portfolio performance regularly to catch a problem early, and possibly save them some out-of pocket pension contributions.

Retirement Expert: Robert Powell

 

Robert Powell is a featured writer on the MarketWatch Retirement blog, a Research Fellow at the California Institute of Finance, and  a Featured Contributor here on the CIF blog.

Posted in Employee Benefits, Featured Contributors, Retirement Planning, Robert PowellTagged

Pension buyouts: Who wins and who loses?

March 6, 2013 6:14 pmLeave a Comment

Why are employers offering pension buyouts to former employees who have a vested right to a future pension? This is something many readers are asking about the buyout offers they’ve been receiving lately.

This post follows up my previous two posts that showed a pension buyout is unlikely to produce a higher retirement income, compared to simply waiting and receiving a monthly check from your pension plan. While the amount of retirement income is certainly a critical consideration when you’re deciding whether to accept a lump-sum buyout, there are other important considerations as well. This post addresses these issues and wraps up my series of posts on pension buyouts.

Employers are offering pension buyouts as part of a “pension de-risking” strategy. This means that they’re concerned about continued exposure to stock market volatility, and they’d also like to reduce their ongoing plan administration costs.

If your employer offers you a lump-sum cash-out, it’s really placing two bets:

    • That the assets in the pension trust will perform worse than the assumptions the IRS allows your employer to use when calculating lump-sum payments. Currently, the effective interest rates used for this purpose are around 4 percent to 5 percent per year. So employers are betting that their pension assets will consistently earn less than these percentages in future years.

 

  • That you and your co-workers will live longer as a group than the average life expectancy. Cashing you out now reduces their exposure should you live a long time. This is an important point — lump-sum cash-outs are based on average life expectancy.

If you accept your employer’s lump-sum offer, then you’re on the other side of these bets. In other words, you’re betting that you can invest the proceeds and consistently earn more than 4 or 5 percent per year. To achieve these results, you’ll need to take some risk in the stock market, since interest rates on bonds and CDs are currently below these levels. You’re also betting that you’ll die before your average life expectancy; for the general population, there’s about a 50-50 chance a person of that happening.

If you decline the lump-sum offer, then you’re betting that you won’t be able to invest the lump sum and consistently earn more than 4 or 5 percent per year, and that you’ll live beyond your average life expectancy.

Are there other considerations?

Yes. Some people would rather have access to their money immediately, and maximizing their retirement income isn’t a top priority. For these people, it might be more important for them to be able to leave their lump-sum payment as a legacy to their children or charities, an option that isn’t possible if they choose to receive a monthly income from the plan.

If I decline the offer, can my employer decide not to pay my monthly income?

Federal law requires that your former employer pay your monthly income according to the terms of the pension plan. It can’t change its mind and decide not to pay you. If another company acquires your former employer, the same rules apply.

What if I decline the buyout and my employer later goes bankrupt or is acquired?

Pension plan assets are held in a trust that is protected from creditors. Federal law requires that these assets be used to pay plan participants the pension that is owed them.

If your pension plan’s assets are insufficient to meet its obligations, then the Pension Benefit Guaranty Corporation (PBGC) will pay your benefit, subject to certain limits. The PBGC is a federal agency that guarantees private pensions. Corporate pension plan sponsors are required by federal law to participate in the PBGC’s pension insurance program.

In 2012, the maximum monthly pension payable at age 65 that the PBGC guarantees is $4,653 for a single life annuity and $4,188 for a 50-percent, joint-and-survivor annuity. Lower limits apply to pensions payable at earlier retirement ages. If your monthly pension is below these limits, then you don’t need to worry about the bankruptcy of your former employer.

Once again, if another company acquires your former employer, that company is required by federal law to adequately fund the pension plan of the company it purchased and participate in the PBGC program.

What happens if I decline the lump sum offer and die before my monthly income starts?

If you’re married when you die, then federal law requires that a monthly retirement income be paid to your surviving spouse when you would have been eligible to start payments. If you’re not married, then there’s no legal requirement for a death benefit, and any death benefit would depend on the specific terms of your pension plan.

If you’re single and are in poor health, this could be one reason to elect the pension buyout. But don’t let the lack of a death benefit influence you too much; if there’s a good chance you’ll survive until your retirement age, then the amount of monthly income could still be the deciding factor.

I’ve prepared a longer article on my website that goes into more details on the pros and cons of a lump-sum payment from a pension plan, including a checklist of reasons when it makes sense to elect a lump sum or the monthly income.

If you’re offered a lump-sum buyout, your election is one of the most important financial decisions you’ll ever make. It’s well worth your time and effort to learn as much as you can in order to make the best decision for your circumstances. Good luck!

Steve Vernon

 

Steve Vernon is a featured writer on the CBS MoneyWatch Retirement blog, a Research Fellow at the California Institute of Finance, and a Featured Contributor here on the CIF Blog

Posted in Employee Benefits, Featured Contributors, Retirement Income, Steve VernonTagged

Should you accept a pension buyout?

March 5, 2013 7:27 pmLeave a Comment

Should you accept a lump sum cash-out of your pension from a former employer? A number of readers have received such an offer and have asked me whether this is a good idea. If you have a sizable pension, this is one of the most important financial decisions you’ll make, so it pays to carefully consider the pros and cons.

One of our readers sent me his cash-out election kit to analyze (To protect his privacy, I’ll call him “Jim” and refer to his former employer as XYZ Company.) Let’s take a detailed look at Jim’s offer. If you have a similar pension buyout offer, our considerations and conclusions for Jim will likely also apply to you.

Most Americans don’t have sufficient financial resources for a traditional retirement of “not working” starting in their mid-60s. As a result, they’ll need to squeeze the most reliable lifetime retirement income from their existing resources. So let’s take a look at Jim’s cash-out pension offer to see how he can maximize his retirement income.

Jim is 51 years old and is married to Jo, who’s 49. Jim worked for many years at XYZ Company, but he’s since terminated his employment with XYZ and now works for another company; in pension lingo, Jim is a “vested termination.” Most buyout offers made today are for former employees with a vested pension benefit who haven’t yet started their retirement income. These buyouts typically aren’t offered to retirees who’ve already started their pension, although Ford and GM made headlines earlier this year by offering buyouts to current retirees.

XYZ Company gave Jim a choice of one of the following options:

  • He can keep his lifetime monthly pension of $1,870 per month, starting at age 65
  • He can elect a lump sum of $126,000 that will be paid to him immediately
  • He can immediately start a lifetime monthly pension of $656 per month

If Jim elects the monthly pension, then he can also elect a joint-and-survivor annuity that would continue monthly income to his wife Jo after Jim passes away.

Because Jim is currently working, it makes no sense to start his pension immediately, so we’ll dismiss that option from the get-go.

So here’s the real question: If Jim takes the lump sum, can he generate a lifetime monthly income at age 65 that’s bigger than $1,870 per month? As it turns out, after working through the numbers, I determined that it will be hard for Jim to do this. I estimated Jim’s retirement income if he had elected the lump sum cash-out and used three different options to generate retirement income:

  • Option #1: Invest his lump sum now, and buy an immediate annuity at age 65
  • Option #2: Buy a deferred lifetime annuity from an insurance company that starts at age 65
  • Option #3: Invest his lump sum, and use systematic withdrawals at age 65 under the “4 percent rule”

The graph below compares the estimated retirement income under these three options to the retirement income he’ll get if he simply waits and takes the monthly retirement income from the XYZ Company Pension Plan.

The graph shows that it would be very unlikely for Jim to be able to generate a monthly income from his lump-sum payment that’s greater than simply taking the monthly retirement income from the XYZ Pension Plan.

Why does the XYZ Pension Plan generate more income than the three options? The answer depends on the specific option.

The first two options involve buying an annuity from a commercial insurance company. The IRS allows employer-sponsored pension plans to use actuarial assumptions for determining lump sum cash-outs that are more favorable than the assumptions that insurance companies use to price their annuities. In addition, insurance companies need to build in margins for profit and administrative expenses, while employers operate their pension plans on a nonprofit basis.

With the third option — systematic withdrawals — the so-called “safe” withdrawal rate is purposely set conservatively so the retirement savings can withstand “worst-case” scenarios (for example, the retiree living well beyond average life expectancies or experiencing poor investment returns).

Stay tuned for my next post on this topic, which explains my calculations in more detail. A third post will discuss considerations other than the amount of retirement income, and answers some questions that individuals commonly ask about these buyout offers.

Steve Vernon

 

Steve Vernon is a featured writer on the CBS MoneyWatch Retirement blog, a Research Fellow at the California Institute of Finance, and a Featured Contributor here on the CIF Blog

Posted in Annuities, Employee Benefits, Featured Contributors, Retirement Income, Steve VernonTagged