By Diane L. Young, President of The Athena Group.
General Motors has just joined Ford in offering retirees a lump sum option for their pension plan. What this means is that a retiree would give up that monthly check for a lump sum of cash that they would then manage themselves.
So, is this a good deal for retirees? It depends.
First, let’s look at how a pension plan works. Companies that offer pension plans are obligated to put assets aside for employees. When they subsequently retire, they get a monthly check for the rest of their lives. Basically, the company is buying an annuity for the retiree. Married individuals typically sign up for a joint benefit, which means they will receive a reduced monthly benefit upon retirement, but will also allow their spouses to continue receiving a benefits after they’ve passed on. Pensions end when the person (or surviving spouse) dies. If the retiree (and their spouse if there is one) dies before the fund principal is exhausted, the remaining money goes back into the pension assets that can be used to fund other retirees’ pensions.
This worked very well when the average worker only lived a few years into retirement and the stock market performed consistently. Now, however, we are seeing large numbers of people retiring and living longer, and investments often performing poorly. This has resulted in enormous pension liabilities for companies like Ford and GM.
So, why would anyone want to give up a monthly pension stream? First, they may recognize that they may not have an “average” life expectancy. Retirees that have a history of cancer, heart disease, or other illness that reduces their expected mortality may choose to take the lump sum now to allow them meet their immediate goals. Others may want to start a business and use this lump sum as the startup capital. Some may view this as an opportunity to pass this asset along to children. Uncertainly stemming from recent economic events also comes into play. Some retirees have told me they are worried about their company going bankrupt and the pension plan being taken over by the Pension Benefit Guarantee Corporation. If this were to happen, some benefits could be reduced significantly. Although I don’t think that is the plan here but after what happened during the Great Recession, we can never say never! You can see what the PBGC will cover by clicking this link.
In the case of GM, the remaining pension assets will be turned over to Prudential Insurance Company and will no longer be covered by PBGC. If something were to happen to Prudential, then insurance law would take over. So basically, there are no guarantees left for this pension plan. It comes down to how you want to manage risk. Very tricky.
In deciding whether or not to take a lump sum payment, one must also honestly assess his or her money management skills. If you have never managed a large sum of money or if you never seem to be able to save money, you may be better off getting a monthly check. It takes a lot of discipline to manage money proficiently.
There are also tax considerations for taking the lump sum and they need to be handled carefully. I urge anyone considering this option to seek professional advice. Making the wrong decision could cost a lot in unintended taxes and penalties.
So while buyout plans may be beneficial for the financial health of these companies, make sure it is the right step for your own financial well-being.
About the author:
Diane L. Young is the President of The Athena Group, a local financial services firm based in Rochester, Michigan. She has over twenty years experience serving individuals and businesses. Securities and advisory services offered through Royal Alliance Associates, member FINRA/SIPC. The Athena Group is not affiliated with Royal Alliance nor is it a broker/dealer or registered Investment advisor.
The Athena Group 822 N. Main Street Rochester MI 48307 248-453-5252