Strategies to consider in the event of a pension freeze or buyout.
Determine if your current or previous employer offers a pension benefit
Consider all factors and options before electing to accept lump-sum buyout
Make regular retirement contributions to reduce dependence on pension benefit
Unlike 401(k) plans, employees do not contribute directly to pension plans but receive a guaranteed income payment for life after meeting various eligibility requirements.
Sounds like a pretty sweet deal for an employee, which is why you rarely see a pension plan listed as a current employee benefit.
Pension plans are very expensive and risky for employers. Not only are employers responsible for making all contributions to the plan, but they are also on the hook for paying the benefits even when the investments do not generate the returns needed to meet the monthly benefit obligation.
Because of the mounting costs and liabilities many businesses face with their pension plans, it is very common for employers to freeze their plans and/or offer employees a buyout.
Know the difference - Freeze vs. Buyout
When an employer decides to freeze its pension plan, any benefit that the employee has accrued is locked or "frozen." While employees are entitled to any benefit that has accrued up to that point, that benefit will no longer grow, so the pension payment will remain the same for the remainder of an employee's life.
In some cases, employers will offer to initiate or increase a 401(k) match to help bridge the gap. If your pension plan is frozen, then you should request an updated benefit estimate to determine what your pension benefit will be and how much you may need to increase your personal retirement savings.
In the case of a buyout, employers offer a lump-sum payment in lieu of the ongoing pension benefit. Pension plans are expensive to operate and are often underfunded so it is very common to see buyout offers because they provide a quick way to reduce the employer's liabilities.
While the buyout amount may be eye-catching and tempting, remember that it is an option, not an obligation. If the plan is well-funded and/or insured against insolvency, then your pension benefit offers guaranteed payments for life. And the guaranteed payments may be more beneficial to you than the lump-sum payment. However, if the plan is underfunded and experiencing challenges, then taking the buyout rather than risking your benefit altogether might not be a bad idea.
Common ways to manage your pension buyout
Annuities are an insured investment option for a pension buyout, and one people seem to consider first, but be careful when going down this path. Yes, annuity contracts can offer tax-deferred savings and lifetime income, but they are a huge commission product for salespeople, carry very high ongoing fees, and can be very complex because there are many kinds. Keep in mind that your employer just offered you this lump-sum payment to get itself out of something very similar to what you're about to get in to.
If you are comfortable with and have the time to perform investment research and manage your investment portfolio, then a DIY portfolio is an option. Because your lump-sum payment is made up of pre-tax dollars, you'll want to initiate a direct Rollover to your IRA provider to make sure that the distribution is not taxed as ordinary income. From there, you will have full control over how every dollar gets invested going forward and benefit from tax-deferred growth.
Managing a portfolio is a full-time job, so if the DIY route feels like more than you want to take on, then invest a little time and interview a few advisors. A trusted advisor can help you develop and evolve a personalized strategy to optimize your benefit. Take the time to interview several advisors to learn about their approach, fees, and business model in order to determine who will be the right fit for you.
More and more companies are trying to reduce their pension obligations, so keep in touch or check-in with old employers to see whether you left behind a pension benefit. If you receive a lump-sum buyout offer, then take the time to evaluate your options and consider your income needs, longevity, wealth transfer plans, and other factors to make the best decision for your circumstances.
Even if you're not facing a freeze or buyout with your pension plan, we highly recommend contributing to your 401(k) or similar employer plan. By doing that, you're not completely relying on your pension benefit to support your financial security, and you'll be taking advantage of any free money your employer is offering by way of a match contribution.
Not sure which pension option is best for you? Schedule a free consultation.
Need to see if you're on track for your retirement needs? Try our planning tools.
Do you know how your pension benefit will impact your tax return? Let's run a projection.
Frank Iozzo, CPWA®
President, Private Wealth Advisor