If you are due a pension from a former employer, there is a good chance you were or soon will be offered a lump-sum payment in exchange for giving up that guaranteed monthly check for life.
Should you take it? Probably not, but making a smart decision depends on a complex set of assumptions about future interest rates, possible rates of market returns and your longevity. It is a tough analysis unless you have an actuarial background.
Unfortunately, employers are not providing enough information.
That is the conclusion of a recent review by the U.S. Government Accountability Office of 11 lump-sum-offer information packets provided to beneficiaries by pension plan sponsors.
The key failings included unclear comparisons of the lump sum’s value compared with the value of lifetime pension payouts. Also lacking were many of the explanations of mortality factors and interest rates used to calculate the lump sums.
Even more worrisome was missing information about the insurance guarantees that probably would be available to participants from the Pension Benefit Guarantee Corp in the event of a sponsor default.
That is a major problem because fear of pension failure is one of the biggest factors driving participants to accept lump-sum offers. Having PBGC insurance is like having your bank deposits guaranteed by the Federal Deposit Insurance Corp; if a plan fails, most workers receive 100% of the benefits they have earned up to that point.
The GAO did find that the packets were in compliance with the Internal Revenue Service rules on disclosures to employees. However, it urged the U.S. Department of Labor to tighten reporting requirements on lump-sum offers and to work with other federal agencies to clarify the guidance sponsors should be providing.
Better information certainly would be helpful to beneficiaries as the lump-sum trend continues to grow.
Private sector pension plans are trying to lower their risk that recipients will live longer and therefore collect more than the actuaries originally planned.
Twenty-two percent of sponsors say they are “very likely” to make lump-sum offers to former, vested workers this year, up from 14% in 2014, according to a study by Aon Hewitt, the employee benefit consulting firm.
But better information alone is not likely to lead to better decisions,” says Norman Stein, a law professor at Drexel University and an expert on pension law.
Beneficiaries often make up their minds based on emotional factors like fear of a pension plan default or the appeal of getting a large pile of cash up front, says Steve Vernon, an actuary and consulting research scholar at the Stanford Center on Longevity.
In most cases, beneficiaries will come out ahead by sticking with a monthly check from a pension, but you should evaluate the lump-sum offer against such factors as your likely life expectancy and other sources of guaranteed income (Social Security or a spouse’s pension).
Some beneficiaries accept lump sums expecting to get better returns by investing the proceeds. But an apples-to-apples comparison requires measuring the rate of return used to calculate your lump sum against risk-free investments like certificates of deposit or Treasuries. After all, most private-sector pensions are a guaranteed income source backed by the U.S. government.
You could also take the lump sum and buy an annuity, but these commercial products typically will generate 10% to 30% less income than your pension, Vernon says.
“A good measure of the lump sum offer is to calculate how much it would cost you to buy that annuity from an insurance company,” he says.
But Vernon has a more basic way to think about a lump-sum decision.
“Just the fact that employers call this ‘pension risk transfer’ should give you pause,” he says. “These big corporations want to transfer mortality and interest risk to you because they don’t want it.
“Ask yourself: ‘Why should I take something my employer doesn’t want?'”