Lump-sum pension buyouts are a good deal for employers. But workers who take them could lose out if interest rates rise.
If you work for a company with a pension plan, don’t be surprised if you get an offer soon for a lump sum buyout—a deal where you accept a pile of cash in exchange for the promise of lifetime income when you retire.
The price tag for these offers is especially attractive right now, from the plan sponsor’s perspective. But workers might do better by holding out for a better deal, or by rejecting the buyout altogether.
A growing number of plan sponsors are trying to get out of the pension business, or lighten their obligations, by buying out workers. The number of buyout offers has accelerated in recent years, in part because of interest rate changes mandated by Congress that reduce their cost to plan sponsors.
Now, revised projections for average American longevity are giving plan sponsors new reasons to accelerate buyout offers. New Internal Revenue Service actuarial tables that take effect in 2016 show average lifespans up by about four years each for men, to an average of 86.6 years, and women, to 88.8 years.
The new mortality tables will make lump sum offers 3% to 8% more expensive for sponsors, according to a recent analysis by Wilshire Consulting, which advises pension plan sponsors. Another implicit message here is that lump sum offers should be more valuable to workers who take them after the new mortality tables take effect.
Unfortunately, it’s not that simple.
“We’re definitely seeing an increase in lump sum offers from plan sponsors,” says Jeff Leonard, managing director at Wilshire Consulting, and one of the experts who prepared the analysis. “But if it was one of my parents, I’m not sure if I’d encourage them to take the offer now or wait.”
The reason for his uncertainty is the future direction of interest rates. If rates were to rise over the next couple years from today’s historic low levels, that would reduce lump sum values enough to offset increases generated by the new mortality tables. Leonard estimates that a rate jump of just 50 basis points would eliminate any gain pensioners might see from the new tables.
Deciding whether to accept a lump sum offer is highly personal. A key factor is how healthy you think you are in relation to the rest of the population. If you think you’ll beat the averages, a lifetime of pension income will always beat the lump sum.
Another consideration is financial. Some people decide to take lump sum deals when they have other guaranteed income streams, such as a spouse’s pension or high Social Security benefits.
The size of the proposed buyout matters, too. If you’ve only worked for your employer a short time and the payout is small, it may be convenient to take the buyout and consolidate it with your other retirement assets.
Some people think they can do better by taking the lump sum and investing the proceeds. It’s possible, but there are always the risks of withdrawing too much, market setbacks or living far beyond the actuarial averages, meaning you would need to stretch that nest egg further.
And doing better on a risk-adjusted basis means you would have to consistently beat the rate used to calculate the lump sum by investing in nearly risk-free investments—certificates of deposit and Treasuries—since the pension income stream you would receive is guaranteed. Although the math here is complicated, it usually doesn’t work out in a pensioner’s favor.
Could you wait for a better deal? Lump sum buyouts are take-it-or-leave it propositions. But Leonard says workers who decline an offer may get additional opportunities over the next few years as plan sponsors keep working to reduce their pension obligations. “Candidly, I think we’ll see a continued series of windows of opportunity.”