As Honda’s U.S. sales slumped due to COVID-19, it offered early retirement to some of its older workers. Those who accepted had the option of staying with their pensions (monthly payments for the rest of their life) or taking a lump sum payment calculated to approximate such a pension. The possibility of taking home a large sum of money enticed many employees.
Many retirees face similar dilemmas with the pension or lump-sum decision driven by corporations trying to reduce debt. Is it better to let your old employer manage your pension money or to let you handle it? The choice you make is a potentially life-changing decision. In addition, it is often made in haste since employees often don’t have much time to decide, and many do not have access to objective financial advice. These decisions are typically irrevocable.
Choosing the right option may not be obvious. In retirement, you run the risk of running out of money if you take a lump sum. In contrast, if you choose monthly payments and die prematurely, your heirs will receive much less than if you had chosen lump-sum payments.
Calculating whether a lump sum or a pension is better for you is a complicated math problem with many variables you cannot control. In particular, how long you (and your partner) will live and how much money you might earn by investing a lump sum. Employers should explain how they calculated their offers.
Such a calculation cannot account for uncertainties like the devastating risk of a collapsing stock market soon after retirement. There are also emotional and behavioral issues to consider. There is no doubt that receiving a lump sum can be a big deal, but there are risks involved, according to Karen Friedman, executive vice president of the Pension Rights Center. In a MetLife study, 1 in 5 people who took the lump-sum option depleted that money within five and a half years. Another 35 percent were concerned about running out of money.
What should I do? According to experts, you should seriously consider a lump sum if:
- Your employer’s financial health concerns you.
Financial health relates to a corporation closing or filing for bankruptcy, mergers, or other aspects that you believe may affect the value of the company.
- You are comfortable investing.
Investing and managing your finances are things you already do, or if you have a trusted financial adviser, taking the lump sum provides more flexibility and potential upside..
- The money is not necessary for you.
If you (and your partner) are already covered for retirement through another pension, retirement plan, or inheritance, taking control of the money allows you to spend, give away, or save it as you see fit. The benefit of rolling the money directly into an IRA or your 401(k) is that taxes won’t be due until you withdraw it; if you are between 55 and 59 1/2, you won’t have to pay an extra 10 percent withdrawal penalty.
When a pension makes sense
In reality, companies offering buyouts are doing so to benefit their bottom lines, not yours. Consider the annuity option if:
- You are married.
A joint-and-survivor pension allows for a lower monthly payout; to a surviving spouse. They will receive a lifetime pension (Between 100 to 50 percent of the primary benefit). Because most women live longer than men, losing this benefit can negatively impact the wives of men with pensions.
- Spending is a part of your nature.
The discipline imposed by a pension can be helpful if you are inclined to spend too much of your money — for example, taking a vacation, helping out adult children, etc.
- You are anxious about the decision.
A secure payment plan can provide you with great peace of mind.