Safeguard your pension with a lump sum?
By Laura Bruce • Bankrate.com

It doesn't take a corporate bankruptcy to jeopardize your pension. Sure, when a company such as United Airlines declares bankruptcy and says it can't afford to pay its pension obligations, employees scramble to determine the damage to their retirement finances. But often the scenario is more subtle.

Across the country, many companies are struggling with underfunded defined benefit pension plans.

Some plans, such as Northwest Airlines', are underfunded by billions of dollars. Officials at the Pension Benefit Guarantee Corporation, or PBGC, a federal corporation that guarantees the payment of basic pension benefits, say 1,108 American corporate pension plans are underfunded by a total of $354 billion. But, the true amount is worse than that; companies aren't required to report underfunding unless the deficit is more than $50 million.

As pension plans become vulnerable because of underfunding or corporate bankruptcies, workers must decide whether to take their payout in a lump sum or agree to an annuity and, perhaps, risk learning later that they might receive a fraction of the benefit they had expected.

"The pros of taking a lump sum outweigh the cons much more today than five or 10 years ago," says Eric Hutchinson, certified financial planner and chairman of Hutchinson/Ifrah Financial Services in Little Rock, Ark.

"In today's environment, it would be hard to advise taking the annuity because of the underlying risk involved of whether they'd actually see those payments. Or, if PBGC takes over, they get substantially reduced payments than they expected."

PBGC annually sets the maximum benefit for plans that it takes over. For instance, plans terminating in 2005 will pay a maximum benefit of $45,614 per year to workers who retire at age 65. That can be a major blow to airline pilots or skilled tradesmen expecting a far-greater pension to see them through retirement.

Another fly in the ointment in all of this is that PBGC has financial problems of its own. PBGC gets its funding from, among other things, insurance premiums paid by companies with defined benefit pension plans. The organization says it ended 2004 with a deficit of more than $23 billion. PBGC is a government corporation, but its obligations are not backed by the "full faith and credit of the U.S. government."

Not all corporate-pension plans allow participants the choice of taking a lump-sum payout, and usually workers can only access their pension after leaving a company. There's an Internal Revenue Service penalty if you take a distribution before age 59½, but you can avoid that if you roll your pension into an IRA.

To a large extent, the lump sum is based on your age at retirement and the interest rate the pension plan uses, which is usually the 30-year Treasury.

"The hard part about a lump sum is the low interest-rate environment requires the pension to give you a bigger lump sum than they would otherwise, because with interest rates so low you need a bigger sum of pension money to create the pension you're supposed to receive," says Chris Cooper, CFP and founder of Chris Cooper & Company, in Toledo, Ohio.

"A lot of people would like to retire now and take a lump sum, because they'd get as big a sum now as they'd ever get because of interest rates being so low."

But a change could be in store if Congress passes legislation aimed at reforming funding rules for defined benefit plans. A Treasury Department proposal creates a corporate bond yield curve for determining how much money companies must pay into their plan and also for determining lump-sum payments. The yield curve would be based on high-grade corporate bonds.

Norman Stein, a law professor at the University of Alabama, says the effect on lump-sum payouts, currently determined using the 30-year Treasury, could be significant.