Get ready to make a retirement planning decision. If you are eligible for a pension from a former employer that is worth more than $5,000, it is likely that early next year you'll hear from that former employer offering you a lump-sum, cash-out option.
This is one of the tenets of the Pension Protection Act, or PPA, of 2006 that is just kicking in. The new PPA rules make lump-sum options easy and very appealing to employers. Here's a quick explanation courtesy of Prudential, which manages pensions for hundreds of firms:
- Companies now can amend plans to allow full lump-sum distributions on a favorable interest rate basis even if the plans were originally set up to allow only annuity payouts.
- High-quality corporate bonds can provide the interest rate basis instead of the more conservative U.S. Treasury rates used before PPA. Higher allowable interest rates result in lower lump-sum cash-outs because less money has to be accumulated to pay out enough to meet what actuaries calculate as the pension obligation.
- Even if there was previously a lump-sum option, the company can switch to the new rules without any obligation to use any parts of the old calculation. But don't worry; if you're already collecting a pension, companies can't switch midstream.
These cash-outs are attractive for companies because lump sums get them out from under long-term pension obligations at a much lower payout rate than before. They can give you a lump sum that is lower in 2012 and going forward than it would have been this year or in previous years.
You don't have to take it -- the company can't legally force this option on you. But as Joan Bozek, vice president, Defined Benefit Product, Service and Operations for Prudential, says, "Participants who elect a lump sum get to take the money now and do what they want with it. They can invest it as they see fit."
Conventional pensions are very appealing retirement plans. They usually pay out more than you could get on your own if you take the lump sum and invest in a private annuity. If you leave the money in the plan, you can take advantage of the investment strength of millions of dollars under professional management, and you can generally count on getting the monthly payout for as long as you live.
On the other hand, taking the lump separates you from your former employer, and if that employer is in a shaky financial condition, that might be a good thing.
In any case, if you have a pension owed to you by an employer for which you no longer work, particularly if that pension has been frozen, be prepared to make a decision.