Last week, General Motors followed Ford Motor Co. in offering retirees with a monthly pension payment a lump-sum buyout.
The retirees who were offered the deal are under no obligation to take it but in some cases, choosing a lump sum could make good retirement planning sense, says Leon LaBrecque, a Detroit-area attorney and certified public accountant who specializes in managing auto company pension plans.
About 80 percent of the time, LaBrecque says the monthly pension payment is the best deal for someone living in retirement because it leaves both the longevity and investment risks with the company -- you keep getting the money no matter how long you live or how lousy the return on investment is.
If you opt for the lump sum, you take on the investment risk yourself. If you make bad decisions or you're just unlucky, you could run out of money. But taking the lump eliminates the risk that you and your spouse will both die young and neither you nor your heirs get what you've earned.
"The main risks of staying with the annuity is that you don’t live long enough to get value or that you’re losing purchasing power. The risk of default is low," LaBrecque says.
Here's an example of a situation in which LaBrecque thinks taking the lump makes the most sense:
"Mike and Tonya are both 56. Mike has retired from GM and is offered a $700,000 lump sum on his pension. Tonya is an executive at another company and makes $200,000 a year, which is adequate to maintain their lifestyle. Tonya intends to work until age 66. Mike could roll his lump sum into an (individual retirement account) and accumulate the balance for 10 years. If he could achieve a 7.5 percent rate of return, his IRA would be worth about $1.44 million by the time Tonya retired. They then might take 4 percent a year, or about $58K a year from the IRA to supplement her pension."
If you are faced with a similar decision, here are some questions to ask yourself:
- How healthy am I? How healthy is my spouse?
- What kinds of retirement income will I have. Will my spouse have a significant pension?
- How important is it to me to leave money to my children or a charity.
- Is it important to me to be able to have flexibility in the amount I withdraw?
- Will I manage my own money or delegate investment management to someone else?
- What kinds of financial obligations will I have after I retire?
- What will be my tax bracket after age 70½?
- What is my risk tolerance?