North Carolina Long-Term Care Planning Attorney Explains "Lump Sum Option" Pension Deals
You might remember this formula from high school or college. For some of us, it still pops up in the middle of the night smack in the middle of that dream, the one where you're in a final exam for the class you never attended. That's the Quadratic Equation in a nutshell.
Why are we writing about the quadratic equation? Simple: If you have a pension plan—a good old-fashioned regular pension plan from a former employer—the odds are high you're going to get an offer from that company that will require old math skills long dormant.
With almost no warning, and even less fanfare, the Treasury Department issued a notice in March that will allow employers to 'buy out' their retirees' pensions. This revives a practice the Obama administration ended in 2015 banning the practice.
Banned in 2015
Buy-outs of defined benefit pensions were banned by the Obama Treasury Department even though opting to take a lump sum instead of a monthly payment is entirely voluntary. At least in theory. Unfortunately, when first offered, they look . . . well, cool. Enticing. Maybe even life-changing.
For someone about to retire, or even someone who has been retired for years, the sudden offer of, say, $400,000 in one shot can be overwhelming. That's the problem, of course. It looks great, and study after study has shown that people tend to value "money that's right in front of them over money they will get in the future."
Aside from that, there's almost always an immediate need (like house or car repairs) and/or pressure from family members to help out. And why not, when it's so much money?
The Treasury Department stopped the practice after years of complaints and a sharp uptick in retirees running out of money long before death. A MetLife study found that one in five retirees who took the lump sum had spent it down to zero within five and one-half years of receiving it.
Who Wins?
This shouldn't be a matter of who wins in the long run, it should be about what's fair and taking care of elders. But, of course, that's not the case.
The short answer here is that pretty much everyone wins - except the retiree and their family.
Companies win because pension plans are big corporate liabilities—the kind that Wall Street rating agencies notice. Pensions are also expensive to manage. Eliminating those pensions is extraordinarily beneficial to the corporate bottom line.
Financial services firms are looking at a sharp influx of money to manage. That, of course, means commissions, fees, more money under management, and all the perks that may entail.
None of that would matter all that much except for the fact that - again, in study after study - it turns out retirees who take the lump sum are usually doing so at a significant discount from what the pension is actually worth. In most cases, the retiree is getting 20-30% less than what the pension could have bought over time.
A Mail Blitz and The Quadratic Equation
If you're retired on a defined benefit pension you almost certainly will be contacted soon about 'your lump sum option.' The offer will look great. The offer will be enticing, especially if the house needs new gutters, you want to put in a pool for the whole family, or a grandchild is headed for college and could use some help.
The math . . . well, the math is not straight forward. It is, in fact, immensely complicated. It is not just about the six figures; it's about deriving income from it while not fatally pulling down the principal, the tax implications, and much, much more.
But, how do you turn down a check for, say, $500,000? By realizing you're actually giving up a lot more. Which is exactly what you are most assuredly doing.
If you get one of these offers, please call us before you do anything. Too much can go wrong.
