People who live and work in the Detroit area have seen their share of corporate buyouts and layoffs, particularly in the automotive industry. Just last week, Ford announced the first wave in a new round of job cuts that will lead to the reduction of 7,000 salaried positions globally. According to news reports, some employees are receiving voluntary buyouts, while others received news that they will be laid off.
At AMDG Financial, we’ve worked with a number of automotive workers who have found themselves in this situation, and one of the most common questions we get involves pension distributions. Companies like Ford, and others, are increasingly offering employees the option of taking a lump-sum payment now, or monthly payments later. Allowing eligible employees to take a lump sum helps companies reduce the size of their pension obligations, which makes their financials look better. Depending on your financial situation, a lump-sum distribution could be better for you as well, but not always. Let’s take a look at some of the things you should consider:
How a Lump-Sum Distribution Works
Let’s say the ACME company has decided to offer its eligible employee, Jane, the choice of a lump-sum payment of her pension now, or the chance to take monthly payments later. If Jane opts to take the lump sum, ACME will issue a check from its pension fund, either to Jane directly, or to Jane’s tax-qualified retirement plan, such as her traditional IRA. If Jane chooses to put the money in her IRA, it can be handled as a direct rollover, and Jane won’t pay taxes on the money until she starts taking IRA distributions. If Jane takes the money directly, it will be taxed as ordinary income in the year she receives the payout.
While getting a large pot of money all at once may seem desirable, I always remind my clients that It’s not about the money; it’s about the money you keep after taxes! Taking the money directly without rolling it into an IRA not only could push Jane into a higher tax bracket for the year; she could also face a 10-percent early withdrawal penalty ifshe is under the age of 59½.
In this scenario, Jane has a number of other factors to consider. First, if she takes a lump sum, it’s on her to make the money last for as long as she needs it. If she needs a monthly income, one option could be to purchase an immediate annuity, which could provide Jane with monthly checks, but not a tool for investing. If monthly payments are critical, Jane should weigh whether it’s better to stay with the company’s monthly distribution plan instead of trying to negotiate an annuity on her own, because the company may have better negotiating power.
If Jane invests the money, she is subject to the ups and downs of the market just like all other investors. Depending on her longevity, she may not be able to withstand a prolonged downturn or generate enough income from her investments to provide a sustainable income.
How a Monthly Distribution Works
If Jane opted for the monthly distribution instead, ACME’s pension plan would provide her with a set payment every month for the rest of her life, and Jane may also have the option to allow her husband to receive payments for the rest of his life, should Jane die. In this option, Jane is essentially taking an annuity payment from ACME, which – in theory – ensures she will have regular income and won’t have to worry about running out of money. But the monthly payment option isn’t perfect either. Here’s why:
If Jane is taking the monthly payments because she has left ACME’s employ, that means her payments will likely stay the same, even if her cost of living increases. Without inflation protection, Jane’s purchasing power will diminish over time.
And what if ACME were to go out of business and suddenly couldn’t make Jane’s monthly payments? Jane could recover some of the money she’s owed from the Pension Benefit Guaranty Corporation, a government agency that protects pension benefits to a limited extent. However, the rules are complicated, and the guarantees are more favorable for those over the age of 65.
Your Adviser Can Help
When thinking about your options for pension distribution, it’s important to consider how long you might live, what other sources of income you’ll have in retirement, what your expenses will be, and whether you plan to transfer your wealth to your children, grandchildren, or a charitable organization at the end of your life. When we work with clients on their pension distribution choices, we discuss all of these factors, and may also work with their estate planning attorney, if they have one, to ensure we’ve covered all of the bases.
Separations – whether voluntary or involuntary – can stir plenty of emotion and leave employees with more questions than answers. Seeking the assistance of a financial adviser can help reduce the stress of decision making and provide you with potential options you might not have considered. If we can be of assistance, please feel free to schedule a no-obligation appointment with us to discuss your needs. We’d be glad to help you weigh the pros and cons of pension distributions.