Retirees who take these buyouts often lose money and spend too quickly
by Kenneth Terrell, AARP, March 20, 2019
A recent change to pension guidance makes it easier for companies to buy out a retireefs lifetime annuity payment with one lump-sum payment, a switch that could hurt the long-term financial security of many older Americans.
Looking for ways to cut their overall costs, many companies have offered
former employees who currently receive pension payments the option to get one
large payment upfront instead of monthly checks for the rest of their lives. But
in 2015, the Obama-era Treasury Department said it was going to prohibit the
practice because it had determined that most retirees ultimately end up losing
lots of money when they choose the lump-sum option. The Treasury Department
started working on rules to that end and advised pension plans to halt the
lump-sum practice for current retirees.
Earlier this month, the Treasury Department quietly announced that it no
longer planned to work on the rules, meaning that companies once again have a
green light to buy out pensions of those already receiving them, offering lump
sum (IRS Notice 2019-18 on March 6). Advocates for older Americans say that lump sums usually are a bad choice
for those who get pensions.
gOften retirees think that if they exchange their pension for a huge chunk of money — sometimes as large as $300,000 or even $400,000 — they can do a better job investing it themselves in the stock market,h says Karen Friedman, executive vice president and policy director of the Pension Rights Center. gBut economists warn that rarely, if ever, can people replicate the security of a pension.h
A lump sum is not guaranteed to last a lifetime, and all the investment risk
is shifted back to the retiree, said AARP Legislative Counsel David Certner. A
bad choice here will lead to great financial hardship for many, he said.
More than 26 million people currently participate in employer-paid pension
plans, but that number has been dropping for decades as employers have offered
401(k) plans instead. Companies typically prefer 401(k) plans because they shift
the risks to employees and donft require the same long-term financial
commitments as employer-paid pensions.
But when people with annual pensions take lump-sum buyouts, they often spend
the money too quickly. A 2017 survey from MetLife found that 21 percent of
those who took such a payment had spent all of the money in an average
of just over five years. And among those who still had money left from a
lump-sum payment, 35 percent said they were worried they would run out of money
before they died.
The money collected from lump sum payments on pensions often isnft even spent
on retirement
needs. The MetLife survey found that 63 percent of those who had taken lump
sums said they had used the money for major purchases
or spending within the first year, such as vacations, home
improvements and luxury items. Thirty percent used the money to pay
down debt or other expenses.
gIf youfre a retiree already in pay status receiving a guaranteed pension that you canft outlive, then being offered a lump sum is a bit like Adam contemplating eating that apple in the Garden of Eden,h Friedman says. gYou may be tempted by something that looks good — but if you give in to temptation, you may come to regret it.