By Karen Friedman
Sometimes important changes in pension law are made through the regulatory process or even, more subtly, through guidance that agencies issue to address key issues. Often the guidance sounds technical, but it can make a world of difference, either positively or negatively, to the economic security of retirees.
One negative change was announced without fanfare by the Treasury Department recently when the agency declared that it was reversing its 2015 guidance that prohibited pension plans from offering retirees who already are receiving their pensions the option of a lump sum.
You may be asking, what’s so bad about offering lump sums? Well if you’re a retiree already in pay status receiving a guaranteed pension that you can’t outlive, then being offered a lump sum is a bit like Adam contemplating eating that apple in the Garden of Eden. You may be tempted by something that looks good – but if you give in to temptation you may come to regret it.
While a lump sum seems like a lot of money, it will short-change most retirees, according to Drexel law professor Norman Stein, who is also a senior advisor to the Pension Rights Center. Stein says that because of interest rate assumptions, loss of legal protections, and insurance of benefits, retirees will lose a significant part of the value of their pension by taking a lump sum. That loss to retirees is a windfall to companies, which is the primary reason companies want to offer lump sums.
Also, almost every retiree is taking a risk when they exchange a pension for a chunk of money says economist Alicia Munnell, who is the director of the Center for Retirement Research at Boston College. Munnell warns that “only those with serious illnesses or who believe they don’t have much time left should even consider it.” But then she notes that we can’t predict our own mortality and sick people may live longer then they think.
Often 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. But economists warn that rarely, if ever, can people replicate the security of a pension.
Also, be forewarned, participants who take lump sums often have to pay high fees to investment advisors and to mutual funds who take no responsibility if the market dips and their investments lose value. On that note, we’ve heard stories of when companies announce they’re doing buy-out offers – largely in “derisking” transactions where plans are taking liabilities off the books – financial advisors, who may not have the retirees’ best interests in mind, swarm like bumble bees to flowers to get access to that money. They’ll say they can manage your money better than the pension plan, but while retirees lose out, the financial advisors will be able to buy a new boat with the commissions they earn and the high fees they charge.
Also, keep this in mind: if you are the retiree and take a lump sum it’s not just you who can outlive your money. Think about your spouse. You will lose the automatic survivors benefits that come with a traditional pension plan. Women typically live longer than men so losing that annuity is going to put a spouse at dire risk of losing out.
So don’t be fooled by the blandly-numbered Treasury Notice “2019-18.” Reading the notice may put you to sleep, but the impact should keep you up at night. What it means is, “we’re undoing very good guidance that protects retirees in favor of companies saving money at their expense.”
The Pension Rights Center and allies are going to challenge this ill-advised reversal.
Fact sheet: Should you take your pension as a lump sum?