Big Money, Big Risks: Should You Take a Lump-Sum Pension Buyout Offer?

lump sum pension buyoutWhen times are tough, it often feels as if the only shot you'll ever have at making ends meet is winning the lottery. If you're one of the fortunate workers with a pension, and you're offered a big lump-sum payment in exchange for it, you might well feel like your lottery wishes have been granted.

And the odds of it happening are somewhat better than that lottery windfall: Ford (F) and General Motors (GM) alone made such offers to more than 130,000 of their workers earlier this year.

In reality, though, how you handle an offer from your employer to buy out your pension benefits may be the biggest money test you'll ever face. If you decide to take the money and run, then you'll have another tough task ahead of you: putting it to work in the best way possible.

What Not to Do

The first trap that many workers fall into when they're handed a lump-sum pension payout is to treat it like ordinary savings. That can be the most costly mistake you'll ever make.

Most pension distributions are treated the same way as withdrawals from a retirement account. So if you just take the money and put it into a regular bank account, you could end up having to pay taxes on the entire amount, potentially losing hundreds of thousands of dollars of your hard-earned pension to Uncle Sam.

To avoid that, all you have to do is roll over your lump-sum payment to an IRA. That way, you'll preserve the tax advantages of your retirement money. You'll still have to pay taxes when you take money out of the IRA, but you'll get to decide when the time is right. By spreading out withdrawals over time, you'll likely pay a lot less in taxes in the long run.

Invest Smarter
By taking a lump-sum distribution, you're essentially saying that you think you can do a better job investing your money than your former employer. The challenge is figuring out how to do that.

There's no one perfect investing strategy that will work for you. Because everyone's different, it's essential to come up with a plan that matches your specific needs. But here are some general guidelines to consider:
  • You need this money to last the rest of your life. If you gamble on a hot stock and things turn out badly, you don't have anything to fall back on.
  • You have to take some risk. Unfortunately, safe investments like short-term bank CDs that used to pay reliable income of 4% to 5% now pay less than 1%. Unless you've got a huge pension, that won't come close to meeting your living expenses. The recent popularity of dividend stocks comes in part from this hunger for income, but as we all found out four years ago, even safe-looking stocks won't always protect you from market collapses.
  • Protect yourself from a personal financial crisis. The benefit of having a monthly pension is that it's guaranteed for life. Even if you take a lump sum, you can lock in monthly income with a portion of your assets by buying what's called an immediate annuity. In exchange for money up front, an insurance company will guarantee monthly payments for the rest of your life, with options for payments to go to a surviving spouse or other family members after your death if you choose.
  • Consider your other financial resources. For many workers, a lump-sum pension payout represents their entire retirement nest egg. But if you've been prudent enough to save money for retirement elsewhere, whether it's through a tax-favored retirement account like an IRA or 401(k) or simply in a regular bank or brokerage account, then you have more options in considering how to integrate a lump-sum payment into your overall financial plan. If you have substantial savings, you won't have to take as much risk with your lump-sum payment in order to have a comfortable retirement.
Taking on responsibility for investing a lump-sum pension payout is a big commitment. But if you make the right moves, it can also be the most rewarding thing you'll ever do with your money.

For more on making the most of retirement:

Fool contributor Dan Caplinger expects to get no pension payouts. He doesn't own shares of the companies mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares of General Motors and Ford, as well as creating a synthetic long position on Ford.

Increase your money and finance knowledge from home

Introduction to Retirement Funds

Target date funds help you maintain a long term portfolio.

View Course »

Managing your Portfolio

Keeping your portfolio and financial life fit!

View Course »

Add a Comment

*0 / 3000 Character Maximum


Filter by:
Ken Krausman

Please watch our recent "Town Hall" discussion, hosted by WDIV's Rod Meloni. Please "share" with everyone you know who may be affected by this growing trend of Pension Buy-Outs.

December 06 2012 at 9:40 PM Report abuse rate up rate down Reply

Beware of men in suits with big checks!

September 09 2012 at 3:41 PM Report abuse +2 rate up rate down Reply

I took a lump sum when I retired at age 52. I found a really good investor and the two of us sit down every 6 months and go over everything. I would have received $20,000 a year from a pension. Which would have ended when I died. I am now 62 years old and I have been removing $36,000 a year from my investments and I still have the same amount as the day I first opened the IRA account even with the way the market has been.When I die my wife will still have the money to live off of.

September 09 2012 at 2:13 PM Report abuse rate up rate down Reply

The largest risk to not taking a lump sum is that you are betting that your company will last as long as you do. Companies come and go and have the bankrupty option when they get in financial trouble and the courts do not look favorable on defned benefit pensions. So you end up with the PBGC which can significantly reduce your monthly pension. Get a good advisor and take the lump sum.

September 09 2012 at 11:12 AM Report abuse rate up rate down Reply

If you take a pension buy out or vote for the GOP you will be sorry and broke during your retirement years.

September 09 2012 at 3:27 AM Report abuse +5 rate up rate down Reply
1 reply to toosmart4u's comment

vote democrat, four more years of thieves stealing from us!

September 09 2012 at 11:44 PM Report abuse -4 rate up rate down Reply

I, like many of my former coworkers declined the lump sum buyout. The cash was equal to about 11 years of pension payments, and my gene pool and present health point to 20 more years of payments. BTW, the payments are no longer sent by GM, but by a large insurance company. I assume GM tendered the rejected buyout money to them in order to purchase a guaranteed annuity. By doing it that way, GM removes those pesky legacy costs from its books.
I have been out of stocks for a few years, way too volatile for me. My 401(k) money is invested in bond funds which return at least 5% per year....not a bunch, but better than 1% in money market or bank CDs

September 08 2012 at 8:04 PM Report abuse rate up rate down Reply


September 08 2012 at 4:56 PM Report abuse -2 rate up rate down Reply

I took a partial lump sum (20%) payout when I retired in 1990. I deversified by placing some in Insurace savings, some in CD, some in IRA's and I owned my home at the time. All I can say is that my home is worth about 2/3 of what it was when I retired. My IRA has not grown and I only withdrew the required minimum. The CD's earned some modest interest for a few years , but have earned less than 1% in the past decade. The portion of my retirement that remained in my original retirement plan has become my primary income. Overall I have survived, but have obviously reduced my standard of living. The primary issue that has impacted me has been the high/increased cost of energy and food and medical insurace cost. My diversified investments did not grow and that seems to be the story of most Americans. Am I better off than I was 4 years ago? Not by a long shot!

September 08 2012 at 10:23 AM Report abuse +1 rate up rate down Reply
1 reply to Charles's comment

I took the retirement lumpsum payout, and a very large percentages of coworkers did the same. I have an excellent financial advisor. In more than 10 years, I withdrew over 90% of the original payout, but still have 67% of the original amount left. Now I have a full time government job and collect Social Security. My advisor's worried about me running out of $$, but I've got another pension due when I retire again in 12 years. The workers who decided not to retire are screwed. The company is under bankruptcy and their pensions are not being funded any more.

September 08 2012 at 9:48 PM Report abuse rate up rate down Reply
1 reply to RetiredWorking's comment

What happens to your noncontributory pension when you die after retiring? Doesn't it revert back to the company you retired from?

What happens if you choose your wife as a survivor beneficiary, and she dies before you? You're stuck @ that reduced payout for the rest of your life. What happens if you divorce your wife after choosing her as a beneficiary?

The bottom line is that ya can't leave your pension to your children when you die, but you CAN, if you choose a lump sum payout. It may not be as much as IF you lived a long life after retirement. It'll be a whole lot more, especially if you die a few years into retirement.

I know I just HAD to take the lump sum, so I can leave the balance to my children. Besides, with the lump sum in my IRA, if I need $25K, it's as simple as a phone call to my financial advisor. He's concerned that I'll run out of $$. However, I can retire in 12 years with another pension. Moreover, my family's life line is short, so I'll prolly die on this job that I love. I also have two children who will support me, and my new younger wife makes more than I do..

September 09 2012 at 4:30 AM Report abuse rate up rate down

Anything you get now will be better than what you will get in a year or two when our financial system fails or the dollar becomes worthless or hyperinflated. Get your money now and do something with it before it is too late. What a shame it will be, when millions of people wake up one day soon and find that they are absolutely broke. Do not let that happen to you.

September 08 2012 at 9:19 AM Report abuse rate up rate down Reply

Take a lump sum buyout or a vote for the GOP will ruin your retirement years.

September 08 2012 at 9:12 AM Report abuse +3 rate up rate down Reply
2 replies to toosmart4u's comment

You Are An Idiot

September 08 2012 at 10:57 PM Report abuse -2 rate up rate down Reply
Dave & Jill

God Luv Ya but you actually have it backwards.
Taking your retirement in a Lump Sum and investing in an IRA which you control will reap much more in the long run than monthly payments from your company.
Also, The GOP wants you to KEEP more of your money. The Demorcrats want to Take more of your money so that they can spread it to those that don't or didn't ever work.
You don't have to believe me, just check your facts. Obama wants to Increase The Capitor Gains Tax drastically and Romney doesn't.
Just in case you don't know what that means: Capitol Gains is what your retirement money will be making (in other words, your profits from your retirement money)
Forget everything and just look at it this way:
- Do you want to keep more of the money that you spent a lifetime accumulating? Republican ideas.
-Or would you rather be force to give more of it away? Democrate ideas.
(wouldn't you rather have the choice?)

Now, don't get yourselves in a huff. I'm just offering some free advice that has been working for us.
If you believe that your way is better than Go For It! <<

September 09 2012 at 12:31 AM Report abuse -1 rate up rate down Reply
1 reply to Dave & Jill's comment

IRAs are not taxed as capital gain. IRA withdrawals are taxed as normal income. Dream on about IRA or other investments providing the difference between the loss in guaranteed pension income and a lump sum. The market has been flat for years, and the future does not look rosy.

September 09 2012 at 5:52 AM Report abuse rate up rate down