This blog is NOT meant to make you scared about your pension. I personally LOVE when clients have a pension and rarely suggest they take a lump sum payout if offered.
However, it happens occasionally that people come to me with an offer from their former employer to buy out the pension obligation that is currently being paid. Now, this can look pretty exciting at first glance. There is usually a nice 6-figure number in that letter that can be all yours if you just give up your monthly lifetime pension payment.
Not so fast, I say. If a company is making this offer, you can be sure it’s not to benefit you – it’s to benefit their bottom line.
There is one easy way to figure out whether the offer is a good one. If you have a financial calculator, or access one on the web, you can figure the average rate of return the pension company expects you to get by investing the lump sum on your own. If that rate of return seems too high for a risk-free investment (like you currently have with your pension), the lump sum they are offering you it too low.
For example, let’s say Joe is 65 years old and getting a $1,500/month pension payment. Assuming he lives until age 90, at a 2% risk-free rate of return (the current yield on a 10 year US Treasury bond), the present value of the lifetime payments is $354,000.
If his company is offering $200,000 to buy him out of his lifetime payments, they are saying the Joe could get a 7.75% annual rate of return with no risk. Not possible in today’s interest rate environment.
So remember whenever someone offers you a big check – if it sounds too good to be true it probably is. This is the time it will be worth it to pay for an hour of a financial adviser’s time to help you with the decision.