SHOULD I TAKE A LUMP SUM BUYOUT?

By Ian Berger, JD
IRA Analyst
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As a result of the current economic downturn, we can expect more and more companies to offer lump sum buyouts to employees with defined benefit (DB) plan benefits. A lump sum buyout is a limited opportunity for DB plan participants to elect one lump sum distribution in exchange for giving up future periodic payments.

The decision of whether to accept a lump sum buyout is a difficult and important one. Because the stakes are so high, it is crucial that you consult with a financial advisor before making a final decision. Here are several factors that you and your advisor should consider:

· What are the terms of the buyout? The plan calculates your lump sum amount by determining the present value of future payments, using interest rate assumptions. The lower the interest rate assumption, the higher the lump sum. A lump sum offered in the current environment of very low interest rates is likely to be as high as it will ever be.

· How financially secure is the plan and the plan sponsor? If the DB plan sponsor goes out of business with an underfunded plan, your existing or future pension payments may be reduced. That would be a factor favoring a lump sum distribution. The Pension Benefit Guaranty Corporation (PBGC) insures pension benefits up to a certain amount. But, since the PBGC is experiencing severe financial difficulties, you probably shouldn’t count on the PBGC guarantee.

· How is your health? The lump sum offered you is calculated on the basis of average life expectancies. If you expect to outlive your life expectancy, then you may want to consider passing up the lump sum. However, if you are facing medical issues, taking the buyout offer might be the right decision.

· How much financial discipline do you have? It is extremely tempting to be offered an unexpected check for tens (or even hundreds) of thousands of dollars. Make sure you understand what you are giving up in exchange for that lump sum. If you spend the lump sum on a luxury item, it may be difficult to replace the lost monthly income.

· Understand the tax implications. DB plan monthly payments are typically fully taxable in the year received and cannot be rolled over. On the other hand, DB lump sum payments are eligible for rollover to an IRA. Once rolled over, your funds become subject to required minimum distribution (RMD) rules. But aside from that, IRA withdrawals are extremely flexible.

· Will your spouse consent?  If you are married, your spouse must consent before you can receive a lump sum.

These are just some of the factors that should be part of any consideration about accepting a lump sum buyout offer. Remember: Don’t make this crucial decision without getting help from an expert.