En español | A recent change to pension guidance makes it easier for companies to buy out a retiree’s 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 sums. Advocates for older Americans say that lump sums usually are a bad choice for those who get pensions.
“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,” says Karen Friedman, executive vice president and policy director of the Pension Rights Center. “But economists warn that rarely, if ever, can people replicate the security of a pension.”
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 don’t 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 isn’t 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.
“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,” Friedman says. “You may be tempted by something that looks good — but if you give in to temptation, you may come to regret it.