Dealing with company buyouts – Part 4: Pensions

PART 4: Pension plans

Mergers and acquisitions are a common business strategy and often result in a realignment of talent among mid- and upper-tier executives. Many jobs are eliminated, and severance packages are offered. If your company has recently been acquired or will merge with another company, it’s wise to consider taking immediate action to preserve the compensation you have earned. In addition, it makes sense to develop a strategy designed to strengthen your financial future.

In our six-part series on the potential impact of a company buyout, we’ll discuss several important issues related to your finances.

In this article, we consider aspects of the pension plan.

When should you start receiving pension plan benefits?

If you’ve been fortunate to work for a company that still offers a traditional pension plan, you’ll have major decisions to make regarding the timing and payout election for your pension. First, understand the earliest date you can start your pension. If you’re age 50 and your pension can’t begin until age 65, you’ve got time to plan. However, if you can commence your pension now or within the next few years, it’s important to run the numbers and understand the pros and cons of starting early. 

With many pension plans, there are early reduction factors if you take your pension benefit before a certain age. However, pension formulas are often subject to prevailing market interest rates, and if interest rates are higher in the future, your pension benefit could be worth less than if you took it early today.

Next, calculate your break-even age. For example, let’s say you’re 55 and start your pension today. The pension benefit is $3,000 per month today, so over the next five years, that will equate to $180,000 in payments. If you wait five years to commence at age 60, and your projected pension benefit is $4,000 per month, that’s a 15-year break-even. It’ll take you until age 75 to receive the same total pension benefits.

Consider whether you need this pension income to meet your living expenses now, which could be the case if you would otherwise be liquidating investment accounts to pay your bills. Rather than liquidating your investments heavily in early retirement or paying a 10% early withdrawal tax penalty on retirement accounts, starting your pension early could make a lot of sense.

Lump sum or regular payments?

A primary question clients often ask us is, “What pension option should I elect?” You may have options such as a lump sum or a monthly pension over your single life or joint life with a spouse or partner. Almost everyone wants to know, “Should I take the lump sum?”

While the answer regarding pension options does depend upon each person’s particular situation, there are a number of common factors we think you should consider, such as the following five:

1. Your age and health at termination
   
2. Whether you are married
   
3. If you have any other pensions or stable monthly income streams
   
4. If you plan on going back to work
   
5. How soon you’ll need to start living off your retirement assets

Finally, we look to determine what percentage of your future retirement income is coming from “you” (i.e., your investment portfolio, consulting income, etc.), from Social Security or from a company pension plan, as the answer can help you make a sound, informed decision.

Individuals with significant liquid assets may want to look at other pension options, such as a lump sum from the pension plan. In cases where a lump sum makes sense, the proceeds can be rolled over directly to an IRA, deferring the taxes on the lump sum for years to come. Or, if you’re planning to return to work and have several years to invest and grow your lump-sum pension in an IRA, electing the lump-sum distribution option may be the right choice. The lump sum, if not entirely spent during your (and/or your spouse’s/partner’s) lifetime, can be passed down to your children, which may be an attractive feature as part of your intergenerational wealth transfer plan.

If you’ve been participating in a non-qualified pension plan (or supplemental pension plan), then your payment options may be different. Even if a lump-sum payout is offered, it can’t be rolled over to an IRA and will be subject to tax upon payout. When running financial calculations, it’s important to keep in mind the immediate taxation of any lump-sum payments from a non-qualified pension plan; the value shown on your statement is a pre-tax number and will be eroded by income taxes upon payout.

Managing the impact of inflation

We also have some clients who comment that “the monthly annuity seems stable, but what about inflation?” To be sure, inflation is a major consideration when planning for your retirement, and it’s likely that your purchasing power will decline over the years if you take the monthly pension, as most are not indexed (i.e., the payments don’t increase) to account for inflation. If you take the monthly annuity, you’ll need a higher level of growth on your investment portfolio during retirement so you can withdraw larger amounts each year and preserve your inflation-adjusted standard of living. Over time, the eroding effects of inflation can make a substantial difference in your quality of life if you don’t find ways to counteract them.

At CI Private Wealth, we’ve helped a number of clients make wise choices with their pension payout elections. We believe having a clear picture of how your pension coordinates with your overall cash flow and investment strategy is one of the “large rocks” to address.

We’re ready to support you

To make wise decisions when facing a corporate restructuring, we think you need to understand all aspects of how this significant change may impact your finances now and in the future. Our team has the experience and expertise to develop your personal strategy, helping you make appropriate moves regarding your separation or transition package and, more importantly, gain clear insights into the potential impact on your overall financial well-being.

Other topics in this series:

• Severance, deferred compensation, investments
  
• 401(k) and Supplemental 401(k)
  
• Stock options and restricted stock
  
• Insurance planning
  
• Tax and estate planning
  

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