By Ian Berger, JD
IRA Analyst
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Earlier in my career, I worked for a company that sponsored a defined benefit (DB) pension plan. Up to now, I’ve chosen to defer payments from the plan. A few weeks ago, I received an official-looking package in the mail containing the news that I qualified for a lump sum buyout. A lump sum buyout is a limited opportunity for former DB plan participants to elect a one-time cash payment in exchange for giving up future periodic payments.

Deciding whether to accept a lump sum buyout is an important choice that shouldn’t be made without consulting with a knowledgeable financial advisor. Here are several factors that should be considered:

What is the effect of interest rates?

The lump sum amount is calculated by taking into account several factors, including an assumption about interest rates. The lower the interest rate assumption, the higher the lump sum. Not surprisingly, interest rates used by plans to calculate lump sums have been rising fast and are now as high as they’ve been since 2008.

How is your health?

The amount of the lump sum is also based on average life expectancies. If you expect to live longer than an average person of your age, you may want to consider passing up the lump sum. However, if you are facing medical issues, taking the buyout offer may be the way to go.

How financially secure is your employer and your plan?

If your employer goes out of business with a pension plan that doesn’t have enough funds to pay benefits, your existing or future payments could be reduced. That would be a factor favoring a buyout. The Pension Benefit Guaranty Corporation (PBGC) does insure pension benefits up to a certain amount. However, even though the PBGC’s financial picture has improved somewhat, it might be risky to count on that lifeline.

Will your spouse agree?

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

How tempting will a lump sum be?

Be honest with yourself. You may be the type of person who wouldn’t be able to resist spending a large check instead of putting it away for retirement. If you are, taking a lump sum now may jeopardize your financial well-being in later years.

Know the tax rules

DB monthly payments are typically fully taxable in the year received, and you can’t roll them over. But a lump sum payment is eligible for rollover to an IRA. Once rolled over, your funds become subject to required minimum distribution (RMD) rules. But aside from that, you have lots of flexibility with IRA withdrawals.

The Verdict

The relatively high level of current interest rates, the good health of my wife (my beneficiary) and me, and the solid financial shape of my former employer all led me to turn down the lump sum buyout. But believing this was the right move didn’t make it any easier to pass up the largest check I’ll ever see.