Be careful of the “lump sum illusion” and talk to your financial advisor
The last few years have not been kind to General Electric – the once invincible, well-known blue-chip company that was one of the most widely held stocks for decades.
Consider the last three years:
- For the year ending 2017, General Electric was the worst-performing stock in the Dow Jones Industrial Average, losing about half of its value.
- For the year ending 2018, GE would have been the worst DJIA performer again, but mid-way through the year, GE got kicked out of the DJIA-club (GE lost about 56% in 2018, by the way).
- A few months later after getting kicked out of the 30-company DJIA, GE’s CEO got the boot.
GE Freezes Pensions
Then on Monday, October 7, 2019, GE announced plans to freeze pension benefits for about 20,000 employees in an attempt to shrink its pension deficit and shore up its balance sheet. Further, GE is “offering a limited time lump-sum payment option to approximately 100,000 eligible former employees who have not started their monthly U.S. GE Pension Plan payments.”
What to Know About Lump Sums
A lot of companies have made changes to their pensions, including plan terminations, plan freezes for employees, and changes to the formula by which pension benefits are calculated. In fact, GE is joined by a growing list of companies making changes to their pensions, including UPS, L.L. Bean, the Boston Red Sox, the Washington Post, Boeing, General Motors, American Airlines, and Bank of America, to name a few. Should you object to a wad of retirement cash all at once? Here are a few things to consider before you opt for that lump sum.
The Lump Sum Illusion
In a recent podcast, Olivia Mitchell, executive director of the Pension Research Council and professor at Wharton talks about what she calls the “lump-sum illusion.” She told her listeners that, “Somebody who gets a lump sum of say, $100,000, might think they are suddenly rich, but that money doesn’t go very far. Based on annuity estimates, a $100,000 payment would provide a monthly income of $560 for a 65-year-old male, and $530 for a female, because women live longer than men.” Mitchell then adds, “But a lump-sum payment could help many older people who are entering retirement with far more debt than they did in the past. Baby boomers are getting into retirement not having paid off their mortgages, and not having paid off their credit cards. A lump sum in such cases could really help older people pay off their debt and move into retirement less exposed to interest rate fluctuations.”
Lump sums might make sense if you expect to die soon without a surviving spouse who will need lifetime income. They might also make sense if you already have another secure source of retirement income or are trained in handling such amounts of money at once. In many other cases, however, accepting a lump sum payout rather than income from a pension may significantly affect your retirement funding unless you take proper steps.
Regarding taxes, for instance, if you receive a lump-sum distribution and were born before January 2, 1936, you may qualify to elect optional methods of figuring, reducing or deferring tax on the distribution, according to the Internal Revenue Service.
Among other tips for you to consider:
- Take your time. You can’t reverse your decision to take the lump sum.
- Lump payouts may not include subsidized benefits that some employers offer as an incentive for early retirement.
And most importantly:
- As you might after any large windfall, plan your decision with your financial advisor.