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GM Pension Plan Buyout

July 31, 2012

GM is offering its pensioners buyouts with a “value equivalent” lump sum payments.  These offers need to be considered and analyzed against individual circumstances and financial goals.  What called my attention to this announcement, which has become a common occurrence among companies seeking to rid themselves of the future obligation of providing lifetime pension payments, are the reasons many individuals are giving to justify their decisions.  I think many of these reasons are misguided.

Company pensions provide lifetime income, or variations based upon decisions made when someone is about to retire.  In most instances these decisions cannot be changed.  Lump sum buyouts offer a pile of cash that can be transferred tax-free into an IRA account where the participant can make their own investment decisions. 

Many people interviewed for a recent NY Times article indicated they like the lump sum alternative because it enables them to either leave a “nest egg” for their children, because it gives them the freedom of knowing they have the money and that this money is under their control.  This is where I see problems.

The problem is that people lose sight of the purpose of the pension which is to provide cash flow during retirement.  Having a lump sum rather than an assured lifetime cash flow makes people feel richer, but those feelings cannot be spent.  Only cash flow can be spent.  True, distributions can be made from the lump sum, but when that occurs, not only does the principal get diminished, but the cash flow can run out at some time.  How and when that occurs depends on the ages of the participant, their spouse or partner, if married or in a civil union, the starting balance, withdrawal and earnings rates and costs.

This new desire to leave a “nest egg” can easily be satisfied with a life insurance policy. The fixed premium cost can come out of the pension payment.   Control is ethereal and not a practical choice as can be seen by the following issues that need consideration:

  • loss of a definite guaranteed cash flow
  • ability to duplicate the amount of cash flow from the pension plan
  • lack of financial knowledge
  • capability to find a suitable investment manager and financial planner
  • costs of management
  • time that needs to be devoted to the portfolio
  • construction of an appropriate asset allocation formula
  • monitoring the formula
  • making and timing decisions about rebalancing
  • navigating the myriad choices in executing investment strategy
  • vagaries of the markets
  • probable lack of time needed to recover from severe market declines
  • inability to mentally deal with the ups and downs that are a regular part of the markets

Note that there are other issues that can make you decide on the lump sum, but the point I want to make is to look at the big picture of the purpose and the use of the pension as it has a real effect on you.

Increased asset values are great, but you do not spend asset values, you spend cash flow!

For additional information, see my blogs dated Feb 15, Feb 24, Apr 12, May 3, May 8 and Jul 12.  If you are considering a lump sum payout, make sure you understand everything I wrote in those blogs.  If you do not, then enter a comment here and I’ll reply to you.

3 Comments leave one →
  1. July 31, 2012 6:10 pm

    Ed,
    The article is concise yet thorough and provides excellent advice for those who may be faced with such a decision.
    One additional comment I would have included is that there is at least one factor that may tip the balance in the direction of a decision on whether or not to take a lump sum payment – the health of the person about to retire. If, for example, the imminent retiree has a medical condition that would significantly reduce their life expectancy, a decision to take a lump sum distribution might be the right way to go. Of course, there are “lifetime” annuity plans that may include guaranteed payment periods, etc. so, as usual, the devil is in the details.
    The person commenting asked me to not include his name. It is a great comment and wanted to share it with my readers.

  2. Raymond G. Russolillo permalink
    August 1, 2012 1:48 am

    I have often counselled clients who face this choice to think of a retirement annuity as an anchor to windward – a fixed income substitute that they cannot outlive. For most people, taking on a significant additional investment responsibility when they may have neither the skill nor the inclination is not a good thing. However, for those who are disciplined and like to invest, a lump sum can be a marvelous thing!

    • August 9, 2012 1:56 am

      Good comment Ray.
      Sometimes discipline trumps knowledge. Many people that have great knowledge about investments and the markets do not always stick to their game loan or goals by trying to jump on to an “opportunity” or get caught up in some market timing maneuvers.
      Further as you said, managing investments is a responsibility and many do not have the ability to properly handle that responsibility which needs to be backed up with knowledge and understanding of the markets and skills and experience to determine the proper asset allocation formula and assemblying the portfolio elements underlying that plan.

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