Financial Education Can Help Your Pre-Retirees With Their Pension Distribution
January 29, 2013With growing concerns about retirees outliving their retirement savings, one crucial decision that some workers have to make can have a huge impact on their chances of not outliving their nest egg, and that is which pension payout option they select at retirement. This important choice, which is irrevocable once selected, is often misunderstood by employees. I’ve heard many employees who were planning to overlook a period certain option because they thought the payments would end at the end of the period (such as a 10 year certain and life annuity) if they outlived the time frame or employees who simply ask “What do most people pick?”.
An interesting study recently released by the Employee Benefit Research Institute looks at the role that plan rules plays on the payout decision on defined benefit plans. Not surprisingly, the rate of annuitization varies directly with the degree to which plan rules restrict the ability to choose a partial or lump-sum distribution. Plans that do not offer a lum-sum distribution have annuitization rates close to 100%, since employees aren’t tempted to cash out their balance. Defined benefit plans that have no restrictions on the lump-sum distribution had more than half of their participants choose the lump-sum option at distribution.
Having the ability to select a lump-sum distribution can be very attractive to retirees who don’t need the cash flow and would prefer to continue to defer taxes on the pension by rolling it into their 401(k) or an IRA and can be beneficial for inheritance purposes. However, these retirees are taking on two very big risks: market risk and longevity risk That’s why it’s important to provide your workforce with the education they need to analyze both the pros and cons of taking a lump-sum distribution and help them understand how to minimize the risks.
Employees need to be educated on the various payouts available to them, preferably prior to their retirement. This gives them the time to understand what the options are and how a lifetime income compares to taking a lump-sum distribution in their own personal situation. This can be an overwhelming task if the employee is introduced to the options just a few months before they retire and can lead to an uneducated selection that may not be in their best interest. For mid-career employees, an efficient way to educate them on the pension payout options is as a component of a retirement planning workshop. However, as a late-career employee gets within a few years of retirement, this education is better handled with a 1-on-1 financial counseling session. Most importantly, the education should be free of any conflict of interest, since many financial advisors are on the lookout for lump-sum distributions as a way to generate a commission.