Financial Updates With Erin Kennedy & Peter Richon | Should You Take that Pension Buy Out Now?

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Peter, it's good to see you. We have an important topic today. Should you take that pension buyout now?

And this was something that was really important to you and some of your clients, so I'm glad that we're talking about it. Rising interest rates will cause lump sum pension buyouts to be significantly lower in 2023. So that has a lot of pre-retirees wondering if they should be considering an early retirement. So first, how do these interest rates affect those lump sum offers?

Well, yeah, interest rates on the rise has impacted many different aspects of the economy and our financial situation. But one thing that people don't really, I think, have a full grasp on is how rising interest rates could impact pensions. And so pensions don't affect a lot of people. A lot of people are not in a company that offers a pension any longer. Companies have shifted that responsibility onto our own shoulders with 401Ks. But for those among us that still do have a pension on the table, so to speak, this is a big, big factor that we need to understand and consider that as interest rates go up, the lump sum that may be offered in lieu of a pension income from your company probably will be set to decrease. And that's because companies look at replacing the income. And so just for ease of math and round numbers, let's say that a company had offered to replace 50% of my $80,000 a year annual salary.

So they're going to give me $40,000 a year in retirement. Well, when interest rates are at 4%, that would be a million dollar equivalent portfolio value or lump sum that is likely on the table. But if interest rates rise to 5%, the company no longer needs that million dollars to generate the $40,000 of income. Now, instead, they only need $800,000 to generate the same $40,000 income. So as interest rates have been low for a historic period of time here, those lump sums have actually risen.

But as we are seeing interest rates reverse course and begin to rise, as we have seen this year, the lump sum that is being offered to individuals into the coming year will likely be decreased. And we need to get the word out about this so that those individuals are aware of that potential and likelihood. Right.

Okay. So we're going to break down some of the considerations. But first, I think the question that everybody has top of mind, right, is if I were considering the pension buyout for 2023, should I be moving my retirement to this year instead? Well, that's a little bit of a double-edged sword, two sides to that coin. On one hand, the pension lump sum may be lower if you do wait and delay into 2023 or beyond. But on the other hand, whatever personal savings that you have to supplement that pension that's probably invested inside of your 401k has already lost value in the neighborhood of 20 to 25% where market indices are right now. Now, we've got a little bit more control over that 401k. So potentially we were proactive or could do some things where if markets turn around, that bounces back. But I think you've got to consider both sides of that. You can't just rush out and say, oh, no, my pension is going to be less. Let me go ahead and retire, because if markets are down simultaneously, we've got to generate that income from somewhere. I think that no financial decision can be considered in a vacuum in isolation.

Just like Social Security or Roth conversions, you've got to look at the rest of the context of your financial picture. All right. Right. I only wish it were simpler.

I know it's not right. It's not. So, of course, the lump sum, as you're mentioning, shouldn't be the only factor when I am considering my retirement date. So what else then should I be considering? And first on your list here is tax planning, Peter. Yeah, tax planning is big.

It's not what you have. It's what you get to keep that lump sum from the pension, the lump sum that you've got in your 401k. All of that is yet to be taxed money. And we do have some opportunities to proactively control that tax liability. You know, there's a number of different types of risks to retirement. A risk is anything outside of your control that can impact and determine your outcome. Well, there are steps that you can take to mitigate and control certain risks. Tax risk and tax planning is one of the big major steps that we all should consider carefully when retiring. And Peter, I kind of took these out of order.

I apologize. First on your list was income planning. Income planning is big and pensions are absolutely part of income planning. Do I take the income that my company is offering and guaranteeing to me for the duration of my lifetime in retirement? Do I take a spousal benefit from that pension? A hundred percent spousal income, 50 percent reduction, 75.

Do I have a bump up option where if my spouse does not outlive me, that I bump back up to my original amount or do I take that lump sum, right? That's part of income planning. But again, along with Social Security, along with your personal savings and investments, you've got to look at filling the income gap. What are your expenses? What are your sources of guaranteed income through that pension or Social Security?

And then how much is your portfolio going to be responsible for generating? And in recent years, what we have found is that we can actually go out in many cases and generate an equivalent income to what a lot of pensions have been offering. That was not the case for many years. Companies were tending to offer a significantly higher income. But in recent years, that has come down to a place where you could roll out that lump sum privately, take control of your money to have access to it, and still find ways to generate that same equivalent income on a pretty guaranteed basis. Okay, so we talked income planning. I think you hit on spousal income dependency. Was there anything else that we need to know about in that category specifically?

I think there's a little bit more to that. When looking at the pension options, that top line of income, the one that gives us the maximum amount of income for life, obviously looks the most attractive. But oftentimes is for single life only. And if you predecease your spouse, if you're married, that income disappears. And when you make that decision on a pension, that's kind of a final decision, the lump sum kind of evaporates. I mean, if you pass away early, and there is a residual amount, it might go back to the company to pay other workers who are out living life expectancies.

It's not your money any longer. It's your stream of income that you're entitled to. But unless you have chosen some type of spousal survivorship income option, that can disappear or be reduced along with other sources of income that can disappear or be reduced in retirement, namely Social Security. If you've got a married couple, then both of them typically are entitled to their own separate stream of Social Security income. But one person only receives one Social Security check. So when one of a married couple passes away, you might have a reduction in pension and Social Security simultaneously and compounded by the fact that that survivor goes from married filing jointly to now single head of household. So their income decreases and their tax rate and bracket may increase. OK, so I think the other question a lot of people are wondering, how are these rising interest rates going to affect me if I've chosen monthly annuity payments? From your pension, right?

Yeah, it won't. That's the thing is that the company has been calculating and promising you a certain amount of paycheck replacement in the form of that pension. And that's the number that they're shooting for. That's the number that has been promised, which is why as interest rates are rising, the lump sum option, kind of the alternative is being reduced. But the amount of income that they are promising to replace, unless there's some type of renegotiations and restructuring of the pension, which do happen, but that's not connected to this interest rate conversation, right? The fact is that companies have a huge liability when they are funding a lifetime of income for their retired workers. It has put some companies behind financially and they have gone through some negotiations and restructuring of the pension saying, hey, if you want to receive pensions at all, collectively, you're all going to have to accept a reduced amount.

That does happen, but that's not necessarily connected to this interest rate conversation. If anything, the higher interest rates should make company pensions a little bit more solvent and stable. Okay, so speaking of this continued conversation, I want to backtrack just a little bit for another consideration here that you mentioned, and that's legacy planning.

What does that mean specifically? Right, yeah, again, with pensions, when you make that decision, a lot of times if you choose the income stream, legacy is evaporated. What could have been that legacy, taking those assets into your personal control, and then if you don't spend them over your lifetime, if they grow, if you don't withdraw them for income, they pass along to next generation beneficiaries, that is typically gone. There are some options that you can choose, and this is why every pension decision needs to be very carefully considered and worked through, hopefully with a goal-oriented investment, financial, and retirement planning professional to help you evaluate this. But social security and pensions do have an impact on legacy. We don't think of them in that way, but the more that you can get from your pension and or social security, then the more you can protect your personal wealth and assets and hopefully grow and preserve that to pass along as a legacy. We need to think of that not only in terms of our spouse for that spousal income dependency, but also what impact it has generationally.

Of course, and as you mentioned, none of this can happen in a vacuum. So we have to remind everyone that retiring into a bear market presents its own kinds of risk. We've talked before you and me, Peter, about sequence of returns risk, and we are in a bear market right now. Yeah, and we haven't seen sequence of returns risk for quite some time.

We've talked a lot about it over the last 14 years or so since the Great Recession. The fact that if you retire into a bear market or a declining market or stock market losses, it can make the trajectory of your retirement a little more difficult and not as optimal. And so we are seeing market losses this year, and this is why we've got to consider both the market environment along with the potential impact of these rising interest rates on the lump sum from the pension. And the article that we cited for this discussion actually kind of promoted that people should step up their retirement date and retire early because of the rising interest rates and the lump sum impact. But when you look at everything together, maybe that's the case if we were only looking at the pension. But we also have to look at our investments on the other hand and what has happened to them. And I think that most individuals would find it difficult to retire into the market environment that we're currently experiencing.

And many that I talk to are even considering delaying until the market bounces back or stabilizes. Right. Perhaps that article was just trying to have a catchy headline there. Yeah. Yeah. That happens. Yeah, that does happen.

But that's why we break it down, Peter. And that's why I have you as such a great resource. This was really helpful. So if somebody has questions again about determining all these factors because there are so many considerations, what's the best way to reach you?

Yeah. Give us a call at Rishon Planning, 919-300-5886, 919-300-5886. You can go online. richonplanning.com is what it looks like. richonplanning.com. It's my last name, Rishon.

You can also email me, Peter, at RishonPlanning.com. All right. Pete, thank you. Absolutely.

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