Factors to Consider If You’re Offered an Early Retirement Package

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As the coronavirus pandemic continues taking a toll on the finances of many U.S. corporations, some are looking to lower costs and future pension obligations by offering some employees an early retirement package. These packages usually include an option to receive a one-time, lump-sum payout of pension benefits or monthly pension payments over a period of time, including for life.

If you are offered this kind of package, you’ll need to do some number crunching to figure out which option is best. Here are some steps to follow to help you make the right decision.

Guaranteed Return vs. Higher Earning Potential

If you take a lump-sum payout, you’ll probably roll the cash over into an IRA. So the main question becomes: How much would the monthly pension payment be compared to how much you could potentially earn in an IRA?

One rule of thumb states that if the monthly pension payment will be 6% or more of the total lump sum, taking the pension payment could make the most sense. On the other hand, if the monthly pension payment will be less than 6% of the total lump sum, taking the lump sum and investing it yourself might be smarter. With this strategy, you’re essentially creating your own personal pension plan.

If you deposited your lump sum payout in a low-risk, low-rate money market account and withdrew 5% a year, the funds would last at least 20 years. So you could withdraw 5% of the lump sum each year to provide income to cover your living expenses during the first 20 years of retirement. 

Instead of parking the payout in a low-rate money market account, of course, you could invest it in hopes of earning a higher return. In this case, the payout could possibly be stretched out for longer than 20 years, though there are no guarantees. 

Use This Calculation

There’s a simple calculation that can help you make the right lump sum vs. monthly pension payment decision. Multiply the amount of the monthly pension payment by 12 and divide this by the lump sum total being offered.

For example, let’s say you’re offered a monthly pension payment of $2,000 for life or a lump sum buyout of $320,000. Here’s the equation: 2,000 x 12 = 24,000/300,000 = .08. In other words, taking the monthly pension payment would give you a guaranteed return of 8%. While it’s certainly possible you could earn more than this by investing the funds yourself, the risk-free nature of this return makes it pretty attractive for many people.

Now let’s consider a different example. Suppose you’re offered a $1,300 a month pension payment for life or a lump sum buyout of $300,000. Here’s the equation: 1,300 x 12 = 15,600/300,000 = .052. In other words, taking the monthly pension payment would give you a guaranteed return of about 5%. This is a lower barrier than 8% when it comes to taking a lump sum and investing the money in an IRA yourself, so you might consider taking the lump sum in this scenario.

More Factors to Consider

In addition to making this calculation, there are a few other factors you should consider when making the lump sum vs. monthly pension payment decision. For example:

  • What is your projected longevity? While nobody knows how long they’re going to live, your family history and health status could give you clues. The longer you live, the more valuable a monthly pension for life is.
  • What type of pension payout is offered? Some pension plans offer various payout options like paying benefits based on your life only or on the life of your surviving spouse. Another option referred to as “period certain” pays benefits to surviving family members for a period of time if you die soon after monthly payments begin. These options could affect your final decision.
  • Do you have a large emergency savings fund? If not, you could take comfort in knowing that you have a large cash stash at your disposal if you ever face a future financial emergency.
  • How solvent is your employer? If you decide to receive monthly pension payments, you should carefully investigate your employer’s financial condition to make sure they will be able to make these payments for many years to come. Find out if the Pension Benefit Guarantee Corporation (PBGC) insures the plan in case the sponsor goes bankrupt.

Run Your Own Numbers

The lump sum vs. monthly pension payment decision could have a significant impact on your retirement finances if you accept an early retirement package from your employer. Therefore, you should run these numbers yourself or talk to your financial advisor about the best option for your financial situation.

Give us a call if you’d like to discuss your situation in more detail. We’d be happy to run the numbers with you and help you analyze other factors that could be relevant to your decision.


The commentary is limited to the dissemination of general information pertaining to Frontier Wealth Management, LLC's ("Frontier") investment advisory services. This information should not be used or construed as an offer to sell, a solicitation of an offer to buy or a recommendation for any security, market sector or investment strategy. There is no guarantee that the information supplied is accurate or complete. Frontier is not responsible for any errors or omissions, and provides no warranties with regards to the results obtained from the use of the information. Nothing in this document is intended to provide any legal, accounting or tax advice and Frontier does not provide such advice. This information is subject to change without notice and should not be construed as a recommendation or investment advice. You should consult an attorney, accountant or tax professional regarding your specific legal or tax situation.

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