With our baby boomer-in-chief turning 60 earlier this summer and the baby boom generation marking that same milestone this year, we're providing a number of articles that might be useful to this noteworthy generation. This article was originally published on Nov. 23, 2005.
If you've got a pension in the offing for your retirement, you're not among the majority of workers today. Traditional pensions are referred to as "defined benefit" plans, because the amount you'll receive is specified. Their more prevalent counterparts today are "defined contribution" plans, such as 401(k)s, which feature specified contribution amounts. For example, you might have 6% of your salary invested in your 401(k) plan, with your employer matching 25% of that amount.
With these latter plans, the amount you'll ultimately end up with is quite uncertain. It all depends on the investments you select and how they fare.
The big choice
But back to you pensioners. One big decision you'll likely face as you approach retirement is how to take that pension. A typical choice is taking it either as a big, one-time lump sum, or receiving monthly payments for the rest of your life. The latter option holds much appeal for a lot of people. It keeps you from blowing the lump sum on 22 at a roulette wheel. It also keeps you from having to manage the money effectively, and it means you don't have to try to figure out how much you can withdraw on a regular basis to live on while leaving enough to last you for many more years.
But these days, many experts recommend forgoing all the convenience of monthly payments and instead opting for the lump sum. The reason? Well, look at how unstable many pension plans are.
Companies in trouble
As my colleague Chuck Saletta noted last year, "Companies such as Lucent Technologies (NYSE:LU) have dramatically scaled back retiree benefits, not just for new retirees but for current ones as well. Others, like bankrupt United Airlines, have essentially given up, turning their pensions over to the government's Pension Benefit Guaranty Corporation (PBGC), which will pay out only pennies on the promised dollar. Recently joining United in bankruptcy, fellow major carriers Delta and Northwest may soon do the same with their pensions. And it's not as though the worst is over. If struggling automobile titans Ford (NYSE:F) and General Motors (NYSE:GM) don't stop hemorrhaging cash and are unable to turn their businesses around quickly, they, too, will likely join the airlines and declare bankruptcy, turn their existing pension obligations over to the government as well, and drastically cut benefits going forward."
Take your lumps
According to Consumer Reports Money Advisor, the PBGC says that more than 1,100 companies are close to turning over their pension obligations to the PBGC, "with $354 billion in underfundings." Yikes. In such an environment, it can make sense for many people to take the lump sum while they can, since their monthly pension payments may not be too reliable. There is an upside, though: The lump sum can grow if it's invested intelligently, whereas monthly payments typically don't increase over time, even to account for inflation. In addition, you often can't pass them along to your children and grandchildren -- whereas that's something you can do with the remains of your lump sum.
Another choice
If you're a defined-benefit plan holder, you may face another decision -- whether to switch your plan to a "cash-balance pension plan." These plans are growing in popularity, but they may not serve you too well. The employer reserves sums of money for employees and guarantees the rate at which the money will grow. When the workers retire or otherwise separate from the firm, they then take a lump-sum payment.
So, what's wrong with these plans? According to an Associated Press article, "Many companies, including IBM and AT&T (NYSE:T), have converted from traditional defined-benefit pension plans to cash-balance plans in the last 15 years, and employees have taken some of the companies to court over it." The AP article also noted a recent Government Accountability Office (GAO) report, which looked at pension plans at 31 large companies and 102 smaller ones and found that "when employers switch from defined-benefit pension plans to cash-balance plans, 'most workers, regardless of age, would have received greater benefits under the [defined-benefit] plan.' Also, unless older employees are given the right to remain in the traditional plan, they 'experience a greater loss of expected benefits than younger workers.'"
Proponents of the plans like them for their portability and security.
Assess your situation
Everyone's situation is different, so to determine what your best course of action is, take some time to read and think more on the topic.
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This article was updated by Fool sector head Joey Khattab. He does not own shares of any of the companies mentioned. The Fool has a disclosure policy.
