Personal Finance

Senate Democrats' bill tries to ease pension lump sum vs. income stream choice

Key Points
  • Many companies have offered the option to pensioners of accepting a lump sum of cash instead of a monthly income stream.
  • Senate Democrats introduced legislation to try making that financial decision easier for individuals.
  • These "pension buyouts" come with many trade-offs and can't be undone later.
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Americans may be getting more information about a big financial choice regarding pension benefits.

Pension plans traditionally pay retirees monthly streams of income that last for the rest of their lives. Companies may also offer a lump sum to current and former employees, allowing them to trade in that ongoing monthly income for a one-time pot of money when they retire.

These lump-sum "pension buyouts" let companies offload certain risks and costs. But they pose a complex financial choice that comes with many trade-offs for individuals. They also can't be undone later.

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A Senate bill introduced Wednesday — the Information Needed for Financial Options Risk Mitigation Act of 2022 — would set a baseline level of disclosures to pensioners with the aim of helping them make a more informed decision.

Sen. Patty Murray, D-Wash., who chairs the Health, Education, Labor, and Pensions Committee, and Sens. Tina Smith, D-Minn., and Tammy Baldwin, D-Wis., sponsored the legislation.

"It's probably a fair statement that, as often as not, pensioners don't really understand the value proposition they're dealing with," said John Lowell, an Atlanta-based partner and pension consultant at October Three.

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Companies also generally offer lower lump sums as interest rates rise, Lowell said. The Federal Reserve in March began a cycle of raising interest rates to combat high inflation.

There were 32.8 million people participating in pension plans in 2019, according to most recent data from the U.S. Department of Labor. That number has steadily fallen over the past decade, as companies have adopted 401(k)-type plans more readily.

What could change

The proposed legislation would require companies to send a notice about lump-sum offers at least 90 days before an individual must make a decision.

The memo would give information about a worker's future estimated monthly benefit at retirement age (or the monthly benefit if payments begin immediately) and the lump-sum amount available, as well as how that lump-sum amount was calculated.

The bill would also require companies to explain the potential consequences of taking a lump sum, such as the risk of outliving the money, the loss of certain federal protections from the Pension Benefit Guaranty Corporation and the loss of protection from creditors and spousal protections.

The PBGC insures pensioners receive full or partial pension benefits in the event a company can't pay. In a 2015 study, the Government Accountability Office found many individuals cited the fear of company default as an important factor in their choice of a lump sum; however, that study also found few companies notified pensioners of the federal insurance benefit.

The legislation comes as companies sponsoring 401(k) plans must start sending regular notices to workers this year about how their savings would translate into a monthly income stream in retirement.

Opting for a monthly stream of pension income can offer certainty in the face of certain variables, like investment risk and the duration of retirement, according to Allison Wielobob, general counsel of the American Retirement Association, a trade group.

Guaranteed monthly income might also lead to less reliance on federal programs like Medicaid in old age, in the event some retirees deplete their lump sums before death, Wielobob said.

Some observers might view the legislative proposal as steering retirees toward the income-stream option, which might be seen as paternalistic, she added.

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A lump sum might make more sense for certain people. For example, retirees may want more control over their money, Lowell said. They may opt to invest the cash or a certain portion of it themselves, he said.

Those with health risks likely to curtail one's life span may also get a financial benefit from a lump sum, Lowell said.

A pensioner who dies soon after retirement wouldn't collect as large an amount of money in total monthly payments relative to a lump sum. (However, depending on the chosen benefit, a pensioner's spouse might continue to collect monthly checks.)