Be wary of lump-sum retirement

Value Judgments

Your Money

September 26, 2004|By JANET KIDD STEWART

A FRIEND recently confided his agonizing struggle to decide whether he and his wife should accept an early-retirement buyout from her employer.

It was a debate that lasted, maybe, 12 minutes.

The cash-strapped employer (in this case, the state of Illinois) is offering to double workersM-F pension accounts, plus some interest, if they convert the money from a traditional pension to a lump-sum distribution and leave the payroll.

State officials say they hope to eliminate up to 3,000 noncritical jobs through the offer, saving $81 million in the current budget year. They acknowledge that the offer is far skimpier than a previous administrationM-Fs buyout deal a few years ago.

Workers arenM-Ft exactly storming the exits. As of Sept. 15, with about two weeks to go before the application deadline, 377 of the 22,927 eligible workers had applied.

Perhaps some are waiting for their employer to sweeten the deal, which state officials have indicated might happen. Others might be wary of the privatesector job market right now.

Or perhaps, after years of work force reductions, workers are more knowledgeable about lump-sum economics.

M-tItM-Fs been shown that people irrationally overvalue lump sums,M-v said Alicia Munnell, director of the Center for Retirement Research at Boston College. Munnell is wary of early-retirement packages that offer to replace traditional defined-benefit pensions with payouts that can be invested. Even if the lump sum is bigger than the traditional benefit at first, retirees risk outliving their investments, she said.

M-tUsually, these deals are good for a very limited number of people,M-v said Karen Norman, a certified financial planner in Troy, Mich., who has worked with several auto industry early retirees. M-tSome people simply assume itM-Fs going to be a good deal without really checking the numbers.M-v

I asked Michael Knight, a Libertyville, Ill., certified financial planner, what his advice would be to two hypothetical state workers considering the offer. The examples came from state officials and included a 37-year-old making $2,224 a month with almost six yearsM-F tenure and a 63-year-old with 27 years of service who makes $6,502 a month.

Leaving the job would qualify the younger worker for $11,894, a little more than five monthsM-F pay. But if, like most people, the worker had to use that money for living expenses while job hunting, the money would be taxed as income and penalized for early withdrawal, and would last less than five months. Even if the worker landed a new job within that time, he would then have to start retirement savings again, this time at age 37 instead of 31.

The 63-year-old would qualify for a $211,710 payout, impressive on its face but not so much in the details.

That worker would be giving up a defined-benefit pension of $2,880 a month for life (that would add up to $691,200 if he lives for 20 more years) with no investment risk, Knight said.

M-tWith increased life expectancy, [the pension] is an extraordinary benefit for the plan participants,M-v he said. M-tAs a taxpayer, IM-Fd love [a state employee choosing the lump sum], but if these were my clients, IM-Fd want them to take a really close look because it may be a huge giveup.M-v

My friend, a professional money manager, did some quick back-of-the-envelope calculations and found that his wife would be leaving roughly half of her guaranteed retirement on the stateM-Fs table if she bought a low-cost private annuity.

Potential retirees who have plenty of outside financial resources and a compelling hobby could do well with an early buyout, but anyone else should proceed with extreme caution, said Munnell, who saw colleagues at a former workplace regret leaving early.

M-tFor many people itM-Fs unwise. They react so strongly to what seems like a pile of money, and in the first year people are thrilled to do the things theyM-Fve always wanted to do. And then reality sets in.M-v

E-mail Janet Kidd Stewart at

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