photo - Jane Young- It's Your Money
Jane Young- It's Your Money 

In an effort to reduce pension obligations, many corporations have been offering current and former employees a lump sum to buy out their defined-benefit pension plans.

At first glance, this may seem like a great opportunity, and pension administrators say that 50 percent to 70 percent of recipients take the lump sum. Analyze this carefully; it's an important and complex decision that is different for each individual.

Generally, the lump sum offer is based on an actuarial calculation indicating the present value of a pension's income stream, based on your age and a reasonable rate of return. You can evaluate the relative value of the lump sum offer by calculating the internal rate of return of the income stream or by running present value calculations using various rates of return and life expectancies. A fee-only financial planner or an accountant can help you with these calculations.

Life expectancy, readily available on the internet, is one of the biggest factors in determining whether to take a lump sum offer.

However, the typical life expectancy may not apply to you. Healthy individuals with a history of longevity in their family may live longer than the standard life expectancy.

Individuals with health issues or a family history with shorter life spans may anticipate a shorter life expectancy. Generally, monthly payments from a pension are better if you anticipate a longer life expectancy and a lump sum is better if you anticipate a shorter life expectancy.

Other considerations include having the discipline to invest the funds from a lump sum to be gradually used throughout retirement rather than spending the entire amount over a short period. Also consider your comfort with investing the lump sum and your willingness to take some risk to earn a reasonable return. A lump sum may be a good option if you need access to a large amount of money in the short term.

It's good to strike a balance between fixed-income streams that can provide more certainty and an investment portfolio that is more volatile with potential to earn a higher return. If you have another pension, consider a lump sum. If you don't have another pension, a fixed income stream may add some stability to your finances.

Another huge factor in the decision is the safety of your pension. Pensions offered by most public corporations are insured by the Pension Benefit Guarantee Corporation (PBGC) up to a limit of around $60,000 for an individual and $54,000 for a 50 percent survivor benefit. Unfortunately, state and local pensions are not covered by the PBGC. The pension administrator can tell you if your pension is insured by the PBGC and how well it is funded. Anything under 80 percent is a red flag. If your pension is not insured and is not well funded, it may be wise to take a lump sum.