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What to do when your pension plan is terminated?
Your mind on money

What to do when your pension plan is terminated?

The traditional defined benefit, or pension plan, is truly becoming a thing of the past. A recent GAO survey of 183 pension plans indicated that even among those plans that do still exist, 20 percent of employer sponsors intended to terminate the plan in 2015 alone. This trend is certainly in full swing in Northwest Indiana as well.

When a pension plan terminates, each vested participant in the plan receives a notoriously complicated notification letter announcing the termination. For many younger workers, their employer’s pension plan was something way off the radar, so when the convoluted notice comes in the mail it often causes even more confusion.

But it does require some decisions, and options must be considered wisely.

Usually the employee entitled to the pension can choose one of four primary options: to keep the retirement benefit (typically payable at age 65), take a much smaller income benefit immediately, take the current cash value of the benefit in a check now or rollover the cash value of the benefit to an IRA.

The full scope of matters to consider in this situation is beyond this column, but we can use a little common sense to come up with solid logic to approach these confusing options.

Let’s start with a process of elimination. First, if you are under 59 1/2 and elect to take the current cash value of your pension benefit in a check, the check will most likely be subject to income tax and a 10 percent tax penalty. This will result in a roughly 30 percent reduction in your after tax check, so unless the amount is very small (under $1,000) this is rarely the best option.

Second, for younger workers (those under 55) the typical current monthly benefit offered is not compelling. Most pension plans have age and service “bumps” that increase benefits considerably over time, so benefits offered with plan terminations tend to be kind of meaningless in the grand retirement scheme. So oftentimes, this option can be quickly eliminated as a viable choice as well.

This leaves us to consider keeping the pension benefit available at 65 and “letting it ride." A concern frequently expressed regarding this option is mistrust the pension plan will have the money to make good on its promised benefit. While this concern sounds valid, most pension plans actually insure their ability to pay benefits through a government insurance program called the PBGC. So unless your promised benefit is unusually large, the benefit is most likely secure and needs to be considered independently of this concern.

This leaves us with the rollover option. If a rollover is selected the current cash value of the pension benefit can be transferred to an IRA without incurring tax or penalty. Many employees find this option attractive and end up wondering if the amount offered in the cash value is a “good deal."

This is where math and planning come in. In order to figure out the “good deal” part, a calculation called a current value of future annuity is needed. There are many calculators online that can perform this calculation and some reasonable life expectancy and return assumptions can be used to do this math yourself.

Or, facing this decision is a good time to start a relationship with a financial adviser. A qualified adviser will understand the logic and issues involved in this situation and could prove invaluable in helping make the right choice for your particular situation.

Opinions are solely the writer's. F. Marc Ruiz is a local financial expert. Reach him at newstips@nwi.com.

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