Ace the Biggest Money Test You'll Ever Face

If your boss offered you a six-figure check to walk away from your pension, would you take it? As tempting as such an offer might sound, it might actually be smarter to turn down the money in many circumstances -- but with a huge number of variables involved, it's far from a no-brainer, especially given the amount of money on the line.

Lump sums and you
Lump-sum pension payments are back in the news because of big deals from Ford (NYS: F) and General Motors (NYS: GM) . Back in April, Ford started the ball rolling by offering 90,000 former salaried workers and retirees a choice to receive an upfront payment in lieu of the monthly benefits they'd be entitled to receive under the automaker's pension plan. Then last month, GM followed that up with a similar offer to 42,000 white-collar retirees, with an added twist: rather than getting monthly payments directly from GM, workers will have to choose between the lump sum and a private group annuity from Prudential (NYS: PRU) .

But having a choice between monthly pension benefits and a lump-sum buyout is nothing new. Many pension plans offer such decisions to workers, and the dilemma workers face always boils down to this: Is the flexibility of having a lump sum to invest and spend worth the responsibility for managing your money prudently, or would you prefer just to get a reliable monthly check for the rest of your life without any fear that it will ever run out?

Why is this happening?
Corporate America has struggled with pensions for years, with underfunding being a constant problem. In today's financial environment, low returns have made it even harder for companies to generate the investment gains they need in order to meet their pension obligations. As a result, companies like Ford and GM are essentially giving up, saying that they'd rather pay billions of dollars now in order to extinguish what could be much larger payouts down the road for decades to come.

But other factors are also at work. Calculations of lump-sum payouts are fairly complicated, but some changes in pension law that took effect a few years ago helped allow Whirlpool (NYS: WHR) and Dow Chemical (NYS: DOW) to produce substantial savings on what otherwise would have been higher lump-sum payment obligations.

One size doesn't fit all
Perhaps the most important thing to understand is that lump-sum payouts first and foremost represent a gamble about your life expectancy. In simplest terms, if you live longer than an insurance actuary would estimate as your likely lifespan, then you'll likely do better taking monthly payments rather than the lump sum. But if medical and other considerations suggest that your personal life expectancy is below average for your age group, lump sums make more sense.

Yet even then, the decision isn't so simple. Consider:

  • Both choices have tax consequences. You can roll a lump-sum into an IRA and have control over when and how much you take -- and consequently how much you have to include in your taxes each year. With pension payments, you have no flexibility: You get what you get.

  • With a lump sum, it's up to you to find good investments. If you can produce better returns than the rates on which your payout is based, then taking a lump sum will leave you ahead. But if you squander your money on a bad investment, there's no safety net to rescue you.

  • It's a tough market out there. If sophisticated companies are having trouble investing well, you have to question whether you can do a better job.

What to do
The key to understand is that a lump-sum payment isn't like winning the lottery. It's money that you've already earned, that you have a right to. Make sure to take the time you need to make a smart decision, and get the help you need to make that decision the right one for you. That way, you'll never have to regret your choice in the biggest money decision you'll ever make.

Meanwhile, you should also have some investments outside your company pension. Read about some good prospects for a retirement-oriented portfolio in the Motley Fool's special report on long-term investing -- just click here and start reading your free copy right now.

At the time thisarticle was published Fool contributor Dan Caplinger doesn't expect to see a big lump sum coming his way. He doesn't own shares of the companies mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool owns shares of Ford. Motley Fool newsletter services have recommended buying shares of General Motors and Ford, as well as creating a synthetic long position in Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is always a good decision.

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