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What Is a Pension Buyout?

Byline profile imageEdited by Mike Obel
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Byline profile imageEdited by Patrick Villanova, CEPF®
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A pension buyout is an offer from your employer to take either a lump sum or an annuity in exchange for giving up future pension payments. Companies often use these programs to reduce expenses and lower long-term liabilities, gaining immediate benefits like cutting administrative costs tied to running pension plans. While the arrangement can be appealing to employers, employees don’t always view it the same way, and mishandled buyout efforts have at times led to dissatisfaction or even legal disputes.

Consulting a financial advisor may help you make decisions related to your pension payments. Connect with an advisor for free.

What Happens During a Pension Buyout?

As retirement inches closer, individuals are often faced with intriguing options, one of them being a pension buyout. This option begins when the company offers a buyout to eligible employees. The offer usually comes in the form of either a lump sum payment, an annuity or a blend of both. The calculations involved in determining the buyout amount can be complex, typically valuing the present worth of future pension payments, based on factors such as your age, years of service and projected retirement date. 

The popularity of pension buyouts has grown since the 1980s, primarily due to evolving market conditions and legislative dynamics. Companies looking for ways to reduce overhead and minimize liabilities began extending these buyout offers to employees, particularly those nearing retirement.

Your Options During a Buyout

A couple looking at their three pension buyout options.

In the face of a buyout offer, you typically have up to three different options, but each choice isn’t always a possibility. Your three options could be: 

  1. Lump sum payment: You could accept the lump sum payment, granting you immediate access to funds but also waiving your right to future pension payments. 
  2. Annuity: You could opt for the annuity route, guaranteeing a constant stream of income over a specified duration. 
  3. Stick with the pension: Turning down the buyout offer is also a potential choice, especially if you trust in your company’s financial stability and prefer a secure monthly income in retirement.

There is no one-size-fits-all solution to this type of situation. It’s important to make sure you understand what your options are and how they will impact your finances over the next several years before you make that choice. For instance, if you’re grappling with hefty medical debt or other immediate financial needs, the lump sum payment could be your lifeline. In the same vein, if you can successfully invest the lump sum for a higher return, you might emerge better off accepting the buyout. 

Potential Consequences of Taking a Buyout

Just like most financial decisions, electing to take a pension buyout can come with its fair share of financial tradeoffs, such as the potential for outliving your savings, dealing with a staggering tax bill or losing a guaranteed income stream.

Risk of Outliving Your Savings

Opting for a lump sum places the responsibility for managing your retirement income squarely on your shoulders. Unlike a traditional pension that pays for life, a lump sum can be depleted if withdrawals outpace investment growth or if you live longer than expected. This possibility makes it important to think carefully about how the money will be invested and how much you may need each year.

Tax Implications

A large payout can create an unexpected tax burden if it’s taken as cash. The distribution may be treated as ordinary income, pushing you into a higher tax bracket and reducing the amount you get to keep. These consequences can be avoided by rolling the lump sum into an IRA, where taxes are deferred until you make withdrawals in retirement.

Loss of Guaranteed Income

For those accustomed to the security of a monthly pension benefit, giving up that guaranteed income can feel like a major shift. A buyout removes the predictability of fixed payments and replaces it with market-based outcomes, which may fluctuate over time. To replicate steady income, some people consider purchasing a private annuity using part of the lump sum.

Bottom Line

A financial advisor covering the pension buyout options for a couple.

Understanding a pension buyout and deciding how to proceed can be intricate. Unraveling the minutiae of the offer, reflecting deeply on your unique financial situation and retirement goals and getting professional financial advice are important steps in making a choice that fits you best. 

Retirement Planning Tips

  • A financial advisor can best help you make these tough financial decisions. If you decide to take a buyout they can also help you find the right way to invest your money for long-term success. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now. 
  • You may want to consider using SmartAsset’s free investment calculator before making any investment decisions to help you see what your potential returns could look like.

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