A picture taken on September 17, 2019, shows the logo of U.S. giant General Electric in Belfort, ... [+] France. (Photo by SEBASTIEN BOZON / AFP)

Are pension plan participants being shortchanged when their former employers offer them lump sum buyouts?

The short answer is, It depends.

And this is actually a reversal for me, as Id previously defended companies against those who say theyre cheating their employees.

It turns out to be a bit murkier.

But lets backtrack:

Is your former employer offering to buy out your pension accruals with a lump sum, or offering you the opportunity to start your pension earlier than usual? The lump sum offer has become a preferred method for companies to reduce their pension liabilities, and financial experts have warned repeatedly that this can be a poor decision for participants because the value of a pension goes beyond the dollar amount of the payments made over time. Thats because the actuarially fair calculation the company is required to perform is not the same as what it costs to buy an annuity that protects you against outliving your assets.

At the same time, Ive written in the past that these programs do not cheat employees because employers are required to base their math on actuarially fair assumptions, but employees nonetheless should evaluate their particular situation; in most cases theyre better off keeping the lifetime benefit but there may be some situations (ill health, solid lifetime benefits from another source) in which the lump sum is the right choice. For especially young employees, a rollover to an IRA of money they might otherwise forget about or struggle to find out how to claim at retirement age can be a particular help.

And now Im hearing reports of a new offer employers are making to their former employees: the option to begin their retirement benefits well in advance of the usual benefit commencement date. Why might companies do this? There are some reasons why this would help them with risk management: This can be a first step toward settling liabilities by purchasing annuities with insurance companies, and this will reduce their risk profile by moving more benefits into payout status. And, again, in principle, this is all done on the up-and-up and with actuarially fair calculations.

But theres a loophole. Some companies may be deceiving their employees, or, more neutrally stated, causing them to unknowingly opt out of valuable retirement benefits.

I was passed on a letter sent to a former General Electric employee who was eligible to begin a vested benefit at retirement age, to see how the GE pension buyout looks for an individual participant. The form offered not just a lump sum but, in fact, two new options to eligible employees: in addition to retirement benefits payable at age 60 or 65, participants may elect a lump sum payable immediately or an early pension option in which benefits would also start immediately. In this case, the individual was 53 years old and the monthly benefit offered for starting right away was only 45% of the monthly benefit at age 60. How, my correspondent asked, could the reductions for seven years be so dramatically lower?

The answer was in the fine print:

GE offers a pension with a normal retirement date of 65, and the lump sum value and the early pension option monthly benefit were both based on the actuarial equivalents to the monthly age-65 benefit.

But the plan also contains a provision for what they label an early retirement subsidy in the form of the ability to begin benefits as early as age 60 without any reduction. And the value of this subsidy is not reflected in the lump sum or early pension option calculations. It can only be obtained by waiting until age 60 to begin receiving benefits, and choosing an annuity rather than a lump sum.

Whats more, this benefit is substantial. In this particular employees case, opting for a lump sum early rather than beginning benefits at age 60 would reduce his benefit by about 30%!because the reduction was from 65, rather than 60, to 53.

Now, GE, in its defense, would say that its materials are perfectly clear on this point. They say, in bold print and with underlining, that

This [early retirement] subsidy is not included in the amount in [the lump sum choice] or [the early pension choice], which is based only on your benefit at age 65. If you start your pension before 65 under [the standard retirement provisions], those monthly payments are expected to be worth more than a lump sum or an immediate annuity under [the alternate choices] (assuming average life expectancy).

Is this clear enough for them to have met their ethical duty to treat plan participants fairly? Should they have made it clearer exactly how much money participants who chose the extra-early monthly payment or lump sum option are leaving on the table?

To be clear, GE is not in violation of any law, and participants are not losing any part of their protected age-65 benefit. But those who elect the lump sum do so without knowing (absent additional research on their part) how much additional benefit value they are forgoing.

And GE isnt the only company.

UPS is engaged in another wave of what it calls a Special Pension Payment Offer, in which former participants with vested benefits are able to take lump sum benefits; as with GE, they are not merely offering the lump sums that make the news but also the opportunity to begin retirement benefits early.

How early? An anonymous employee at a UPS employee discussion board posted the offer he received. UPS is offering him the option to elect an early retirement benefit 20 1/2 years early, that is, at the age of 44 1/2. Not surprisingly, his benefit is reduced by a factor of 0.27that is, 73% less than if he had waited until his normal retirement age, and, judging by the conversation on that board, no one is seriously considering taking that level of monthly benefit, and advice is split on whether to roll over the money into an IRA or live for today (which one presumes were largely in jest).

At UPS, there is no general availability of early retirement subsidies, but certain former employees, depending on employee group, are able to retire early after 30 years of service without any reduction in benefits, or receive other forms of early retirement subsidy, according to an SEC filing. I sought clarification from the company as to whether the value of these benefits are reflected in the offers eligible former employees are receiving, or whether, as with the GE former employees, they, too, are forgoing valuable benefits without knowing it; the response I received was a carefully worded nonanswer to the question.

A former employee also shared with me the decision guide being provided to employees. The company does state that

You will be responsible for investing your distribution, which may increase or decrease your income over your lifetime and

If you live beyond your life expectancy assumed in the lump sum calculation, you could end up with less money than if you received a monthly benefit. Alternatively, if you die earlier than assumed in the lump sum calculation, you may receive more under the lump sum option.

Is this sufficiently meaningful information to enable a participant to make an informed choiceespecially when one of those choices is a monthly benefit, but begun at what may be, depending on the participant, a ridiculously early age?

And how many other companies are engaged in the same approach, enabling former employees to unknowingly opt out of early retirement subsidies, and offering early retirement benefits at an age well below what makes any sense for a workers financial well-being?

Again, companies are following the law. But are they acting ethically?

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The Hidden Way Employers May Be Shortchanging Employees In Their Pension Lump Sum/Early Retirement Offers - Forbes