As is often the case with financial terminology, a word or phrase may have several different meanings depending on the context in which it's used. For example, the term "pension buyout" describes at least three different transactions. An insurance company or investment bank's assumption of the assets and liabilities of a defined benefit pension plan in exchange for a premium that funds a group lifetime annuity for all plan participants is called a pension buyout. When an employer encourages a worker's voluntary retirement by agreeing to pay the employee for a year or two until the company's retirement plan kicks in, that's also called a pension buyout. Finally, a consumer finance company engages in a pension buyout when it advances the retiree cash immediately, in exchange for several years of future guaranteed monthly pension payments.
Defined Contribution Pension Buyouts
While pension buyouts have been transacted in the United Kingdom for many years, they're just getting started in the U.S. As reported in the Prudential Newsroom website in December 2010, "United Way of Central Maryland has selected Prudential’s Portfolio Protected Buy-Out to support the termination of its defined benefit retirement plan." This transaction allowed the United Way pension trustees to transfer their liability for future retirement payments to the insurance company, which would then cover each retiree with Prudential's group annuity.
Early Retirement Pension Buyout
Employers seeking to reduce their overhead expenses in a down economy may persuade older employees to voluntarily retire early by offering to buy out the time between the current date and the worker's pension starting date. In exchange for paying the employee to retire early, the company shrinks its payroll, FICA withholding and health care costs. Workers who accept these buyout packages are usually required to sign waivers of their rights to later sue employers for discriminatory termination.
Lump-sum Pension Buyouts for Retirees
Under certain circumstances, retirees receiving fixed payment pensions may negotiate with a consumer lender to sell part or all of their future retirement income stream for a lump-sum cash payment. The cash might cover high interest credit card debt or finance a new business venture. Before agreeing to a pension buyout, the pensioner ought to measure the interest cost of the transaction against the benefit gained from the intended use of the money. In addition, the retiree should factor in the risk of losing the guaranteed future pension income plus the risk associated with the proposed application of the funds. A younger retiree who's still doing some work may be a more suitable candidate for a pension buyout.
The jargon used to describe insured defined benefit plan buyouts, early retirement buyouts, and lump-sum cash pension buyouts can be misleading and confusing. A retiree may be misunderstood if he uses a general term when seeking information regarding an issue such as "pension buyouts." To render useful assistance, a financial adviser should first clarify the question, then proffer an explanation using non-technical terminology.
- Photodisc/Photodisc/Getty Images