It's a challenging calculation that
involves several unknown variables
General Electric is
the latest company to offer a pension buyout to former employees as it tries to
shore up its pension plans, which were $27 billion underfunded as of year-end
2018.
The company
is offering lump-sum
payments to 100,000 former employees, in addition to freezing its pension plan
for 20,000 U.S. employees.
There are several
factors financial advisers need to weigh for clients who are approached with
such an offer, from GE or any other employer.
"There will be
a mathematical side, but there will also be more of a qualitative, big-picture
side," Matt Cosgriff, wealth management group leader at
BerganKDV Wealth Management, said of the pension buyout variables.
[Recommended
video: Advisers demanding help to improve
the client experience]
The first
consideration for advisers and their clients is to understand the terms of a
buyout. Buyouts often come in the form of a lump-sum distribution that
represents the present value of an employee's future pension payments.
Employers offer
workers these lump-sum payouts to remove pension obligations from
their books. GE, for example, said the recently announced
pension changes would trim $8 billion from its pension deficit.
Employees who stay
in the pension plan will receive monthly annuity payments, often with the
option to choose between a single-life annuity and a joint-and-survivor annuity
that would continue paying income to a spouse in the event of the employee's
death.
Once an adviser
knows the available options, the key considerations boil down to the client's
goal for the money and the adviser's beliefs about the future, such as life
expectancy, investment returns and employer solvency, said Jeffrey Levine, CEO
and director of financial planning at Blueprint Wealth Alliance.
Mathematically, it
may make more sense for a client with a high likelihood of living a long
time to remain in the pension plan.
Employers offer
lump sums based on actuarial tables of average life expectancies, rather than
individual life expectancies. That means a man or woman who runs marathons and
eats healthy and whose family members have a history of living well into their
90s or even longer would probably outlive the average life expectancy, and
therefore earn more over their lifetimes with the monthly annuity payments than
they would with the lump-sum distribution. But a client with low life
expectancy would likely be better off taking the lump sum.
"You have to
make a guess in terms of longevity, in terms of how long those monthly payments
are going to last," said Brad Arends, co-founder and CEO of advisory firm
Intellicents Inc.
Client risk
tolerance and an adviser's belief about future investment returns are
also important. For example, clients in their 40s with an aggressive risk
tolerance may be more likely to invest a lump sum and generate more future
income than they would get from the pension plan.
"Risk
tolerance comes into play in a huge way,' Mr. Arends said. "A good planner
is going to come back with options. They'll say, 'Here's a conservative way and
a more aggressive way to look at it.'"
In addition,
advisers should weigh the financial stability of an employer and its pension
plan. If the company defaults and its pension obligations are supported by the
federal Pension Benefit Guaranty Corp., retirees may get only a portion of the
benefits they'd previously been promised. If there's concern about a company's
future solvency, an employee may be better off taking a lump sum.
Another important
consideration here is the client's goal for the assets — a client looking for
income would likely be better off rejecting the buyout offer and staying in the
pension, whereas a client planning to leave a legacy for children or
grandchildren may benefit more from a lump-sum payout.
There's also a
behavioral element, advisers said.
"If you have someone
who's incapable of living within a budget, maybe the annuity is better from a
behavioral perspective," Mr. Cosgriff said.
Taking a lump sum
also affords tax flexibility that a pension wouldn't. For example, clients
would have the opportunity to accelerate that income periodically to fill up
marginal income tax brackets, or do Roth conversions.
Taxes are largely a
secondary consideration, however, Mr. Levine said.
No comments:
Post a Comment