The Markets

Jun 3, 2012 | Blogs, Daily Financial

Terrry Sawchuk Financial Advisor Terry Sawchuk
Founder & Chairman

TO LUMP OR NOT TO LUMP…

General Motors and Ford recently announced the plan to offer certain retirees the option to “trade-in” their monthly payments for a single lump-sum payment in an effort to reduce their long-term burden of pension funding and management. The media suggested the move would save the automakers tens of billions of dollars. As you can imagine, the news has been met with a wide range of emotional responses from: skepticism, to fear, to joy, and even anger. Perhaps the best word to describe the situation is, uncertain. It’s easy to understand why retirees would meet the offer from their former employers the way little red riding hood would meet an offer from the big bad wolf; in a word, trust. In a world where big business and politicians have repeatedly mismanaged corporate and public finances, ransacked taxpayer-funded institutions, saddled future generations with debts and obligations that cannot be met, it would be foolish for anyone not to wonder if they’re shaking hands with the devil.

We are here to help you through this process. We have extensive experience in this area and can assist you in making the best choice for you and your family. We have included a number of considerations for you to think about in the following pages on this topic. This letter is meant as a general overview of just some of the factors that could play an important role in your decision. If you have read enough and are eligible for the buyout option please call us, 248-269-9700, at your earliest convenience to discuss your options.

The line of thinking goes; if it’s good for the auto companies then it can’t be good for the retirees. The reality is however, that it can be good for both. You’ve heard the phrase, “if you want the job done right, then do it yourself”. We’re not suggesting retirees take the buyout and manage it themselves; the dot.com, condo and gold bubbles are recent examples of why that might not be such a good idea. We are suggesting that separating the futures of retirees and their former employers could be a very good idea. It means that if you receive an offer, you will have to do some leg work. Ultimately, it could be one of the most important financial decisions of your lifetime, being lazy or blindly turning over the decision to someone else is not advisable. It’s your future, make sure you stay involved but it’s probably not best to go it alone.

The decision of whether to take the lump sum shouldn’t really be based upon potential investment performance, because the harsh reality is that nobody has any idea what the future holds. Instead, it should be largely based on calculation and management of various risks. What risks? Some risks to consider: longevity (accidentally living too long), investment, personal behavior (are you or your spouse a spend-thrift likely to burn through that lump-sum), corporate (will the former employer need another bailout or worse), and even legal risks (such as possible divorce or law suits).

Mark Twain’s famous quote “there are three kinds of lies: lies, damned lies and statistics”. Numbers can be made to dance, but the numbers really do need to be thoroughly analyzed for an informed decision to be made. Be leery of anyone who gives you cookie cutter advice that minimizes the evaluation required in making this decision. As you might imagine, the announcement of the lump sum option was seen as an enormous opportunity by the investment advice wielding community and there will be numerous overtures directed towards luring you into their open arms. You should know that lump sum calculations are based upon several factors: age and life expectancy, current guaranteed lifetime payments, and interest rates, among others. Working backwards, if you know the value of payments in today’s dollars, the remaining variables are how long you will live and what interest will your money earn? Naturally if interest rates are hyper-low, larger lump sums would be required as earned interest will make a smaller percentage of the overall total obligation. The older you are , the fewer the number of payments are needed to satisfy the balance owed to you, which could offset the benefit of lower rates. It doesn’t entirely rule out the lump sum option for an older person (think over 70), but it could potentially reduce the appeal on the numbers alone. The bottom line is that every situation needs to be considered on the merits of its own independent circumstances, there are no blanket solutions to the question of whether a lump should be taken or not.

Another consideration: how would a buyout potentially impact your spouse or your beneficiaries? You may be given an opportunity to greatly enhance the legacy you leave your spouse and children should you take the lump sum. On the other hand, if you elected a survivorship option on your pension, you need to consider what impact the rollover may have on your spouse if you die first. Sometimes life insurance works, but not everyone will qualify. Without life insurance, when you pass there is nothing that goes to the kids, the income stops with you and or your spouse. There is much to discuss and consider on this topic, but for now just keep in mind that your family may benefit from a lump-sum option.

Financial planning software programs designed to make projections with respect to hypothetical investment growth rates, taxes, inflation and other factors, can be helpful in analyzing data to assist in the decision. However keep in mind that the software is hardly fool-proof and in all likelihood will be fairly inaccurate. It should be used as a guideline and NOT a rule. In the end, the decision will be made based upon a series of educated guesses, nothing more. This is not meant to discourage the use of the software as it can identify possible outcomes which could be very useful, it’s just naïve to assume that the software has any predictive ability; it’s simply a tool to aid in the decision making process.

We should mention that it would be a mistake to view the offer of a lump-sum buyout of your pension as a one-sided benefit to the auto-companies. While the potential benefits to GM and Ford are somewhat obvious, the potential risks to you are not. In the future, if either of these companies experience financial hardship, it’s safe to say they may not find the political or social environment as friendly as it was in 2008/2009. A trip to bankruptcy court for either company would be unlikely to produce a similar outcome to the one GM was afforded in their 2009 bankruptcy filing. The court system allowed GM to default on their bondholders while not having to turn over their fully-funded pension plan to the government established pension benefit guaranty corporation. The GM bankruptcy was unprecedented in that regard, and there is risk that a future bankruptcy would result in the pension being turned over to the PBGC. The pension benefit guaranty corporation is currently underfunded by billions of dollars, needless to say if your pension landed at the PGGC you may not get all the income you were promised. Given current global macro-economic conditions it’s not inconceivable that either company could have another bout with financial hardship.

You are facing quite possibly the most important financial decision you will ever make, and it should not be taken lightly. You may encounter a variety of emotions that could influence your thought process, having an objective third party to help keep you on the right path may be as useful as a heads-up display. Our experience and expertise are at your disposal, please call our office, 248-269-9700, to set up a meeting and we can begin to work through helping you decide whether the buyout really is the best choice for you or your family.

Best regards,

Terry Sawchuk

Visit www.sawchukwealth.com to review past issues of The Marketview.

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