The Markets

Jun 21, 2012 | Blogs, Daily Financial

Terrry Sawchuk Financial Advisor Terry Sawchuk
Founder & Chairman

The deadline for GM and HP soon–to-be possibly former employees to make their “Oh-so-important” decision as to whether they should take the pension buyout offer is fast approaching. We thought we would chime in one more time, now that most have offers in hand and are spending many sleepless nights wondering what they should do. Relax, we have the answers, and it’s really not that difficult. We know you’ve been slammed with offers to “help” you make these decisions by every broker/planner/advisor/counselor/agent/representative/wealth manager (did I miss anyone?) under the sun. This doesn’t have to be that difficult. There are some very basic factors that must be in place in order to take the lump, if they are not, it doesn’t make sense. If they are, it at least opens the possibility.

Let’s start with the basics. I hate to sound like that self-righteous voice in your head that you’re not even sure where it came from, but honestly, if you haven’t done a good job of saving, investing and living well within your means, then you should not take the lump sum, PERIOD. The fact is, almost nobody can count on taking the lump, investing it, and replacing the entire pension with earned interest without touching the principal. The math doesn’t work, and frankly, it’s not supposed to. The pension itself is NOT designed to generate interest alone that is enough to pay you the monthly check. From a mathematical perspective, the pension is designed to be completely empty, in very general terms, when you reach your early eighties. In other words, each check you get from the pension plan is actually a combination of a return of some portion of principal along with interest. What gives the overall plan the advantage over investing individually is the size of the group. Since nobody knows how long he or she will live, nobody knows how many payments they will receive. It’s a crapshoot. The pension plan benefits because it has a relatively large margin for error in that many will live fewer years than their life expectancy, while others will exceed it. Depending on how early someone dies, it gives the pension extra money to pay the others that exceed the expected age. It becomes a game of probability and the pension managers have some pretty smart actuaries running the numbers. Ultimately, it really boils down to whether the actuaries are right, as to whether the insurance company can run the fund profitably, or not. That becomes a part of your decision, having faith that Prudential can and will be around long enough to make the payments. It’s a pretty safe bet. From our view, it’s highly unlikely that the pension plan payments would not be met. The hitch, if there is one, is that if for some reason they did have financial troubles, in Michigan, the state only backstops $250,000. It’s a far cry from the Pension Benefit Guaranty Corporation, who has vastly larger resources.

So let’s get back to you. The number one factor, by far, in this equation is whether you can safely produce the shortfall in income you would incur by taking the lump sum. To reiterate, the lump sums generally are not large enough to produce enough income without invading principal, to replicate your monthly pension. You will have to make up the shortfall with income from other sources. Perhaps you don’t need the full pension check every month. If that is the case, you can take the lump, roll it to an IRA and only take the income you need, thereby reducing your overall tax burden. If this is you, congratulations, you’ve done a marvelous job of managing your finances. Either that or you’re extremely frugal. Either way, you can take the lump without hesitation. In our experience, however, most people are spending nearly all, if not a little more than what the pension and social security bring in each month. These people have some more thinking to do. The key here is do you have enough other assets to replace the short fall? In our estimation, the range seems to be 25-40%, meaning that if you invest the proceeds of the lump sum, you can conservatively expect to generate enough income to replace 60-75% of what you are currently getting from your pension. For example, let’s say a 63 year old retiree is currently getting $3,500 per month in pension income. And for the sake of discussion, let’s say the lump sum is $500,000. If you take a conservative assumed return of 5%, that will only cover about $25,000 annually, or about $2,083 per month. The question then becomes do you have enough other assets that you can produce the roughly $1400 per month in shortfall? This is a very generic example; however, it’s not far off the typical scenario we have encountered. If you have the assets, then the lump makes some sense because you now control the principal and ultimately, your spouse and children would be much better off. But many people are more concerned about income today than leaving a legacy and that’s when the math gets more difficult. It’s pretty simple, if you need the full monthly amount and don’t have enough other assets to gather income from, you should NOT take the lump sum, no matter what advice someone may be giving you.

There are some other considerations to give thought to. If your health is poor, you have material information that the pension managers don’t. They assume you will live to full life expectancy, but if you know that isn’t likely, the lump sump is better for you. If your health is poor you probably won’t get enough payments to justify the pension. By taking the lump sum, you will leave your spouse or children (assuming you have them) in better shape. It also gives you the option to spend a little more today, knowing there may not be too many tomorrows. Our heart goes out to you if this applies, we hope that the days you have are satisfying and enjoyable and you spend them with the people that you love. In fact, whether you are healthy or not, taking the lump sum does give you the option to spend a little more in the early, potentially more active years, and cut back later as you age and become a bit more home-bound. Naturally, you must be very careful to monitor your finances on a regular basis to make sure you don’t over-do it and leave yourself in a bind in case you accidentally live too long! But the lump does give you more control.

Another consideration is whether you took a spousal continuation when you first made the decision to retire. If you did not elect a reduced pension to provide for your spouse, here’s your chance for a do-over. GM gives you the option to take a reduced monthly check in exchange for either a 50% or 75% survivor option. In either of these cases, the lump may be the better choice, but only if you have savings and assets outside of the pension.

Lastly, much of the decision depends on your emotional make-up. If you are completely risk-averse, have little experience with investing and don’t have a competent, trusted financial advisor, don’t even think about the lump sum as you are welcoming disaster if you do. If you have some confidence, either in yourself, or the people you’ve hired to help you with your money and if you’ve done a nice job of saving and investing, the lump sum is a viable option. Think about a dentist for example. When a dentist retires, particularly if he was in private practice, he has virtually no pension. In fact, most of America doesn’t have a pension. They have to rely on their own personal savings and they do, every day. It can be done, but the numbers have to be right. It’s pretty simple math really, you either have enough or you don’t. From a psychological stand point, taking the lump sum puts you and whoever is helping you with your money, squarely in control of your financial future. The mistakes of others from GM, the Federal Government or Prudential, will never impact your ability to live comfortably. Of course, the sword cuts both ways, some people do not want that kind of responsibility, they like the perceived security that others are in charge and will serve their best interest. A word of caution; Bill and I have been doing this a long time now and we’ve seen an awful lot. Some people simply refuse to take responsibility for their own finances, maybe they are afraid of making a mistake, or maybe they just don’t have the confidence it takes to bear the burden of responsibility, so they somewhat blindly turn over their money to others, without really doing their homework. They figure they can delegate the work and that the “experts” should have the answers. I hate to be the one who exposes the wizard behind the curtain, but the “experts” aren’t always right. There is no substitute for experience and hard-work. PERIOD. Between Bill and I, we have more than 30 years of experience in this business. Unless you have a relationship with us or someone like us, if you are the person I just described, you should not take the lump sum. Your best option is to continue to take the pension from Prudential and let the chips fall where they may. This is an element that most advisors won’t touch; it’s the psychology behind the money. If you are confident and competent, or you have people helping you that are both, a lump sump might be your best option, otherwise stick with the pension.

Finally, a commercial for Sawchuk & Langenstein. We have met with many families who are working through this decision process, and through those meetings we have gained valuable experience that can help you make your decision. Frankly, there were ways of thinking that we would have never guessed, but through these meetings clued us in to certain things that are on the minds of the people in this process. We have software and what-if scenarios that make the whole process pretty simple and can quickly identify whether you should consider the buyout or not. If not we will tell you, and if you should consider it, then we can begin to work through what is best for you. Our biggest objective when it comes to long-term retirement-planning is to make sure the stock market does not ruin your quality of life. To be very clear, we don’t avoid the stock market, but we plan very carefully, and put safeguards in place to make sure that if we don’t get what we want or expect from the market, our clients will still be able to live comfortably. As I said earlier, there is no substitute for hard work, experience and having the right contacts, the kind that you can only gain by being in this business for a long time. We stand ready to help you make the best decision for YOU.

Best regards,

Terry Sawchuk

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