About 90,000 white-collar retirees of Ford Motor Co. and the financial advisers who help them are facing a major decision: continue to receive a monthly check from the defined-benefit pension plan or leave the plan by taking a lump sum that the auto giant will likely offer over the next 30 to 60 days.
In what has been cited as the largest voluntary buyout in history, Ford said last month that it wanted to lighten its $49 billion U.S. pension obligation by offering non-unionized former salaried employees a one-time payment.
The size of that payment depends on the number of retirees who choose it, of course, but Ford thinks that its offer could reduce its U.S.-based pension obligation by about a third (or roughly $16 billion), Robert Shanks, the company's chief financial officer, said during an earnings conference call last month.
He didn't share any information on the assumptions that will be used to calculate the size of the payments.
Of course, the key factor in determining how much Ford will offer is the interest rate that it will use to calculate the present value of retirees' pensions. The Pension Protection Act of 2006 requires that long-term corporate-bond yields be used to calculate minimum lump-sum payments from defined-benefit plans.
Using that yield, now at about 4.20%, would save Ford a considerable sum over using the rate for comparable Treasury securities, now about 2.8%. Pension plans were required to use the Treasury rate until this year.
In the meantime, many Michigan-based financial advisers are preparing clients for what could be their most important choice in retirement.
Considerations going into the lump-sum or payment stream decision include individual and spousal life expectancy assumptions, tax-planning issues, legacy plans and the fairly negative investment outlook that most advisers see over the next five to 10 years.
“The first conversation I'm having with these clients is making sure that they understand the transfer of risk,” said Wayne B. Titus III, founder of AMDG Financial Advisory Services LLC of Plymouth, which manages $40 million in assets.
“Ford bears the investment and longevity risk if the retirees leave the money there, but if my clients take the lump sum, they are transferring risk to themselves,” he said.
Generally, advisers suggest opting for monthly payments if the client is in good physical shape and has a family history of longevity. The lump sum might make more sense for individuals who haven't been in the best health.
Leon C. LaBrecque, chief executive of LJPR LLC of Troy, cited the case of one of his Ford retiree clients, a woman in her 60s, in remission from cancer, whose husband is in good health.
“I'm probably going to suggest that she take the lump sum, and we'll invest heavily into fixed in-come,” said Mr. LaBrecque, whose firm manages $420 million in assets. “The payment she's receiving from Ford now is like a superbond, and we want to stay conservative.”
Another situation favoring a lump sum is one in which the spouse of a deceased retiree receives survivorship benefits. That payment stream ends once the surviving spouse dies, leaving nothing for any heirs.
But if the survivor opts for the lump sum and invests it wisely, whatever remains after generating retirement income becomes part of the survivor's estate.
“Health is a huge consideration,” said Lynn M. Vance, senior partner at Global Financial Planning Group LLC, a firm in Troy with $150 million in assets under management.
“People don't understand that with a pension, they only own the income stream. If you take the lump sum and die in six months, then you've won,” Ms. Vance said.
Making the choice of a lump sum or a payment stream also carries tax consequences. For those younger than 591/2, rolling the lump sum into an individual retirement account means that they can't touch the money without paying a 10% penalty.
Ms. Vance has a personal interest in the dilemma. Her 57-year-old husband, a Ford retiree, is among those being offered the buyout.
The two are inclined to continue the payment stream, as they are using the income.
Ford retirees who opt for the lump sum and roll it into an IRA should be aware of the tax implications that could occur if they make a large one-time conversion to a Roth IRA.
“Advisers need to determine how much money they can convert from a regular IRA to a Roth without boosting the client into a higher tax bracket,” Mr. Titus said.
He added that if a retiree is between 62 and 66, and yet to begin taking Social Security benefits, his or her income may be low enough to begin converting an IRA to a Roth with less of a tax bite.
The conversion makes sense, however, only if the client has enough money to live on and expects to pass on the Roth account to heirs, as the Roth account should be invested for growth, Mr. Titus said.
Advisers who opt to have their clients remain in the pension plan cite the safety of a guaranteed income stream in the face of a negative investment outlook.
Clients who decline to take the payments need to think about whether their lump sum can generate sufficient returns to provide income over their lifetime. Actuaries and advisers said that the value of the lump sum is expected to be equal to the monthly stream of income over a lifetime at an effective interest rate of 4.25%.
“If you had to replicate the income stream yourself for a single life, you would need to place the lump sum in a fixed annuity that earns a rate of 4.25%,” Ms. Vance said. “In a variable annuity, you need 4.25% plus more to cover the expenses to make it worthwhile.”
But choosing a payment stream has risks, too, advisers said.
For instance, if Ford were to become financially unable to pay off its pension obligations, the Pension Benefit Guaranty Corp. could step in and continue paying the pension, but probably at a much reduced rate.
“At the executive level, [the risk of insolvency] is more relevant,” said Jason Close, an adviser at Capelli Financial Services Inc. of Bloomfield Hills, which has about a dozen clients who will choose between a lump sum and a payment plan.