Factors to consider before taking a pension buyout

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.

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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.

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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.