Have an Employer Pension Plan? Then It’s Decision Time…

Most employers have transitioned over to 401(k) plans, but many people in their 50s and 60s still have the older defined-benefit pension plans. And they’re understandably confused when it comes time at retirement to decide which option to select. Unfortunately, I’ve seen some inaccurate, unhelpful, and even misleading information from respectable sources on this topic. If the alleged experts are confused, one can easily imagine that pension participants are confused, too.

There are a couple of key concepts to consider up front. First, are you married? If so, then you have to think about the financial security of your spouse if you die early in retirement. Second, do you have a lump sum option or must you receive your pension benefits in the form of monthly payments?

In general, pension participants can receive benefits in one of two ways: either a monthly payment or a lump-sum option. If a monthly payment is elected – and if you are married – then you and your spouse must decide whether to elect a joint-and-survivor option, but this means that your pension payments will be reduced.

Various options are offered to protect a spouse in case you die first. For example, if a $3,000/month payment is offered for your life (“Life-Only Option”), you might also have the option of reducing this amount to $2,700/month, but your spouse would continue to receive 50% of your pension – or $1,350/month ($2,700 x .5). This is called a joint-and-survivor option (“J&S Option”). In my experience, most people elect the J&S Option. But oftentimes purchasing an individual life insurance policy and electing the Life-Only Option from your pension plan may be a better choice. The lump-sum option might even make sense.

Whether a Life-Only option or taking a lump sum is a better choice will depend heavily on a family’s financial situation, health of the parties involved, and their financial goals. It’s important to get this decision right, because there generally are no “do-overs” once you start receiving monthly pension payments.

Lump Sum or Monthly Payments?

The first decision that must be made is whether to elect a lump-sum payment or monthly payments. More plans are offering lump-sum payments to reduce liabilities on balance sheets. Every situation is unique and must be considered with great care. Consider:

  • Can you take the lump sum and buy an annuity in the marketplace that contains different – even better – benefits and guarantees?
  • How financially sound is your employer? Will your company be able to meet all of its pension obligations?
  • Do you need the money now? Most people do, but if you don’t – it might be best to take the lump sum option.
  • Monthly Payments – Life-Only or J&S Option

    If you decide that monthly payments are best – and you are married – now it’s time to consider which monthly payment option to select. Protecting your spouse with a J&S Option is called a joint-and-survivor benefit, but in my opinion, it might as well be called the “cheap, low-quality life insurance option.” This option will protect your spouse, but there might be better ways to do it.

    In general, there are four basic ways your life expectancy in retirement will play out:

    1) You both live your normal life expectancy – the most likely scenario, if you’re healthy.
    2) You both die early in retirement – unlikely, but something to consider.
    3) Only your spouse dies early in retirement (does your plan have a “pop-up” provision?)
    4) Only you die early in retirement – hence the need for spousal protection.
    Let’s examine each scenario.

    You Both Live Your Normal Life Expectancy

    Assuming you are both healthy, the most likely scenario is that you and your spouse live your normal life expectancy. Even if you elect a J&S Option, your pension plan will only pay income if either of you are alive. But this income stops when you both pass away. Fair enough. But what if it’s important to you to leave some money to the kids, grandchildren, or a charity? Then your pension will not help you with this goal. You could fund this goal with other assets, but a life insurance policy – properly structured and funded – would pay a death benefit and satisfy this goal. In this case, we might take the extra pension benefits received from a Life-Only Option (instead of a J&S Option) and use those benefits to purchase life insurance.

    You Both Pass Away Early in Retirement

    The analysis here is similar to the analysis immediately above. You both die, the pension payments stop. Again, your family or a charity generally receive nothing from the pension plan.

    Your Spouse Dies Early in Retirement

    Many plans contain a “pop-up” provision, but many don’t. A pop-up provision allows the pension participant to “pop up” to the original Life-Only amount in case the spouse of the participant dies early in retirement. To use our example above, if you elected a 50% JS Option at $2,700/month instead of $3,000/month, then your pension payment would be increased back to $3,000/month if your spouse dies before you. Plans generally terminate the pop-up protection after a pre-determined number of years…i.e., 5 years. In other words, if your spouse dies in year 6, you will be stuck at $2,700/month for the rest of your life.

    You Die Early in Retirement

    This is precisely why you elect a J&S Option – to protect your spouse. You die, and your spouse continues to receive income. The death benefits from a life insurance policy, however, can be used to supplement income or buy an annuity at the time of your death. A little homework must be done up front to determine the amount of life insurance that is needed to purchase the same annuity (i.e., $1,350/month to continue our example). But this can easily be calculated by a financial professional familiar with these issues, if appropriate.


    Whew, that’s a lot to consider. This is an important decision. We’re here to help, if you have an upcoming pension election.

    Bottom Line: Carefully consider your options with a financial professional and do not automatically elect the J&S Option.

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    What is Your Financial Advisor’s Net Worth?

    Potential clients rarely ask me about my own financial situation.  This has always surprised me.  During the initial due diligence process, I ask them very detailed questions about their goals, assets, income, liabilities, etc.  I’m sure they would feel a bit awkward asking me the same questions, but it’s a relevant and appropriate topic.  I actually appreciate and respect the courageous individual who asks me for this information because they will see that I’m doing everything I’m asking of them and that I’m invested in many of the same investments which I am recommending to them.    

    The last time a client asked me for this information was about 6 months ago.  I had met with this couple multiple times, and this meeting had the air of “decision time” to it.  She started off asking me detailed questions about the benefits and compensation I offered to my employees (this was also important to her) and then asked me whether she could see a copy of my net worth statement.  I walked back to my office and printed it out – I keep this on my computer and update it quarterly.  The entire conversation on both topics took maybe 10-15 minutes, but that gave her and her husband the comfort they needed to move forward.  There was a sense of “we’re in this together, and we share similar values.”    

     You might be uncomfortable asking for this information, but why would you invest your lifetime of savings with someone who was not also successfully working towards their own financial goals?  On what authority could they possibly make recommendations for financial success when they haven’t followed their own advice?  How can they know your emotional ups and downs during market volatility if they are not invested, too?  Finally, it might simply prompt a better discussion with your advisor – for example, what advantages do see with Money Manager ABC over Money Manager XYZ? 
    Ask the questions.  You’ll do it in a tactful way.  And your financial advisor – if they’re worth entrusting your life savings to – will appreciate the opportunity to share his or her success with you.


    Posted in Uncategorized

    Investing in 2014

    My inner contrarian investor gets nervous when I begin to see such optimism about investment markets, and I’ve certainly noticed a positive change in investor sentiment lately.  A year ago in early 2013, clients and prospective clients were still voicing a lot concern.  You might recall that the “fiscal cliff”, sequestration, tax hikes, etc. dominated the media.  That seems to have mostly faded from investors’ minds, and stock indexes are powering to record highs as I write.         

     For those of you who read this newsletter, you know that I’ve been relentlessly optimistic on stocks for the last five years, and I remain so for longer-term goals.  But given the recent highs and improving sentiment, I’m feeling the need to calm client expectations for 2014.  I will, however, lay out both sides on how stocks might perform this year.  

    My job is to keep clients focused on their longer-term goals and away from the latest noise in the news.  As always, consume the caterwauling media at your own risk.  But we’ll talk 2014 because it might be best to temper expectations going forward.  We haven’t seen euphoria in a long time, and we’re not likely collectively there, yet.  But given the tremendous rise in equity values since March of 2009, it’s important to remember that euphoria can destroy an investment strategy as easily as fear.  

    I don’t believe U.S. stocks in general are overvalued.  Looking at historical metrics, they appear fairly valued.  Earnings are strong, inflation is low, there doesn’t seem to be any “irrational exuberance” in most markets, the U.S. is becoming a major force in energy production[1], the emerging middle-class megatrend continues, U.S. government debt is coming down (as a percentage of GDP), and gridlock in Washington is restraining the government from trying anything too stupid – well, mostly anyway.   

    International stocks actually look cheap in ways.  Emerging market stocks lagged all year, and it appears that opportunities for bargains are emerging  in Europe. 

    Many investors argue that QE is driving the U.S. stock market and that stock prices are artificially inflated.  Perhaps to a degree, but stop and break that argument down.  First, most of the QE money is not making its way into the economy.  It’s hard to push a string, and most of the QE funds still sit on bank balance sheets as reserves (in other words, it’s not being loaned).  Second, it’s primarily earnings and dividends that drive stock prices, and these numbers look solid.  Third, companies have become very lean and cost conscious and are sitting on a tremendous amount of cash.  Companies could be well-positioned to take advantage of near-term opportunities. 

    The concern going forward is that a large percentage of earnings growth is still coming from cost-cutting, stock buy-backs, and low interest rates…QE has helped large companies refinance debt to lower rates.  And it is here that QE has helped publicly-traded companies.  How will the “taper” affect things?  QE is truly unprecedented, and nobody – I repeat nobody – knows for sure how the Fed withdrawal from QE will play out.  

    I believe QE has done its job – and QE could now be harming the economy by distorting markets and restraining banks from lending.  Remember that interest rates are simply the price of money over time periods, and the Federal Reserve is distorting the price of money by forcing this price lower.  Negative, real interest rates (“real” – meaning, after inflation) have traditionally caused inflation and misallocated capital to projects and investments that otherwise would not get presently funded.  Many economists believe that this “malinvestment” ultimately results in a lower U.S. standard of living.  Low interest rates and over-regulation of banks are causing tighter lending standards than we would normally see in a recovery – thereby perpetuating a stubborn, though improving, unemployment problem.  In the last newsletter I argued that long-term interest rates probably need to increase more before banks are properly incentivized to lend money to small businesses, which are the primary job creators in the economy.  (A huge segment of the homeowner population – with good, but not spectacular – credit could also benefit from this.)  Small businesses must rely on bank financing because they do not have access to capital markets.[2]  Let’s use an example of how government pricing might distort markets:  what if the government, pursuant to some larger, benevolent public policy goal, ordered dairy farmers to lower the price of milk to 50 cents per gallon?  How would dairy farmers respond?  Considering the costs of production and running a business, I imagine they would stop producing milk and look to other farming activities for income.  Less milk would be available and perhaps more meat would show up in grocery stores – all distortions caused by the government pricing of milk. Banks are responding in similar fashion.

    [2] For example, your local bakery cannot issue stocks or bonds to raise cash for expansion. 

    Posted in Uncategorized

    Which Political Party Has Been Best for Stocks?

    The answer might surprise you…it surprised me.  This chart came from an e-mail to me from Oppenheimer as part of a larger article.  Interestingly, stocks have performed poorly under a Republican president with a Republican Congress.  Political stalemates appear to have worked best for stocks when a Democrat was in charge of the White House with Republicans in charge of Congress.  I wouldn’t read too much into this chart, but I also wouldn’t automatically assume one political party is best for markets.

    S&P 500 Index Annualized Returns/1928 through July 31, 2012[1]

    President       Congress        Return

    Republican      Republican      2.1%

    Republican      Democrat        8.6%

    Republican      Split                 13.4%

    Democrat        Split                 13.9%

    Democrat        Democrat        14.1%

    Democrat        Republican      18.2%

    Stay invested, my friends.

    [1] Bank of American Merrill Lynch, “Election 2012” August 16, 2012.  Standard & Poor’s 500 Composite Index is a market-capitalization-weighted index that tracks the stocks of 500 primarily large-cap U.S. companies chosen for market liquidity and industry group to represent U.S. equity performance.  Indexes are unmanaged.  Their results include reinvested dividends and/or distributions but do not reflect the effect of any sales charges, commissions, or expenses.  Past performance is not an express or implied guarantee of future results.  Individuals may not invest directly in any index.

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