Ep # 25: Why You Should Pay Attention To Your Pension Election

Benjamin Haas |

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Benjamin Haas  00:03
Hi everyone and welcome to A/B Conversations, where we will help you CFP your way out of it. A podcast where you get into the minds of a couple of Certified Financial Planners on how we feel about everyday financial planning questions and what should really matter most to you. A healthier financial life starts...now.

Adam Werner  00:26
Welcome back. Your favorite time of the week? 

Benjamin Haas  00:30
Took my line, yes it is. I'm happy to be back. How are you? 

Adam Werner  00:35
Doing well. 

Benjamin Haas  00:36
Sun is shining, spring has sprung. 

Adam Werner  00:40
It's feels like it. 

Benjamin Haas  00:41
So excited I could wet my plants. No?

Adam Werner  00:48
I'm just going to let that go. 

Benjamin Haas  00:50
It's like one of our favorite bad dad jokes in my house. 

Adam Werner  00:53
I didn't want to step on it. So today it seems to be a conversation that we've been having a fair amount recently and it revolves around pensions decisions. As we were talking about that there are a few decisions in life that are truly irrevocable and pension election is certainly one of those that, you make a decision and usually cannot undo it. It has lasting effects that may or may not be good in the long run so we'll just share some of the high level of conversations that we've been having things to keep in mind. All of those little hidden things to remember as well. 

Benjamin Haas  01:44
Yeah and I think what makes this a nerdy, fun thing for us to talk about is the fact that in our minds, this is one of those financial planning topics that is so situational because when we're talking about a pension, we're talking about a specific company or institution that you worked for that has their own ways of providing this as a benefit. Then you can take that one step further and say here, we are working with a client who has their own unique set of circumstances that we need to understand. I think we have an opportunity here to get way deep into the weeds but I think where I would like to focus is one of those things that kind of like pick out of this decision-making process that we really want people to know about. I'll kick it off with the one that I think is probably the biggest decision and it may not even apply to everyone and here's what I mean by that. In some situations, people will come to us because they have a pension that's going to provide them with some sort of lifetime payment and sometimes there's a pension option that says, hey, you can do that if you want but by the way, here's a lump sum of money you could have in lieu of a lifetime payment. Let's just start there, if you have that option, that's a really big decision to make and what would go into that. 

Adam Werner  03:05
I think oftentimes, there's absolutely comfort in knowing that, if it's a lifetime payment, that you can't outlive it right. I know I'm going to get this dollar amount for the rest of my life. 

Benjamin Haas  03:23

Adam Werner  03:24
It's not going anywhere.

Benjamin Haas  03:26
Secure. The flip side typically, that payment doesn't change, right. There's no cost of living to that. So we see that as a little bit of a risk that okay, a monthly stipend of $3000, $4000, $5,000 today. 20 years from now that feels like $3000, $2000, $1000. It's not the same. 

Adam Werner  03:54
Inflation in that analysis for us is a big one and it's somewhat of an unknown. We don't know what inflation is going to be 20 years from now but we can make some reasonable assumptions based off of past results and just where we see things now. Then the other option there the lump sum. That's not necessarily secure, right? You're not theoretically, if you are taking just withdrawals as needed, which could be if you're taking withdrawals too aggressively, that could leave that account to go to zero sooner than later. So it may be finite during your lifetime. It may run out at a certain point depending on how aggressively you're pulling from it. 

Benjamin Haas  04:41
How do you feel about investment risk because that's something you want control over as it does feel better to have that consistent paycheck that's very predictable. I guess in the same vein, I think about other money that people may have saved up. It may be great to have that consistent paycheck but you can't say I want this annuity lifetime payment and then call the company up and say, Hey, by the way, we really need a new roof on the house, can you send me $12,000 bucks? No, you can't, you don't have control over the asset anymore so this really is like a give and take to figure out what do you prioritize the most.

Adam Werner  05:22
That flexibility, I think is one of the biggest components to making that decision and you said it but it depends on what other assets, what other savings, what other fixed income, that you have to help make that decision on essentially what is the biggest priority knowing all of these other variables and now this new way of making this decision. What's the most important for this one, now looking at the pension as an asset. Where do you prioritize? Is it the monthly income? Or is it the lump sum? Or maybe it's going a little bit deeper. Maybe it's not just the monthly income but it's I have a spouse that I want to make sure that if something happens to me that then they get a portion of it as well. 

Benjamin Haas  06:08
Let's go into survivorship options in a second but there was something you said that triggered for me, again, just thinking about recent situations that we've had and this is not to say it's the same for everybody. But if that buyout option, that lump sum dollar amount that's been calculated, is something that would come to somebody maybe earlier in life. Maybe it was a merger, maybe it's a new company, maybe the old company is just deciding, hey, we don't want these promises to pay for life with these annuity payments so we're going to give these lump sum buyouts. Yeah, getting that at 55-60 years old so that you can continue to allow that to accumulate or defer taxation, often makes a lot of sense compared to somebody that I'm starting this at 66 or 70 years old, where maybe longevity in your life is not something that you feel is going to make it seem like waiting makes sense so age factors in here. 

Adam Werner  07:08
Yeah, absolutely and so then even just to add on to that, I think we went down that road and then I veered off, it's taking that lump sum option, we would view that as potentially some sort of inflation protection. Depending on how you would invest that lump sum. If you are not leaning on it too aggressively for income when you first retire, you theoretically should be able to allow that to grow over time. Lean on it later in life, again, depending how its invested. Hopefully, it should grow but then that would be hopefully keeping up with cost of living over time. If it's invested in stocks and bonds, that should rise over time in line with at least inflation. So it doesn't feel like your dollars are worth less in that future. Like if it's a fixed pension payment, we know inflation is going to be something moving forward and if that pension number stays the same, your dollar in the future is worth less than it is right now. 

Benjamin Haas  08:09
Yeah, especially when you put them in the same camp as social security and we historically have seen Social Security payments not go up in the same way that maybe your healthcare expenses do so this fixed income that you have today feeling so good the napkin math of yes, this is going to work. To your point, 10, to 15, to 20 years from now, 30 years from now, geez, yeah, people are living longer and certainly not going to feel the same. Another situation kind of popped into my head as you were saying that. I think to some of our teacher friends or people that maybe work in the nonprofit sector, sometimes it's kind of the hedging of the bets, right? I know to our teacher friends, you're allowed to withdraw what you've contributed to that pension system and still get a fixed income on a regular basis. So that's maybe a different situation, all the way to this has to go back 10-12 years, maybe you'll remember who I'm thinking about. A gentleman retired at 67 didn't take survivorship for a spouse and passed away a year later. Heartbreaking story where really this was their retirement and however that happens, unfortunate, untimely death turned into not just an emotional travesty, but a financial one for her. Maybe that's an okay segway. 

Adam Werner  09:27
Yes, let's talk about survivorship options.

Benjamin Haas  09:30
Yes, please. 

Adam Werner  09:31
And even that, again, it's all situational, right? It depends on if maybe the spouse worked, their social security, if they have a pension, what other savings you have, right? If you are making that pension decision on your own, if it's let's just move past the lump sum versus the payment. Let's assume now you're going to take the payment but now the next level of options is do I just take the highest payout, which is only on my life. So as long as I live, I get this payment but if I pass away, it doesn't go to anybody else and then there's usually varying degrees of survivor benefit. Maybe it's 50%, 100%, meaning they would get exactly what I would get or the 50%, they would get half of what I would get while I'm living. There's all those different sliding scales of the survivorship options. 

Benjamin Haas  10:22
It's not meant to overcomplicate it because I would venture to guess when we have these conversations, let's be clear, usually people don't have a lump sum option. I think it's more common that the pension is going to be some sort of lifetime payout and it's very common for somebody to default to, well I love my husband, I love my wife, I'm going to leave them something. I'm going to choose a survivorship option here and often case, the default is 100%. Right? I'm willing to take a little less a month for myself, in order to make sure that no matter when I pass away, my spouse gets that same benefit. But that's where I think, okay, good financial planning comes into play here and one of our first questions always is:

Adam Werner  10:24
Are you setting things up for me? 

Benjamin Haas  11:08
Do you have life insurance? 

Adam Werner  11:11
You froze. 

Benjamin Haas  11:13
No, just waiting on you. 

Adam Werner  11:15

Benjamin Haas  11:16
Do you have life insurance? I think that has to play a role here because really, that's the way I think about the survivorship option. If I'm willing to take a couple $100 less in income a month to make sure that my spouse gets something in a way, that amount of money kind of feels like paying for life insurance so that when I pass away, this money can continue or this now lump sum of money can continue to support my spouse. So if you already have your own life insurance, I think that plays a role in this decision. 

Adam Werner  11:47
Yeah, absolutely and I don't know if we've talked about this on a previous podcast, there's a strategy, we call it pension maximization, which is essentially that. You look at your options of the highest benefit possible, which is usually the single life versus the 100% survivor, meaning I'm going to I'm going to take a lower pension payment while I'm living knowing that if I pass away, then my spouse is going to get the exact same payment. That difference between the single life and the 100%. survivorship as you said, we would take that number, call it a couple $100 a month, how much insurance does that potentially buy? You're essentially buying yourself your own survivorship option but now you control it. 

Benjamin Haas  12:35
Yeah and I guess this is where you give the good disclaimer. This is where age, health, all these things are going to come into play but of course, hopefully people get to get the idea here. It's just a broader way of also thinking. What do we want to have happen here? People have a monthly benefit that's secure to them that supports their retirement, they live a long and healthy life and maybe that's survivorship wasn't really needed. The nice part about either having an asset or a life insurance policy is that can continue to the next generation. Now, this pension has become a multi-generational asset, if there are kids or grandkids involved. That doesn't happen, right? Let's be clear, in a pension life payment scenario, even if it goes to the spouse, it's not going to the next generation. More often than not the vast majority of the time, that's not going to the next generation. This is the way to kind of go back to let's not look at this pension decision as independent of all the other financial planning objectives you have and maybe this pension can play multiple roles. 

Adam Werner  13:42
Not to necessarily veer off course but another option that we see is the term period certain. I think where we've often been posed that question or where people come to us and they're just not sure even what the heck that means. 

Benjamin Haas  13:59
What does that mean? 

Adam Werner  14:00
Let's just give the high level. So often what we see is you can take some sort of single life option. It's the higher payout with 10 years, 20 years, whatever the number is, period, certain. So essentially, what that means is, let's use the example: straight life 10-year period certain. That means I'm going to get the higher benefit during my lifetime but if I pass away in year five, then my survivor is at least going to get the next five years' worth of payment. That means that pension is going to pay that benefit to somebody for at least 10 years and if you live beyond that 10 years, you'll continue to get it for your lifetime but that period certain means someone is going to get that payment for that time period. 

Benjamin Haas  14:43
Again, I think there's a lot of analysis that should go into when would that be appropriate and when isn't it but that's a really good point. There is that option that is usually tied to it too so is there anything else you really want to highlight or can I button that all up?

Adam Werner  15:02
Wrap it up.  

Benjamin Haas 15:03
So our key takeaway would be this is a big decision and while I think there are some common defaults to here's how I'm going to take it and what matters most. We don't see this as being independent of all the other financial goals or other financial planning variables in your life so that can be longevity in your life, that can be other income, other assets. We brought up, is life insurance a part of your portfolio at this point or is it not? Is there legacy planning you want to do and when it comes to that whole idea of lump sum versus annuity, how people feel about risk is really important to talk about. I know there's a lot of, at least in our world right now, a lot of questions around pensions. I hope this was valuable. You got questions, let us know. We're here to answer them.  

Adam Werner  15:55
Yep. Absolutely. 

Benjamin Haas  15:56
Thank you, sir. 

Adam Werner  15:57
All right.

Benjamin Haas  15:58
Another one down. Hey everyone, Adam and I really appreciate you tuning in. Please note that the opinions we voiced in the show are for general information only and are not intended to provide specific recommendations for any individual. To determine which strategies or investments may be most appropriate for you. Consult with your attorney, your accountant, financial advisor or tax advisor prior to making any decisions. Thanks for listening!

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