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Retirement Planning > Retirement Investing > Annuity Investing

When Clients Get Lump-Sum Pension Offers, What to Advise?

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An increasing number of your clients are facing the novel possibility of choosing a lump sum payout from their pensions instead of the traditional annuity option. Recently, General Motors and Ford have made headlines with their pension buyout offers, but this is a trend that is likely here to stay for the wider market. Before choosing whether to remain with the annuity option, which is perceived as a safe bet by many, or opt for the lump sum, there is one thing that every client will need—your advice.

The lump sum option is a once-in-a-lifetime possibility for many clients to customize their retirement income stream, yet it is a decision that few should make on their own. Have you considered how you will advise?

Managing client expectations

Because your clients may not consider all the pros and cons of the buyout option, it is important to manage their expectations. Many will be eager to take the buyout, believing that they can invest in the equity markets and beat the returns offered by their corporate pensions.

This is unlikely. We all know how the stock markets have performed in recent years, and it would be a fluke for a novice investor to realize significant gains through equity investing (of course, if you manage money for your clients, you may have a different opinion.)

Additionally, the sums offered are, in many cases, more money than your client has ever seen at one time. Because your clients have not done the math, many will not fully grasp the reality of what they are receiving—the lump sum offered today will be some portion of the amount that they would receive over a lifetime of pension payments, not the entire amount.

For your clients relying on their pension for living expenses, it is critical that they understand the need to properly manage these funds, rather than using the seemingly large sum to live a more elaborate lifestyle.

So, what should your clients do with that lump sum?

With proper management (and properly managed expectations), the lump sum can provide your clients with a secure lifetime income stream. The primary benefit of choosing the lump sum over the pension annuity payments is flexibility. While an annuity may remain the most secure option for most of your clients, today’s annuity options are incredibly varied.

The pension offers a fixed monthly payment for life. In most cases, there is no adjustment for inflation or fluctuating interest rates. Professional management of the lump sum payment can also provide these protections.

For example, multi-year guarantee periods offered with some annuities can ease your clients’ worries on locking in an annuity at an interest rate that is too low. A technique called laddering can allow clients to protect against interest rate risks by choosing multiple rates over the annuity guarantee period. Your clients who are eager to participate in the equity markets can do so safely, through uncapped index annuities. This strategy ties the earnings of the annuity to a stock index, such as the S&P 500, or to multiple stock indices for greater protection.

Clients who favor the lump sum option because of the ability to leave a legacy can still purchase an annuity and add a rider providing enhanced death benefits. For those concerned about long-term care expenses, annuities with chronic-care riders are available.

And for clients who are simply not interested in a current annuity option, longevity annuities can provide insurance against outliving their current investments.

While there are positive and negative aspects to any of these annuity choices, unlike the traditional fixed pension benefit, each allows your client to customize a retirement strategy to his unique goals. Every client’s individual financial position, life expectancy and personal objectives must be considered in evaluating whether to accept a lump sum offer, and, once the offer is accepted, how to manage the proceeds. One thing is certain; however, those accepting the lump sum buyout will need your professional financial advice.

Your questions and comments are always welcome. Please post them at our blog, AdvisorFYI, or call the Panel of Experts.

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