A Frozen Pension Can Get Chilly

Copyright: <a href='https://www.123rf.com/profile_rolffimages'>rolffimages / 123RF Stock Photo</a>Recently my client (I’ll call him Neil) visited me and was very concerned. Neil and his wife Helen live in West Falmouth. They are both in their mid-50s, with two grown kids who have settled nearby and are raising families of their own. A few weeks ago, Neil received some bad news from his employer – news involving his pension plan.

Neil was informed that while his employer is still managing the pension plan, they’ve frozen it. As Neil said, “This cannot be good.” Neil was right.

You see, Neil’s employer can’t take away the benefits he’s already earned, but that benefit isn’t going to increase between now and the day he retires. The challenge is that pensions typically reach their peak during those last few years before retirement. So, Neil’s going to lose out on the back-loaded peak value he would have received if things had continued the way he expected.

I reminded Neil that even considering this news, he is one of the lucky ones. While a lot of us these days move from job to job and might even change careers several times, Neil’s spent years working for the same Boston-area corporation, where he’s a senior manager with a large staff and a generous benefits package, including that pension program.

Neil’s pension has been a cornerstone of his retirement plan – one that would provide a steady, predictable income he’d be able to count on once he moved from the wealth accumulation phase of his life to the distribution phase. Neil figured he was “set” for life. But now Neil is concerned that those plans seem to be in jeopardy.

When it comes to retirement savings, one of the most significant generational shifts facing American workers over the past 30 years has been the change from Defined Benefit (DB) programs – in other words, pension plans – to Defined Contribution programs, like 401(k) plans. Fewer and fewer companies offer any sort of pension program to new employees, and the reason is apparent: It’s a massive liability for most employers. But there’s a more significant issue as well: Even those that do are, in some cases, dangerously underfunded.

Of the 200 biggest pension plans offered by companies included in the S&P 500, an astonishing 186 of them don’t have enough money to pay current and future retirees. The gap between what they are already obligated to pay out and what they have is $382 billion and growing. Intel and Delta, the two biggest names on the S&P’s underfunded pension plan list, haven’t even funded 50% of their pension programs.

Underfunded corporate pension programs are only the tip of the iceberg. Cutter Family Finance readers with an eye on the news may also be familiar with a vast, looming problem in pension programs for government workers. Many of us are familiar with the financial issues in Puerto Rico. The government of Puerto Rico was already $50 billion in the hole with unfunded pension liability before Hurricane Maria hit them last year. In total, some estimates peg the total unfunded liabilities of state and local government pensions at $5 trillion.

How did it get this bad? Some of it has to do with overpromising benefits without figuring out where the money was going to come from down the road when it came time to pay out. A lot of it has to do with poor risk management from the fund managers, lower rates of return than were expected on risky investments, and other bad decisions.

But it’s not all doom and gloom. Goldman Sachs Asset Management’s senior pension strategist Michael Moran says that recent tax reform measures stand to benefit corporate pension plans.

Moran notes in a recent White Paper that plan sponsors can deduct contributions to those plans at a higher tax rate for 8 and ½ months after the end of the 2017 calendar year and still have it count towards 2017. That, combined with lower corporate tax rates, changes to foreign cash repatriation rules, and other changes mean corporations have more money and more flexibility to use that money to fund their pensions. In fact, companies like Raytheon, Caterpillar, 3M and Northrop Grumman plowed $3.1 billion in discretionary contributions into their DB plans in the fourth quarter, partly because of the Tax Cuts and Jobs Act.

Neil learned that his employer is offering pension plan participants the option of taking the pension money they’ve already earned as a lump sum buyout. Neil must decide what to do and was looking for some guidance. As I said to him, I will never tell my clients what to do, but I will teach them the questions they need to be asking so that they can make informed decisions.

That being said, there are some downsides to taking that pension money as a lump sum. For one thing, it’s a loss of guaranteed lifetime income after Neil retires. For another, moving the money from a private pension plan also loses the protection of the Pension Benefit Guaranty Corporation (PBGC), the government agency that backs private pensions.

On the other hand, taking the lump sum option does afford Neil flexibility and, more importantly, control of the asset. Neil can use the money as he sees fit – in an investment account, an annuity, or other option; one that may give him the opportunity to save more for retirement than Neil would have been able to if he left the money in the frozen plan. After crunching the numbers and taking a closer look at their expenses and other sources of income, Neil realized that a lump sum payout could be used to provide enough guaranteed income and an asset that he can grow to help create an inflation hedge and use as needed.

Folks, with pension programs increasingly going the way of the dodo, it’s imperative for educated investors to make sure they’re doing everything they can to protect their retirement assets and their financial future.

Remember, be vigilant and stay alert, because you deserve more!

Have a great week.

Jeff Cutter, CPA/PFS is President at Cutter Financial Group, LLC. A wealth management firm with offices is Falmouth, Duxbury, and Mansfield. Jeff can be reached at jeff@old.cutterfinancialgroup.com.

Cutter Financial Group LLC (“Cutter Financial”) is a SEC Registered Investment Advisor.

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