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Protecting Pension Recipients

On reaching retirement, several of your clients might have a defined benefit pension plan from which to draw. Often, a client can choose between transferring a lump sum amount to an IRA or taking periodic payments over a certain period of time. But when a client wants (or is forced) to choose the regular payments instead of the lump sum, there are some steps you should take to ensure that those little monthly checks don’t become a big threat to a secure retirement.  

Take it sooner . . .

Even when pension recipients can’t (or decide not to) take the lump sum option, they may still have a choice on the age at which to initiate the payments. The primary motivation to take the money as soon as possible is usually that the clients don’t have any other source of income and need it to cover living expenses. They also may have concerns about the pension’s long-term health, and prefer to get a proverbial bird in the hand instead of waiting for a slightly larger one down the road, when not only may the pension be unstable, but the clients will be that much closer to death.

 . . . or later

There are many potential benefits to delaying a monthly pension check, when the would-be recipients are confident about their current situation and the pension’s future sustainability.

First, the longer clients delay taking the payments, the larger the eventual checks will likely be. Plus, if the clients have other taxable income now (say, from a spouse’s job), delaying avoids the pension income being tacked on and taxed on top of the other income. Waiting on pension payments may also give certain clients time to make tax-saving moves after their jobs end, but before pension payments, Social Security and required minimum distributions begin. For instance, the clients may choose to realize any long-term capital gains that could incur little or no tax, if the clients’ overall taxable income is low enough. Or, they could convert a portion of their IRAs to Roth IRAs, paying little or nothing in taxes now to avoid paying a lot later.

Think of the children?

Some pension plans offer a “period certain” payment option, where the checks will continue to flow to a named beneficiary even after the original beneficiary (and a spouse) has passed away. The next recipient could be the next generation of children, grandchildren, or even a charity. Clients who choose this option will revel in the notion that someone or some organization they care about will get the money, even if the clients aren’t around long enough to collect their share. However, if the monthly check amounts are greatly reduced by adding this option, it’s usually better for the clients to take the higher amount now, and leave any remaining other assets to family or charity.

Social Security sooner?

Pension check recipients should also consider taking Social Security retirement benefits sooner rather than later, especially if they would otherwise have to tap assets to cover living expenses.

Taking Social Security early can serve as a hedge for the client. If s/he and the pension survive longer than the actuaries expect, s/he will beat the pension calculations and collect more than her/his share of the benefits. But if s/he and/or the pension don’t last as long as expected (or hoped), the Social Security checks received early in retirement allow the client to preserve assets for future spending needs or investment opportunities.

Better yet, even when added to the taxable pension payments, at most only 85 percent of Social Security payments will be taxed as ordinary income. So the client’s tax bill may be less than if they were to withdraw needed funds from fully-taxable accounts, like IRAs or tax-deferred annuities.

Don’t forget the spouse

Many pension plans offer a survivor benefit, where when the original beneficiary (or the beneficiary’s spouse) dies, the payment continues, but at a reduced rate. Clients in a couple should be cautious about choosing this option. Yes, they will likely get a slightly larger check now if they choose the option with the reduced spousal benefit; but once one member of the couple dies, the survivor’s monthly expenses aren’t likely to be much less—and in fact, may be the same or more.

Yet, the smaller of the Social Security checks the couple receives while living will go away after the death of the first spouse, which, when coupled with a reduced pension, means that the hardship caused by the death could be financial as well as emotional.

Stay liquid

Getting a pension in small monthly checks instead of a large lump sum compels you and your client to maintain as much access as possible to their precious assets.

That might mean instead of paying off a mortgage sooner than required, the clients make only the minimum monthly mortgage payment and bank any extra funds for future use. Or getting a no- or low-interest rate loan to purchase a new vehicle, rather than paying cash up front. The need for liquidity is further exacerbated if the pension recipient has little or no funds held outside of tax-sheltered accounts.  

Complement cautiously

Pension recipients usually have very little knowledge of what assets are owned in a pension fund at a particular time, much less any say in how those assets are managed.

The health of the pension can be negatively affected by events beyond the client’s control, including miscalculations on future returns and beneficiary longevity and the financial strength of the responsible government, union or corporate entity. Therefore, make sure that whatever assets you and your client control are managed as conservatively as you can stand. If you end up erring too far on the side of caution and asset prices perform well in the future, your client will likely benefit from a stronger, more sustainable pension. But if the investment climate takes a turn for the worse, the client will be glad to have the non-pension portion of their portfolio sheltered from the storm.


Kevin McKinley is principal/owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of Make Your Kid a Millionaire (Simon & Schuster).

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