This week I fielded a question from a soon-to-be-retiree regarding her pension that I thought was worth sharing. Her employer offers a defined benefit pension plan, which she is fortunate enough to receive. Her employer’s pension plan offers the opportunity to receive benefits in the form of a single lump sum payment or various annuity payments that would pay out a fixed payment each month for the rest of her life and, if she chooses, for her husband’s life.
This lady wisely decided to seek out professional guidance and which payment option would best meet her financial plans.
Several years ago she received a financial plan from a CFP but maintains her financial assets with a large bank. Upon learning that she was about to retire, the financial adviser at the bank encouraged her to take the lump sum from her pension and roll it to an IRA. She wasn’t entirely sure that the adviser’s recommendation made sense within the financial plans she had and she didn’t feel like the adviser had adequately explained why the rollover fit into those plans.
This fine lady contacted my office on a separate legal issue with her pension plan and told me about her conversations with the adviser. I directed her to my earlier blog post regarding the difference in the lump sum and annuity options, but I didn’t feel like that post directly answered her concern about why her alleged financial adviser wanted her to make a decision over a substantial amount of money that didn’t fit her financial plans. This post summarizes the information that I provided her.
How financial advisers receive pay
Most “financial advisers” work on commission rather than a fixed payment. They receive pay for bringing in and keeping assets. Typically they do not receive pay for performance or for making the “right” decision for you. As long as the advise is appropriate within the financial service industry’s very loose suitability requirements, it’s very difficult to hold your financial adviser liable for mismanaging your money based on his or her recommendations.
As a result, the financial adviser has a personal financial incentive to convince you to take that lump sum and roll it into an account under their management where he or she can get the commission on bringing in the assets and then try to get more sales commissions based on how that money is invested.
It’s difficult to prove the rollover is not a suitable recommendation because the money can be invested in many different options and it can be paid out to you in monthly installments, just like the annuity options in the pension plan. However, just because the decision is “suitable” doesn’t mean it’s the best decision for you.
Pension plans
In addition to their financial incentive to push the lump sum, the majority of financial advisers have little to no knowledge of how pension plans operate. That makes their ability to adequately compare your options nearly impossible. The annuity options on pension plans are not always favorable or appropriate for every individual but they carry benefits for retirees that other investment options may not offer.
The plan secures payments within a trust and guaranteed by a federal insurance program. The retiree does not pay a commission or fee for receiving annuity payments. The payments continue as long as scheduled to continue (often they are life payments). There is no risk that an account gets depleted of money before you pass away.
However, there are risks to taking an annuity payment. The payments issue at a fixed amount. There is no surrender option. You may die prematurely and end up receiving less money than if you took the lump sum. It is a calculated financial decision but one financial advisers normally do not understand and do not want to calculate.
401k plans
In my years dealing with pension and 401k plans, I have heard everything you can imagine from financial advisers. Some insist pension annuity payments are subject to the same rules as insurance-based annuity plans, such as expensive buy-in costs and investment risk. I’ve heard multiple financial advisers instruct retirees to take the lump sum, roll it over and then buy an annuity.
The purchased annuity comes with commissions and ongoing fees that result in lower monthly payments than what the plan offered. Unbelievable. I’ve heard all kinds of guarantees of investment returns that they could get on the lump sum. I don’t know about you but that doesn’t sound like anything I would call suitable. However, it happens all the time.
Annuity payments
I don’t mean to suggest taking a lump sum and rolling it over for investment or payout on a different schedule than the plan’s annuity options is necessarily wrong. The decision should follow a factual understanding of the plan the financial needs and plans of the retiree.
Sometimes, perhaps even frequently, the lump sum is the better option for the retiree. In this lady’s situation, she paid good money for detailed financial plans. The adviser wanted her to rollover the lump sum and invest it into investment products that didn’t match her plans. I find that suspect. I advised her to talk to other financial advisers and find somebody who she felt she could trust.
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