PENSION ELECTION
• Key Information
About Your Pension
(Optional Forms of Benefits)
• Pension Math and
Factors to Consider
• Pension Maximization
• What Happens if Your
Company Files for
Bankruptcy and Your
Company Plan Is Taken
Over by the Pension
Benefit Guaranty
Corporation (PBGC)
What to Consider When Faced
With the Pension Election Decision
If you are on the verge of retirement and fortunate enough to have a
pension, you may be faced with an important choice. Should you take the
regular, lifetime payments that your company plan offers or should you
select a lump-sum distribution option and invest the funds on your own,
perhaps rolling the proceeds into an Individual Retirement Account (IRA) or
investing in an annuity form not offered under your company plan that is
more tailored to your needs? Before you make an irrevocable decision about
your future, you should take time to understand what options are available
to you and what each choice might mean for you and your family.
If you are within a few years of retirement,
doing groundwork now can help you
understand your options and allow you to
plan for the retirement income program
that you feel is most appropriate for your
situation before a decision has to be made.
Also, in the event that you are laid off, it’s
good to have thought through this decision
well in advance versus having to make
this important decision amid a barrage of
choices that must be addressed within a
short time.
continued
PENSION ELECTION
Your pension payment is an important part
of your overall retirement plan. Be sure to
talk with your Company Human Resources
(HR) Department (who should have the most
information on your company plan), us and
your tax advisor about the following topics:
• Key Information About Your Pension (Optional
Forms of Benefits)
• Pension Math and Factors to Consider
• Pension Maximization
• What Happens if Your Company Files for Bankruptcy
and Your Company Plan Is Taken Over by the
Pension Benefit Guaranty Corporation (PBGC)?
Is Your Company Plan Retirement Benefit Fully
Covered by the PBGC Guarantees?
We address each of these issues in detail on the following
pages and suggest that you use the information provided
here as a guide for your discussions.
Key Information About Your Pension
You and your advisors will need, at a minimum, an
up-to-date Summary Plan Description (SPD) and
the most recent Individual Plan Benefit Statement
(from your Company HR Department). Some plan
sponsors may send these documents (as well as a copy
of the actual Plan document) to the plan participants
automatically. Otherwise, to receive a copy, you should
ask your HR or Benefits Department for copies. The
plan sponsor is required by law to provide you with these
documents upon receiving a written request.
2 MORGAN STANLEY SMITH BARNEY
Your plan documents will spell out when your benefits
become available and what your monthly payment
options are. For the most part, when you can begin
collecting pension benefits is determined by your plan
and is described in the Summary Plan Description. Most
plans will not allow you to receive your pension until
you have separated from service. However, whether you
have separated from service or are still working, upon
attaining “normal retirement age” (usually age 65) you
are eligible by law to begin receiving benefits. Once you
have separated from service, or turn 65 if still working,
you will be presented with your options. These may
include a lump-sum distribution, an immediate monthly
benefit or a deferred monthly benefit that usually starts
at age 65 or the normal retirement age as defined by
your plan.
Once you are eligible to collect, your payment options
may include some variation of these options:
SINGLE LIFE OPTION
• Suitability: This choice may be appropriate for
retirees who want income for their own needs and
who don’t have dependents or heirs that, in the
owner’s judgment, will need or should be included
in future cash flow from this asset. This is the usual
“default” option for single retirees offered under
many plans; if married, the participant’s spouse has to
consent to this selection.
• Benefit: It usually provides for the highest payout,
since the payment is calculated based solely on the
life of the person collecting the pension benefit
(the “annuitant”).
• Risk: Payments end upon death of the annuitant,
with nothing remaining for family members.
JOINT AND SURVIVOR (J&S) LIFE OPTION
• Suitability: This option, which is the “default” option
for married participants, is often selected by retiring
employees who are concerned about the financial
welfare of their spouse who could become a widow
or widower. The monthly payout is calculated on
combined life expectancies of the owner and spouse,
which may result in a smaller monthly payment
versus the Single Life Option. Many plans offer
some variation of J&S annuities that provide equal
amounts to be paid to the participant, and upon the
participant’s death, to the participant’s spouse (usually
referred to as a “100% J&S Annuity”). Some plans
provide other options, with higher payouts for the
participant, and lower payments for the deceased
participant’s spouse. The advantage is that the
payments are structured to last over the life spans of
two people and can be designed to avoid any decline
in cash flow following the death of a coannuitant.
• Benefit: It provides for continued and nonreduced
income (if so designed) for the spouse after death of
the owner/ coannuitant.
• Risk: It generates a lower income than the Single
Life Option because the calculation is based on life
expectancy of both husband and wife.
PERIOD CERTAIN
• Suitability: This alternative is designed for those who
want to guarantee a specific payout for themselves
and/or their heirs.
• Benefit: Annuitant can exercise some control to
generate a certain income stream over a predefined
length of time (“period certain”). Heirs can inherit any
balance, so the funds remaining in the annuity aren’t
forfeited upon death of the annuitant.
• Risk: The defined period usually ranges from 10 to
20 years, so annuitants who commence receiving
payments and then exceed their predetermined range
would outlive the cash flow payout.
Your HR Department is required to provide you with
the projected benefits for each of the options offered
under your plan, and we can help you analyze these
amounts and assist you in determining which option
works best for you given your life circumstances, goals
and other assets/income streams.
Pension Math and Factors to Consider
It’s important to understand that all of the payment
options are designed to be “actuarially equivalent” by
law, meaning that any one of the choices would net
out the same if you and your spouse live for an average
length of time. Currently, American women live an
average of 81 years and American men live an average
76 years1. However, longevity tends to run in families.
With this in mind, your decision should be based not
just on averages but also on other factors specific to
your situation.
It’s important to understand that all of
the payment options are designed to be
“actuarially equivalent” by law, meaning
that any one of the choices would net out
the same if you and your spouse live for an
average length of time.
1
Expectation of Life at Birth, and Projections, 2010 Statistical Abstract,
U.S. Census Bureau.
MORGAN STANLEY SMITH BARNEY 3
PENSION ELECTION
Considerations that favor monthly payments:
• You are likely to live past the actuarial average.
• You would like another source of guaranteed
income to meet current and/or anticipated
future monthly expenses.
• You want the convenience and security of a
monthly check.
• You are not certain of your desire or ability to
effectively manage a potentially large single sum
(also called a “lump sum”) payout.
• Your plan has a “cost of living” adjustment that
increases your monthly pension payments to take
inflation into account.
• Your spouse may not be as capable as you of managing
a lump sum.
• You (and your spouse) have sufficient additional assets
saved to address unforeseen economic needs.
Considerations that favor a lump-sum payment:
• You want financial control over the money and have
the self-discipline and investment knowledge needed
to manage it well.
• You believe that you can earn a higher rate of return
on your lump sum than what is assumed as part of
the pension calculation. (Note: You can determine a
“hurdle” rate of return, which is the rate you would
need to achieve so as to have been better off taking the
lump sum at different assumed life expectancies.)
• The solvency of your employer or your plan is in
question, and the PBGC does not fully guarantee
all of your company pension plan benefit (see “What
Happens if Your Company Files for Bankruptcy?”).
• You don’t need additional monthly income to
meet expenses.
4 MORGAN STANLEY SMITH BARNEY
• You don’t think your pension plan’s cost-of-living
increases (if available) will be sufficient to keep up
with the growth of your expenses down the road.
• You want to have more control over how your
retirement funds are invested. (For example, you want
to invest in “green” technology or don’t want your
money placed with certain controversial companies or
in particular industries.)
• You want to leave all or part of this asset to loved ones
(in addition to your spouse).
This may not be an “all or nothing” decision,
depending on the circumstances. Some other
options include the following:
• If you choose a lump-sum benefit and then use all or a
portion of it to buy an annuity, it would also generate
regular monthly income. Therefore, the choice of a
lump-sum payment does not necessarily mean giving
up the advantages of regular monthly payments, and
individual annuities may offer other valuable features
that are not available under your company plan
options. (You should carefully compare, however, the
costs and features of an individual annuity versus the
cost of the annuity benefits offered under the plan to
make an appropriate decision.)
• Another alternative is to just leave the money in
your former company’s pension plan to grow at a
predetermined rate until you are ready to take it. This
option often provides for lower or company-subsidized
management fees versus some other choices. However,
if your balance is less than $1,000, the company may
require you to roll the funds out of their plan.
Pension Maximization
As the name suggests, this strategy can help you to get
the most out of your pension payment. It takes a bit of
calculation and careful planning. Here’s how it works:
• First, you determine the difference between the single
life and joint survivor payment monthly payouts.
Based on your situation—mainly your age, health
and lifestyle (e.g., smoking status, gender, exercise
level)—you determine how much insurance you can
purchase with the difference between the higher and
lower payouts.
• Based on the calculation that you just did, determine
if you can purchase with that cash difference a
sufficient amount of permanent life insurance on
yourself to provide a cash flow near the level of income
that would be lost to your spouse if you should die
and your pension then ceased. In most cases, and
assuming that you are insurable, the cash difference
you calculated (after any taxes that may be owed
on that cash difference once distributed from your
retirement plan if used to pay for the life insurance
benefit) should be more than enough to purchase the
life insurance needed.
• Secure the life insurance coverage prior to electing
your pension payout option and name your spouse
as the beneficiary. (Note that term life insurance does
not work well for this concept, since it will eventually
expire or become prohibitively expensive.)
• You then select the Single Life regular payment option
at retirement—receiving the maximum monthly
pension payout for benefit of you and your spouse as
long as you live.
• If you predecease your spouse, the life insurance death
benefit would then be paid to your spouse, replacing
the monthly pension income that you were receiving
during your lifetime. This payment can be a tax-free
lump sum or structured as a monthly income to your
spouse for the remainder of her life.
Under pension maximization, if your
spouse should predecease you, you’d have
the option of keeping the insurance and
naming a new beneficiary or cancelling the
insurance and receiving the accumulated
cash value—tax-free unless and until the
amount of your surrender value exceeds the
premiums you’ve paid.
Some possible benefits of pension maximization
include the following:
• You and your spouse receive the highest cash flow
from your pension while you both are living.
• The life insurance could, in some instances, provide
a larger cash flow to your spouse than the former
pension payments that were received while you were
living. (This would be more likely if the insurance
had been purchased several years before your planned
retirement.)
• The life insurance option within the pension
maximization strategy may not be subject to claims
of creditors against you or your estate. (You should
consult with your attorney for proper structuring to
preserve all benefits.)
• Your spouse’s death could precede yours—in which
case, you’d have received a reduced monthly income
for the rest of your life if you had taken the joint
payout option.
• Under pension maximization, if your spouse should
predecease you, you’d have the option of keeping the
insurance and naming a new beneficiary or cancelling
the insurance and receiving the accumulated cash
value—tax-free unless and until the amount of your
surrender value exceeds the premiums you’ve paid.
MORGAN STANLEY SMITH BARNEY 5
PENSION ELECTION
• Any life insurance proceeds remaining at the death of
the surviving spouse/beneficiary could pass to other
family members.
• You could diversify your “insurance risk” by making
sure that the carrier that sells you the insurance policy
is different from the insurance company paying your
annuity payments under the company plan’s policy.
Generally, the younger you are when you purchase the
life insurance element of this concept the better pension
maximization works, since you lock in the premium rate
based on your age at time of purchase and because your
health would likely be better at a younger age as well,
which allows for a better rate. However, this concept
may work as well even if purchased at retirement time.
We can help you determine if pension maximization
works for you.
Generally, the younger you are when you
purchase the life insurance element of this
concept the better pension maximization
works, since you lock in the premium rate
based on your age at time of purchase and
because your health would likely be better
at a younger age as well, which allows for a
better rate.
6 MORGAN STANLEY SMITH BARNEY
What Happens If Your Company
Files For Bankruptcy?
There are two common forms of bankruptcy. In Chapter
11, a company stays in business while it reorganizes its
finances. In Chapter 7, a company goes out of business
and liquidates all assets. In Chapter 11, pension and
health plans are often—though not always—continued,
while these plans are terminated in Chapter 7.
In either case, if the plan is a standard defined benefit
retirement plan subject to ERISA, the PBGC guarantees
“basic benefits” earned before your plan’s termination
date (or the date your employer’s bankruptcy proceeding
began, if applicable). For 2010, the maximum guaranteed
amount is $4,500.00 per month ($54,000.00 per year)
for workers who begin receiving payments from PBGC
at age 65. The maximum guarantee is lower if you begin
receiving payments from PBGC before age 65 or if
your pension includes benefits for a survivor or other
beneficiary. The maximum guarantee is higher if you
are over age 65 when you begin receiving benefits from
PBGC. For a more detailed description of benefits and
the limits on guarantees, see PBGC’s publication, Your
Guaranteed Pension.
If the plan is a standard defined benefit
retirement plan subject to ERISA, the PBGC
guarantees “basic benefits” earned before
your plan’s termination date (or the date your
employer’s bankruptcy proceeding began,
if applicable).
Connecting All The Pieces
You shouldn’t make a decision in isolation about
how to receive your pension benefits. Preparing for
retirement requires a comprehensive planning process.
We can work together to estimate the cost of your
retirement, analyze your income sources and choose
an appropriate investment strategy to meet your goals
and family situation.
Consumer Tips for Safeguarding Your Pension2
• Know your pension plan. Obtain and review your
Summary Plan Description (SPD), the rulebook for
your pension.
• Review your Individual Benefit Statement and
individual account information. Know what your
accrued and vested benefits are.
• Maintain a pension file. Keep records of where
you’ve worked, dates you’ve worked there, your
salary and any plan documents or benefit statements
you’ve received.
• Notify your plan administrator of any changes that
may affect your benefit payments (i.e., marriage,
divorce, death of a spouse).
• Know the person in your company who has
information about your pension plan and can
give you plan documents.
• Get copies of pension estimates from your HR
Department under the various optional forms of
retirement benefits (e.g., single life, J&S, Term)
offered under your plan.
• Explore how a merger or acquisition of your company
might affect your pension benefit.
• Know your pension rights. Request information on
your pension rights and how to protect your pension.
2
What You Should Know About Your Retirement Plan, 2010 Employee
Benefits Security Administration, United States Department Of Labor.
MORGAN STANLEY SMITH BARNEY 7
Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Smith Barney Financial Advisors do not provide
tax or legal advice and are not “fiduciaries” (under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein except
as otherwise agreed to in writing by Morgan Stanley Smith Barney. This material was not intended or written to be used for the purpose of avoiding tax penalties
that may be imposed on the taxpayer. Individuals are urged to consult their tax or legal advisors before establishing a retirement plan and to understand the tax,
ERISA and related consequences of any investments made under such plan.
© 2010 Morgan Stanley Smith Barney LLC. Member SIPC.
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