Severance buyouts require advice

As the economy stalls, particularly in regions of the country heavily reliant on manufacturing, severance packages and retirement buyouts are becoming more commonplace. Navigating their retirement planning, managing carry-over group benefits and dealing with the other practicalities of losing their job is something displaced employees can’t do on their own. They need an advisor.

On Monday, BCE announced that it would be terminating more than 2,500 staffers, while General Motors (GM) offered lucrative buyout packages to reduce its workforce at its plant in Oshawa, Ontario. For employees the situation is less than optimal. They’ve lost their jobs and likely don’t have a clue about how to deploy their severance or buyout money.

Generally speaking, large buyout packages are offered to those who have put in several years with the employer. An advisor with a client who has been terminated or bought out is likely working with someone in his or her prime accumulating years. A misstep in planning here can have devastating consequences in retirement.

Retirement finance expert Moshe Milevsky, the executive director of the Individual Finance and Insurance Decisions Centre and an associate professor of finance at the Schulich School of Business at York University, says there is little chance that the employees subject to this latest trend of buyouts are going to be able to manage their finances on their own.

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Taking the example of the GM workers, there are a number of factors at play. Workers with a certain level of seniority or who are eligible to retire will receive an early retirement incentive package of up to $120,000. This is on top of their existing defined benefit plan that will kick in at retirement.

These workers face the daunting task of deploying their incentive money, in conjunction with figuring out if their DB plan will cover their needs in retirement. Then there’s the risk that their money will not see them through retirement.

“The bottom line is that these GM folks need to talk to a financial advisor or planner about the costs and benefits of their various alternatives. The do-it-yourself approach just doesn’t work for these critical retirement decisions,” he says. “Those GM workers who have some form of DB pension income during retirement are in far better shape — assuming GM doesn’t default on this promise — compared to the many other laid-off and unemployed workers who have to rely entirely on retirement savings to generate a sustainable income.”

Milevsky does note that given the age of the employees, they’re likely going to want to maintain a substantial asset allocation to equities in order to outpace the erosion effect that inflation and draw-downs will have on their savings.

“Given the importance of DB pension income, I would be very reluctant to cash out or commute the monetary value of a DB pension, unless the lump-sum value was extremely generous,” he says.

James Kraemer, a CFP with TFI Financial Services in Winnipeg, says each individual client situation has to be addressed, so there may be some circumstances in which it’s preferable to take the commuted value of the pension.

“The pension will have options about guarantee periods and survivor benefits for spouses and possibly commuted values or various monthly benefits, depending on when they begin to receive pension income. Any delay in receiving benefits will translate into a larger monthly pension received,” he says. “The comparison of a commuted value and a monthly pension has both hard numbers and softer considerations to take into account. Many employees want to make the investment decisions themselves and cut ties with the company. I am not sure if the GM employees have this option of a commuted amount, but one benefit of taking the commuted amount is being able to control the income flow and quite possibly leave a residual to other beneficiaries.”

Kraemer is emphatic that these types of decisions have to be made in conjunction with each client’s individual goals.

“Some will want to spend more money earlier while they are healthy and can travel and be content with less income later in life. Others will want more security of income for a longer period and a continuing higher income,” he says. “Still others will be looking to leave some sort of a nest egg for beneficiaries to inherit and not want to exhaust all of their savings.”

Biljana Manojlovic, CFP, a B.C.-based with RBC Wealth Management advisor, says clients also have to be aware of the tax implications of a lump-sum severance or buyout payment. If possible, she says, clients should consider deferring or breaking up the payment unless they have a specific goal in mind such as paying off their mortgage.

“As soon as someone gets a package like this, they should really sit with a professional. It’s very stressful and emotional. All of these different questions are going through their head, such as whether it was a good idea to take the package in the first place,” she says. “That cash they take out as a cash lump sum — it’s fully taxable. If they can, [they should] negotiate with an employer to split it into two payments or sometimes get that payment to be paid over several months.”

Manojlovic notes that any lump sum should also probably exhaust their RRSP contribution room so that as much of it is growing tax-deferred as is possible.

Doug Lamb, CFP, of Toronto-based Spera Financial, says it’s important that products don’t override process in the initial planning stages.

“Plans have to work with conservative assumptions and might — I stress the word might — be enhanced with product implementation,” he says. “Again, this depends on their circumstances. Their portfolio should have an overall structure of fixed income and equities that is appropriate to their circumstances. Then the investments should be appropriate and well diversified with respect to company size, geographic breakdown, investment style and underlying industry. Then based on whether the money is registered or non-registered and their individual tax situation, consideration can be given to capital class funds and T-SWPs, etc.”

Next: Allocating your client’s buyout

Filed by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com

(07/29/08)

Mark Noble