Old-fashioned pensions might be disappearing, but they haven't vanished. According to a report published in 2010 by the U.S. Bureau of Labor Statistics, 20% of private industry workers and 79% of state and local government workers were participating in a defined-benefit (DB) retirement plan.

Connie Stone, who heads Stepping Stone Financial in Chagrin Falls, Ohio, advises these clients, who are widows, corporate executives, professionals and educators expecting to receive or are currently receiving payments from DB pensions. Some of the financial planners interviewed for this article indicated that approximately 10% of their clients now receive pensions or may receive them in the future.

The financial turmoil of the past few years may have enhanced the appeal of a dependable, lifelong income stream. "For a long time, I was not sure that clients (or even some planners) really understood how valuable a DB pension can be in planning for retirement," says Rob Studin, executive director of financial advisory services at First Financial Group of the South in Huntsville, Ala. "But now, with our present interest rate environment and market volatility, we have come to realize how valuable these benefits truly are for covered employees."

Randy Breidbart, founder of Park Avenue Financial Advisors in New York, voices similar sentiments. "With people losing jobs, the value of guaranteed income goes up," he says. "In many cases, both the husband and the wife qualify for pensions. Such clients might not have as much income as other clients, while working, but they may be better off than many other retired couples."

Retirees with benefits may indeed be better off-if their pensions and related health plans survive. Some states are already pulling back on promises to public employees, while some companies have pared down their pensions. In response, planners may have to rethink and in some cases revise strategies for clients covered by DB plans.



Clients who are counting on pensions may be more suitable for growth-oriented investing than normally would be the case. Ben Tobias, president of Tobias Financial Advisors in Plantation, Fla., says pensions affect his clients' portfolios in two ways.

First, he slightly reduces the amount set aside as an emergency fund. Second, he looks at the present value of the pension as a component of the client's net worth and portfolio. Therefore, the balance of the portfolio can be invested a bit more aggressively.

For example, in today's low-yield environment, receiving $35,000 a year from a pension might provide the cash flow of $1 million invested in bond funds. Such a client could tilt more toward equities.

Tobias cautions, however, that you need to be careful if you invest more aggressively. "Keep the client's risk level in mind. When the portfolio declines due to market conditions, it is the rare client who will factor in the stability of his or her pension," he adds.

Rich Moran, senior financial advisor at Moran, Kimura & Heising, a financial planning firm in Torrance, Calif., concurs that it's vital to consider the risk tolerance of clients with pensions. He could logically be more aggressive with the rest of their portfolios than with other clients, but says that his clients with large DB pensions are "uniformly very risk-averse. So their investment portfolios are typically structured for very moderate growth at less than market risk."



Moran takes pensions into account when doing cash flow modeling for clients' retirement. He applies the guaranteed cash flow first to basic living expenses, he says. Often, that offsets a large part, if not all, of the basics. The negative is that the capital providing that cash flow is not available for inheritance. If that's important-and Moran says it usually isn't-the client would need to dedicate other assets to that objective.

Studin also believes that pension income can cover a retiree's basic needs, which include food, clothing, housing, insurance (particularly medical and long-term care insurance) and transportation. "In order for clients to have a secure retirement, stable income sources should cover their basic needs for a lifetime," he says, adding that those sources should not be subject to market volatility, interest rate risk, longevity risk, inflation risk or any other major risk to retirement income.

Those stable sources of income might include Social Security, DB pensions and guaranteed annuities (either fixed or variable). Once Studin feels these expenses are secure, he uses traditional asset allocation and draw-down planning to meet discretionary expenses, specific goals (weddings, grandchildren's education) and legacy planning.

Using DB pension income (along with Social Security and annuity income) to secure basic needs allows his firm to be more aggressive when funding other expenses, if the client has the risk tolerance, he says. "If basic needs are secure, you can always postpone the extra-long vacation that would deplete too much of the portfolio in a down year."



Such planning-use the pension for the basics and take acceptable risks for discretionary expenses-may be viable for clients with rock-solid guaranteed pensions. However, those guarantees may not be set in stone.

That's been true for a while on the corporate side. Breidbart says that many corporations have rolled DB plans into cash balance plans; in such plans, pensions may be smaller than with traditional DB plans.

"In our local area, we have seen enough companies default on pensions (Republic Steel, for example) to know that there are no guarantees that corporate pensions will be fully paid as promised," Stone says. Tobias has worked with clients whose pensions were reduced because of corporate bankruptcies in the airline industry.

Now it may be time to question the security of public pensions as well. In 2010, the Pew Center on the States issued a report saying that states and participating localities had $3.35 trillion in obligations for retirement benefits and $2.35 trillion set aside, leaving a $1 trillion gap. Some states are moving to narrow that chasm.

In New Jersey, for instance, a new law bans future part-time workers from the pension system, requiring them to participate in the defined contribution plan. For full-timers, pensions are less generous, as a 9% increase granted previously was rolled back. Also, pension payments are to be based on one job, payments of accrued sick leave for future workers has been capped and public workers must pay at least 1.5% of their salary toward their healthcare.

Such retrenchment is by no means limited to New Jersey. "The educators with whom I work, from Ohio and Illinois, are increasingly nervous about their pensions, whether they are currently retired or not," Stone says. "The fragility of state finances and the risk that teachers' pensions will be reduced or eliminated is widely discussed in the media."

Illinois already has enacted legislation, according to Stone, that raised the normal and early retirement ages, changed the "final average salary" used in pension computations and reduced cost-of-living adjustments (COLAs). In Ohio, teachers are paying more for their health plans while several pension reform proposals would reduce payouts, postpone eligibility and tinker with COLA formulas.

Across the country, many states may likewise be revisiting their retiree obligations. In Washington, the new Congress is considering a non-binding resolution to forbid a bailout of underfunded state and local pensions. A bill to require transparent public pension accounting has been proposed, and there is even talk of a law that will permit states to declare bankruptcy, thus leading to decreases in employee benefits.



With uncertainty on the rise, Stone has changed asset allocations for some clients with pensions. "When pensions seemed secure, there was more flexibility in structuring the investment portfolio," she says. "Now if there is some doubt about a pension's future payouts, I will design the portfolio to have a higher amount than usual in stable investments such as bond funds and dividend-paying stock funds. I also will include some aggressive funds for long-term growth."

What's more, when it's time for new retirees to decide how to handle DB plans, Stone often recommends that clients take a lump sum, if that option is available, rather than a stream of payments. "That's the case unless I suspect that a client will not handle the money responsibly," she says. If they take the lump sum, clients know they have the money. If they take the pension, it's at risk of not being fully paid in the future.

In some situations, another factor might come into play when clients must decide whether to take an annuity-type pension or a lump sum. That choice also may affect retiree health benefits.

In Ohio, public educators lose their access to subsidized health insurance after retirement if they take a total lump sum of their account, Stone says. "That's definitely a concern for those who are not yet Medicare-eligible." In those cases, she looks at whether a spouse has access to group health insurance before deciding whether to take the lump sum, she adds.

Taking a partial lump sum and a smaller pension may not disqualify Stone's clients from retiree health insurance. For many years, the planner would advise some retiring teachers and other public employees to take the life annuity and at least the minimum survivor benefit that would qualify for public-subsidized health insurance. In Ohio, though, the premiums have increased so dramatically that the public-subsidized health insurance is no longer always the best option for the retiree or a beneficiary, she explains.

Stone has found that younger clients may decline the public employees' DB plan and instead contribute to the defined contribution plan, even though declining the DB plan rules out retiree health coverage. "They don't believe that the health insurance subsidies will be available when they retire," she explains. "The teachers' retirement system has been very vocal about the fact that retiree health insurance is not guaranteed." She adds that younger clients also want the portability of the defined contribution plan because they have no idea where their careers will take them."



Studin also reports that his firm's planning has changed for clients who have had their pensions frozen or eliminated. "These employees want the same type of security they had with the pension," he says. "Securing basic needs seems to resonate with these clients. They understand the need for a stable source of income." Such pension-deprived clients may be more likely to accept setting aside a certain amount to obtain an annuity that guarantees a specific income stream.

So Studin first determines what percentage of their basic needs clients want to secure with stable sources of income. Then he allocates enough to cover those needs with annuities that have guaranteed income streams or other very safe investments."

In Florida, Tobias reports that there is talk about trimming pensions, but so far nothing has happened. "I have always told clients that even though they have a guaranteed pension, the only guarantees in life are death and taxes," he says. "They must realize that at some point the pension may disappear or be reduced."

Still, Tobias would be much more concerned about a client whose pension is from a shaky corporation than from the public sector. "When a politician speaks, it's best to listen and be aware of what might happen, but not to make changes based only on proposals."

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