GM Lump Sum Offer

 

On June 1, General Motors announced a plan to reduce its pension liability by an expected 26 Billion dollars. In a move similar to one recently announced by Ford Motor Company, GM plans to provide select U.S. salaried retirees a lump-sum payment offer and other retirees with a continued monthly pension payment securely administered and paid by The Prudential Insurance Company of America. Approximately 42,000 salaried retirees and surviving beneficiaries will be eligible for the lump-sum offer. The initial eligibility and options are:

A. Retired from GM on or after October 1, 1997 and before December 1, 2011, you have three options:

• One-time, single lump-sum payment
• Continue with current monthly benefit, payable by Prudential
• New form of monthly benefit (based on marital status)- single life annuity or joint and survivor monthly benefit, payable by Prudential

Retired from GM before October 1, 1997: You will continue with current monthly benefit, payable by Prudential.

Most active Salaried employees and retirees who started receiving their pension benefits on or after December, 1 2011:

• Moved into new GM pension plan
• Lump sum payment
• Monthly pension benefit available at retirement, payable by GM

The lump-sum vs. monthly pension benefit decision is an exceedingly complex one, with tax, estate, mortality, investment, and many more consequences. LJPR, LLC is experienced in this type of analysis. We have written a White Paper analyzing the Ford Lump-Sum offer, and will be providing a similar paper to help GM Retirees decipher today’s offer from General Motors. We are also writing a White Paper with the analysis on Generic Lump-Sum Buyouts. The White Paper on Ford’s Lump Sum Buyout is currently available on our website and can give retirees a start on some of the issues they need to consider when making this decision.

As we state in our White Paper, keep in mind that, in general, comparing an annuity stream to a lump sum is an equation involving Present Value.  This calculation is based on the series of payments, the time period involved and the rate of return.  General Motors will provide the retiree with a lump sum that has been actuarially computed to equal the monthly stream at a rate of interest.  Retirees should note that what they currently have from GM is an annuity and a reasonably nice one.  It is a lifetime annuity for the retiree. For a married retiree, it is a reduced annuity lasting for their lifetime and that of the surviving spouse.   The analysis is therefore:  "Which alternative is best for me?”  Because of the personalized nature of the analysis, here are a few of the ‘moving parts’ or variables of the analysis, in no particular order:

1. What is the age of the retiree?  (Under 59 ½, 59 ½ to 70 ½, or 70 ½ and older?);
2. Marital status of the retiree?
3. What is the relative health of the retiree?  The spouse?
4. What is the sex of the retiree?  The spouse?
5. What heirs or legacy wishes does the retiree have?  (Leave excess funds to children, grandchildren, charity?);
6. How important is the flexibility of withdrawals? (spouse working, spouse’s pension, Social Security);
7. What income tax bracket is the retiree in, what bracket after age 70 ½?
8. What is the size of the retiree’s taxable estate?
9. Does the retiree have dual credit bypass trusts (if married), and if so, how are they funded?
10. What is the retiree’s risk tolerance?
11. What is the retiree’s anticipation of future inflation?
12. What is the retiree’s expected future return on investments?
13. What is the retiree’s investment knowledge or willingness to delegate investment management?
14. What are the retiree’s other retirement income flows? (Spouse’s pension, investment income, Social Security (retiree and spouse), rents, jobs, etc.);
15. What other retirement assets does the retiree have? (SSPP, IRAs, Roth IRAs, Annuities, and other investments);
16. What is the necessary retirement cash flow for the retiree?  (E.g. living expenses, debt service, medical, etc.);

For the Ford Lump Sum Buyout White Paper, click here. For more information on this topic, please call our offices at: 248.641.7400.

Leon

A Slap in the Facebook

Friday, the long-awaited Facebook IPO was launched, to vast media hoopla. I had the opportunity to comment on the deal, and I wondered aloud how FB, with $1B of profit, could sustain a $104B market capitalization. Facebook is nice, and my kids use it, but I figure it needs to grow at about 41% a year for many years just to be worth its current price.  104 times earnings (PE) is a little crazy.

By comparison, a company I like, Apple (I'm writing the blog on my iPad), has a 13 times earning multiplier. Apple has an interesting business plan: make revolutionary devices for people that they hadn't  thought of, and make them an iconic device.  In doing so, AAPL has become huge, and maybe could be a trillion dollar company.  At the same time, Apple sells at a 13 PE.  Apple also has a huge hoard of cash: $97 B. That means that Apple could buy Facebook, for cash.

I'm comparing the promise of the future (Facebook) with the promise of improvement.  It’s wild to me that a 104b IPO can go off at a relative price about seven times higher than the benchmark of new technology; especially when no product is involved. I must misperceive the value of Internet advertising, even though we occasionally use it.

That being said, I doubt Apple will buy Facebook. There are other, less expensive targets. They could buy the Corrections Company of America, the largest private prison company, and create the iCon. Or maybe buy the University of Phoenix, the nation's largest private for-profit college, and have a degree called iKnow.  Or, they may look back and see that they should have bought Facebook and named it iWish. But I think not.  I'm more prone to think in five years Apple will be the iconic computer of this generation and Facebook will have the revenue struggles of any company, and Apple can say iOne.

Ford Lump Sums and the Possibility of Adverse Selection

Leon LaBrecque, JD, CPA, CFP^®, CFA, Managing Partner, LJPR, LLC

As probably everyone is aware, Ford Motor Company is preparing to offer a series of one-time voluntary lump-sum pension payments to its salaried retirees. The purpose of the lump sum is to reduce Ford’s pension liabilities, under the concept that some retirees will opt for the payment, thereby removing their pension liability from Ford’s books (and the balance sheet).  Of course, the retiree decision is highly individualized, so we’ve been working on a comprehensive White Paper for our Ford clients, but as I worked on the section of the paper ‘shifting of mortality risk’, it occurred to me that this action (the lump sum payment) could actually increase liabilities to Ford, at least on a relative basis.  Here’s why:

When a pension plan wants to offer lump-sum benefits, it is required to make the calculations based only on interest rate and unisex mortality.  In other words, to the Ford GRP, all 63 year old retirees are exactly the same in the amount of time they will live.  If a plan is paying monthly benefits, and someone dies early, the pension plan gains (because the liability went away and the money stayed in the plan).  This is called an actuarial gain. If a retiree takes the lump sum payment, Ford has removed the liability, but it has also eliminated the possibility of any actuarial gain (the actuarial gain has been shifted to the retiree’s family).

So, let’s take a simple example:  There are four 63-year-olds in the pension plan, all of whom are receiving either a single life benefit or a reduced joint and survivor benefit of the same monthly amount:

1. Tom, a 63 year old male, single with an adult child, high blood pressure and a history of heart disease.
2. Candace, a 63 year old female, single with no children, marathon runner, yoga practitioner, and in perfect health with a living nonagenarian mother and aunts.
3. Mike, 63 in poor health, married to Sue, 63, in great health.
4. Kathy, 63 in good health, married to John, 63 in poor health.

Under the current pension & actuarial rules, Ford’s liability is exactly the same for each of the retirees due to the unisex mortality table, even though according to the chief actuary of Social Security, 63 year-old women will outlive 63 year-old men on average by 2.83 years.   It’s likely that Tom will predecease Candace, and that Sue and Kathy will probably outlive their spouses, So, with the four above participants, if the healthy people lived 5 years longer than the table and the people in poor health lived 5 years shorter, there would have been actuarial (mortality) gain on Tom and Mike, and actuarial losses on Candace and Kathy.

From the pensions’ liability standpoint, it would be a wash.  Now, let’s look at the situation with the lump sum payments. Ford is required to offer the same amount to all four participants, let’s say its $483,000. Tom and Mike would possibly take the lump sum and Candace and Sue would not (life expectation considerations). Same scenario as before, healthy people live 5 years longer than assumed, unhealthy people live 5 years less. Although Ford reduced its liability on Tom and Mike, it also gave up the actuarial gain; it retains the liability on Sue and Candace AND suffers the actuarial loss. This could potentially increase the overall liability.

In other words, by offering a lump sum, it’s logical that the retiree who may benefit from it (I am going to estimate about 20%) will take it, leaving a cohort of healthy retirees who cost the plan more in the long run.  The plan reduces liability by 20%, but increases the remaining liability with mortality experience.  Balance sheet gets a boost because of the pension math; it's brilliant.

Maybe in the future, plans will send bacon and butter gift packs and hang-gliding coupons to retirees.

Leon

The Buffet Tax: What Am I Missing?

It seems like every day, I’m hearing and seeing more about the ‘Buffet tax’, where Warren Buffet (who I like and admire) apparently complained that he was in a lower tax bracket than his secretary, primarily due to dividends and capital gains. Now, my initial reaction was to suggest respectfully that Mr. Buffet could simply donate the amount he desired to the US Treasury, if he felt it was an efficient use of his capital. Then one of my business partners, Matthew Teetor, pointed out that dividends are already taxed at a rate well over the highest individual rate: a dividend dollar has already been taxed once. Here’s how it works:

Dividends are paid from a corporation’s accumulated earnings and profits, which are subject to corporate income taxes. So a corporation has to pay taxes on its profits and then the shareholders pay taxes on the dividends. Accordingly, dividends are double-taxed. So, suppose I own a corporation, let’s call it Hathshire Breakaway. I’m the chairman of Hathshire Breakaway, but I’m a capitalist, so I work for $1 a year. Hathshire does well, and makes $96,700,000. On $96,700,000 the corporate income taxes are $33,845,000. (I’m only doing federal taxes; there will probably be state taxes as well; if Hathshire was in Nebraska, for example, most of the income would be taxed at 7.81%). So, after taxes, Hathshire has about $62,855,000. I’m the owner, so I pay all of the income out in dividends to the shareholder: me.

I now have $62,855,000 of income, all qualified dividends. Ignoring state taxes (Nebraska, for example, does tax dividends); I pay about $9,428,000 of federal income taxes, slightly less than 15%. I write my $9,428,000 check (I already wrote the $33,845,000 check on March 15). My secretary is sitting at her desk, upset. I ask her what’s wrong, and she tells me that she’s in the 25% bracket. At first, I feel bad for her, after all, I paid over nine million bucks in taxes, but at a lower rate. But then ask ‘What was I thinking?’ Between Hathshire Breakaway and the shareholder, we paid $43,273,250 of taxes on $96,700,000 of corporate income. By my calculations, that’s a 44.75% rate! (Ignoring state taxes).

So, dividends are taxed at a 15% rate, after the corporate profits are taxed at a 35% rate. So I’ll pose another idea to Mr. Buffet: You can pay ordinary rates on dividends, if we eliminate the corporate income tax. Then you can feel good about yourself, and save several million bucks of taxes.

Incidentally, if the Bush Tax Cuts expire, as they are scheduled to do, and the Health Care Bill remains constitutional, then on January 1, 2013, dividends could be taxed as high as 43.4%. Using my previous example, the tax on dividends for me as an individual would now be about $24,700,000, plus a UIMC (‘Unearned Income Medicare Contribution’) or about $2,363,000. Total taxes on my income (the corporate profits and dividends paid out) are now about $60,908,000. That looks like a rate of about 63%. Perhaps that tax rate might quiet the objectors.

Leon

PS: Just for fun, the number I used (the $62,855,000) was Warren Buffet’s income. By the way, Berkshire Hathaway does not pay a dividend; it uses its excess cash to buy back shares, which is a tax-free way of accreting shareholder wealth. Any aspersion on Mr. Buffet’s financial savvy is unintended.

It's Like Deja-vu, All Over Again

It’s Like Déjà-vu, All Over Again

Leon C. LaBrecque, JD, CPA, CFP®, CFA

Funny how sometimes you can see weird patterns emerging. For example, take the beginning of 2011:

• The S&P 500 started at about 1257;
• In the first 45 days, it went up about 6.9%;
• In the first three months, we had three progressive unemployment reports.

Now have a look at 2012:

• The S&P 500 started at about 1257;
• In the first 45 days, it went up about 6.9%;
• In the first three months, we had three progressive unemployment reports.

The quote from Yogi Berra seems appropriate.

Here’s a chart:

Now, to quote Yogi again, ‘the future ain’t what it used to be’. Consider last year (2011), after a decent run up to mid-year last year, the Greece debacle started, and then in August, the real debacle with the Debt Ceiling expiration, coupled with the Treasury downgrade, took the S&P down almost 20%. Well heck, those were unexpected problems: who would have thought that the Greek debt problem was so big? Who would have thought that Congress couldn’t solve a simple problem?

So look at this year: We have maybe a few more tiny issues in the hopper, to wit:

• The Supreme Court decision on the Obama Healthcare Mandate in June;
• Iran;
• The Presidential election;
• The Senate elections;
• The expiration of the Bush Tax Cuts 12/31;
• The Sequestration Budget Cuts on 01/01/13;
• The new UIMC on dividends, interest and capital gains on 01/01/13;
• Oh yes, and the next expiration of the debt ceiling in early ‘13

Now, I’m not a cynic, but if Greece and the debt ceiling can cause problems, maybe one or more of the eight listed above could as well. So, our version of the year is tactical: take profits if possible and protect against the storm (if there is one).

What does it all mean? Well, suppose last year I told you I knew two things would happen: the US Treasury would be downgraded, and that Steve Jobs would die. You’d probably logically avoid Treasury bonds and sell your Apple stock. Both would have turned out to be bad ideas. So, for now, we have to look at the upcoming storm clouds, pay attention, and modify the plan as necessary. To quote Yogi one more time: ‘If the world were perfect, it wouldn’t be.’

Leon