Pension Election. Why is my company pension plan distribution option decision so important?

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1 Pension Election Summary table of contents Why is my company pension plan distribution option decision so important? 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 pension 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. 2 Key information about your pension 5 Pension math and factors to consider 6 Pension maximization 7 What happens if your company files for bankruptcy?

2 Morgan Stanley takes a holistic view of planning for retirement. In considering how your company pension plan might impact your retirement strategy, here are some questions that ought to first be answered: Q. What important plan documents should I review? Q. Why do pension option payment options matter? Q. How can I maximize my pension payments? To get started, you and your advisors will need an up-to-date Summary Plan Description (SPD) and your most recent Individual Plan Benefit Statement. Plan sponsors are required to send these documents to plan participants intermittently, in accordance with the requirements of the Employee Retirement Income Security Act of 1974, as amended (ERISA). Otherwise, to receive a copy of these documents (and the actual plan document), you should ask your HR or benefits department. The plan sponsor is required by ERISA to provide you with these documents upon receiving a written request (although there may be a charge depending on the circumstances). Your plan documents will spell out when your benefits become available and what your payment options are. Generally, when you can begin collecting pension benefits is determined by your plan and is described in the Summary Plan Description. Prior to the time or once you have separated from service, attained your plan s normal retirement age (usually age 65) or otherwise become entitled to commence the receipt of your pension benefits (in accordance with the particular terms of your plan), you should be presented with your payment 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 set forth in your plan. Once you are eligible to collect, your payment options may include some variation of these options: Pension Payment Options Single Life Option Suitability Single life annuities provide regular payments until the death of the pension recipient. 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. 2 Morgan Stanley 2016

3 Joint and Survivor (J&S) Life Option Period Certain Lump Sum Payment Suitability This option, which is the default option for married participants in pension plans, 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 or other permissible beneficiary, which may result in a smaller monthly payment versus the single life option. Many plans offer some variation of J&S annuities that provides equal amounts to be paid to the participant, and upon the participant s death, to the participant s beneficiary (usually referred to as a 100% J&S Annuity ). Plans usually provide other options, with higher payouts for the participant, and lower payments for the deceased participant s beneficiary. Benefit It can provide for continued and nonreduced income if so designed (i.e., a 100% J&S Annuity ) for the spouse or other beneficiary after death of the owner /coannuitant. Risk It generates a lower income than the single life option because the calculation is based on the life expectancy of the participant and his / her beneficiary. Suitability A period or term certain specifies the number of years during which the pension plan benefit is guaranteed to continue. If the participant outlives this period, no further sum is paid unless it is a life income period certain distribution option. The amount paid in a regular period certain is normally more than that for the life income period certain because the total amount to be paid is known in advance. 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 remaining during the period certain, so the funds remaining in the plan benefit aren t forfeited upon the death of the annuitant during the period certain. Risk The defined period usually ranges from 5 to 20 years, so annuitants who commence receiving payments and then exceed their predetermined range would outlive the cash flow payout. Suitability Some plans allow participants to take a one-time lump sum payment of their pension plan benefit. This option is well-suited for those individuals who feel comfortable with managing this money. This alternative is also a good option for those who need this asset for retirement income and would also like to eventually leave what is left to their heirs. Benefit Flexibility and control can help the recipient meet unexpected cash flow needs as well as provide ability to spend on splurge or discretionary items early on in retirement. Risk High spending levels and / or poor investment performance could lead to funds running out prior to cash flow needs ending. Your plan sponsor (through its HR or benefits 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. Morgan Stanley

4 Typically, a retirement plan participant leaving an employer has the following four options (and may engage in a combination of these options depending on their employment status, age and the availability of the particular option): Cash out the account value and take a lump sum distribution from the current plan subject to mandatory 20% withholding, as well as potential taxes and 10% penalty OR to continue tax-deferred growth potential and: Leave the assets in the former employer s plan (if permitted) Roll over the retirement savings into the new employer s qualified plan, if one is available and rollovers are permitted Roll over the retirement savings into an IRA Other factors in making a rollover decision include (among other things) the differences in: Investment Options Fees and Expenses Services Penalty-Free Withdrawals Creditor Protection in Bankruptcy and from Legal Judgments Required Minimum Distributions or RMDs The Tax Treatment of Employer Stock Q. Why should I review my options now? 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 when you are not potentially under the pressure of a deadline. Your company s human resources (HR) or benefits department generally will have the most current information about your pension plan. In addition, financial and tax advisors should be able to help you understand the following topics: Key information about your pension and optional forms of benefits Pension math Pension maximization What happens if your company files for bankruptcy What benefits are covered by the Pension Benefit Guaranty Corporation (PBGC) We address each of these issues on the following pages and suggest that you use the information provided here as a guide for your discussions. 4 Morgan Stanley 2016

5 Pension Math and Factors to Consider It s important to understand that all of a pension plan s payment options are usually designed to be actuarially equivalent, 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 of 76 years (according to Health, United States, 2014, CDC.gov.) 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. Considerations that may 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 other assets to address unforeseen economic needs. Considerations that may 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. 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. You may choose a lump sum benefit and then use all or a portion of it to buy an annuity which would 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 pension plan s 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.) The choice of a lump sum payment does not necessarily mean giving up the advantages of regular monthly payments. * This is a taxable event, distributions from a pension plan are subject to income taxes. Morgan Stanley

6 Pension Maximization s the name suggests, this strategy A 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 and survivor monthly payout amounts. 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 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. 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) would be used 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 payment option at retirement receiving the maximum monthly pension payout for the 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. The life insurance proceeds paid at your death are generality received free of federal income tax. 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 income-tax free unless and until the amount of your surrender value plus any previous withdrawals and outstanding loans exceed 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. 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. 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 income-tax free unless and until the amount of your surrender value plus any previous withdrawals and outstanding loans exceed the premiums you ve paid. Any life insurance proceeds remaining at the death of the surviving spouse / beneficiary could pass to other family members. We can help you determine if pension maximization works for you. 6 Morgan Stanley 2016

7 Q. 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 usually 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 2014, the maximum guaranteed amount is approximately $4, per month ($59, 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. Source: PBGC, your-guaranteed-pension.html 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 help you estimate the cost of your retirement, analyze your income sources and choose an appropriate investment strategy to meet your goals and family situation. Morgan Stanley

8 Insurance products are offered in conjunction with Morgan Stanley s licensed insurance agency affiliates. Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC ( Morgan Stanley ), its affiliates and Morgan Stanley Financial Advisors and Private Wealth 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 provided in a written agreement with Morgan Stanley. Individuals are encouraged to consult their tax and legal advisors (a) before establishing a retirement plan or account, and (b) regarding any potential tax, ERISA and related consequences of any investments made under such plan or account Morgan Stanley Smith Barney LLC. Member SIPC. WP CRC (02/16) CS /16