Why is Ford Motor Company Offering to Pay-Off 90,000 Retirees?

 On April 27, 2012, Ford Motor Company announced via an internal communication a voluntary lump sum buy-out offer for 90,000 retirees and surviving beneficiaries.   Essentially, Ford wants to pay off or pay out as many retirees as possible.  So why of the sudden generosity?     There are two primary reasons:

    1. To get retirees off the books. Paying lump sums will get the pension liability off of their company balance sheet – which according to Bob Shanks, Ford executive vice president and chief financial officer, will "improve the underlying strength of our balance sheet”. And,

    2. The math looks better in 2012. The Pension Protection Act of 2006 (“PPA”), fully in effect in 2012, allows companies to use the higher yielding corporate bond rate versus the lower Treasury rate when calculating lump sum payments; making the cost of a lump sum lower to employers such as Ford.

Point 2 forces us to further consider how lump sum payments are calculated (for all employers – not just Ford Motor) and its impact on our decision making process.  

How the Math Affects the Company and Retirees

First let me apologize to all of the actuaries (i.e. number crunchers with serious calculators) for grossly underestimating the complexity of the calculation.    Calculating a lump sum takes into account factors such as your specific income, years of service, age, and survivor’s age, if any.    In addition, a “discount” rate is used in determining how much all of the monthly payments (present value) would equal if paid in a single lump sum today.   Why is the discount rate important?

    1. The higher the discount rate, the smaller the lump sum.

    2. The lower the discount rate, the greater the lump sum.

On a relative basis, with general interest rates near historical lows, lump sum payments should be higher than say 10 years ago.  However, the change in the discount rate via the PPA significantly reduces an employer’s lump sum payment obligations – perhaps by as much as 30%. So while Ford has had a desire to offer this type of payout in the past – waiting until 2012 provided a lower cost.

So, let’s agree for the moment that this plan is good for Ford’s balance sheet. However, there is a far more important issue: Is a lump sum good for your finances? Are you better off receiving a one-time lump sum payment rather than guaranteed lifetime monthly payments (guarantees based on For Motor’s ability to continue payments)? What’s good for the company….may or may not be good for you. (I don’t say this lightly – growing up in Dearborn I witnessed firsthand Ford’s exemplary community stewardship). I do however suggest taking a page out of Fords book – run the numbers to see what is most appropriate for you.

Is it good for your finances?

So how much is at stake? Plenty. For example, a 60 year old male entitled to a $2,000/monthly pension might be offered a lump sum close to $600,000 depending upon the actual discount rate used (this is a hypothetical only assuming a single life payment and 3.5% discount rate). Depending upon your unique circumstances this might be a “good deal” – but it might not.

On one side, if you are someone with a long life expectancy and very risk averse you should consider declining the lump sum and sticking with the monthly benefit.    On the other hand, if you are single and not in good health, taking the lump sum might be a better option. As you might expect, most folks will fall somewhere in between these two extremes.

At the risk of stating the obvious, this is a complex and important decision, and you are encouraged to consult with a financial planner and/or tax advisor. Talking with an experienced advisor about your personal situation can help lead to an appropriate decision focused on your balance sheet.

The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.