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Severance planning is a strange dynamic for advisors, and it’s generally a negative and frustrating process for clients. For advisors, it creates a lump sum planning opportunity during a time when revenue opportunities are limited. If you’re not maximizing your clients’ wealth, be warned.

Peter Merrick, a CFP and president of merrickwealth.com, is an expert in exit planning and he stresses that advisors who prospect severance planning opportunities are stepping on potential landmines if they look at the situation as a selling opportunity and don’t take their fiduciary obligations seriously.

He spends many of his days now in courtrooms, as an expert witness on valuing severance plans for lawyers of aggrieved former employees. As a fee-for-advice advisor, he’s established a track record of valuing severance plans and employee benefits objectively as they pertain to an individual client’s personal wealth situation. Often severance packages can end up in the hands of lawyers, since there can be significant discrepancies between how an employer values a severance package and how a client does.

For this reason alone, Merrick says clients who come to their advisor with a severance package should call a lawyer before any financial plan is established.

“The first thing you should do is sit down with a lawyer to see if clients are getting the best value for what they are being offered,” Merrick says. “You can provide stock answers such as how you can roll over your group insurance to your private policy. To me that’s all about selling product.”

Merrick points out that much of the value of a severance package will be based on establishing a fair severance proposal to begin with. For example, there is a huge disparity between the cost of health and disability benefits offered by employers versus what they will cost an individual. Merrick say on average, a client will have to pay about 40% more for disability and health benefits with after-tax dollars.

Similar disparities may exist with the valuations of defined benefit pension proceeds.

A labour lawyer can work to settle a plan that attempts to fix these types of costly discrepencies.

“If I was let go from the business and I’ve worked there for 24 years, they may offer me an extra $24,000 dollars of severance to go out there and replace group benefits. If I was going to go out there and replace the same benefits, it could be $50,000 using after-tax money,” he says.

Once a plan has been settled, and the advisor offers advice on how to deploy the money, Merrick strongly recommends documenting all the actions taken in the plan. With buy-out and severance packages — it’s often a core piece of a client’s future savings — if something goes wrong they will go after someone, quite possibly their advisor, Merrick warns.

“You have to [consider] clients may decide to go after you,” he says. “If they decide to take action with the plan, I get clients to sign off on it. I also get them to sign off on things where we chose not to take an action. This way if they were going to take you to court, it’s as their trusted advisor. [If something goes wrong] the courts are going to treat you as a fiduciary who should have known better.”

Carol Bezaire, vice-president, tax & estate planning for Mackenzie Financial, says tax planning and managing your clients’ expectations will form the core pillars of maximizing their severance.

“Just planning ahead, if you look at the environment, you have to count on the fact that generally speaking it’s going to take people longer to get replacement employment than it would have four years ago,” she says. “Chances are you will not make as much money the next time you go somewhere. You have to save and make sure you’re going to have downgraded your debt and commitments to meet your next salary.”

One quick way to shelter a severance package is to use rollover RRSP contributions, Bezaire says.

“The first thing to look at is how long the employee has been with their employer. Statistics Canada shows many people who are in their mid-fifties are being let go right now. There is a strong likelihood that they’ve been with the company for more than 20 years. They are going to have RRSP rollover room. You can actually take $2,000 a year of service and move it into [their] RRSP,” Bezaire says. “Over and above that, they’re going to look at their unused contribution room.”

Clients too young to retire could be eligible for a pension adjustment reversal, which will free up additional RRSP contribution room.

“On your tax return, every year you have to put in what your pension adjustment is, which is how much the company put into your pension. If you get out of the pension plan early, you get a pension plan adjustment reversal because that pension amount they take reduces your RRSP room,” she says.

Also, for middle-aged former employees, if it’s possible, she says advisors should look at trying to keep their health and insurance benefits with their group provider, if that provider will let them roll over those benefits without conducting a new underwriting process.

“It’s a good thing to go to the group benefits provider and ask if you can continue with your own insurance, paying the premiums on it. There might be an opportunity for you to continue the benefits individually, without having to go through a physical,” she says. “If you’re responsible for your own healthcare costs it can get expensive. I know one couple of pensioners where it’s going to cost them about $7,000 a year now, because they already have health issues.”

In the current downturn, many severance packages have gone to executives who were generally well paid. For example, consider the number of high-paying jobs in the financial services industry that have been eliminated. Often with these positions come stock options. Bezaire says rolling over stock options can be a thorny issue.

“If you exercise a stock option, the difference between the market value and what you exercise them at is considered an employment benefit. You get that because you work for somebody and that would be fully taxable. You could defer up to $100,000 per period until you sell the stock. People forget that’s looming in the background,” she says. “For many companies the stock value is down. If you sell the stock, whether the price is up or down, you could very well face this deferred taxation employment benefit you would have received.”

Bezaire notes that the options are taxed at 50% income, at the client’s average tax rate.

(03/20/09)

Originally published on Advisor.ca