Does it move people ? Does it qualify as a crane ? If so, take a step back and consider the application and the various codes, laws, and regulations that might apply.
That being said: describe the configuration of the system and what the separate encoder is doing.
You always need an encoder attached directly to the motor shaft and connected to the VFD directly to run in vector mode well enough to handle a vertical load. My understanding is the PowerFlex 520 series drives support only quadrature pulse type encoders, with the 25-ENC-1 option module for the PowerFlex 525, and the 25-ENC-2 for the PowerFlex 527.
Are you talking about a follower application, where the lift mechanism follows some other mechanism with the encoder on it ?
The SICK AFM60A encoders, like the PowerFlex 525, are treated like cyclic I/O devices. Creating a follower application with I/O devices means writing your own position or gearing logic.
To make use of CIP Motion to do velocity gearing or position follower applications, you need a CIP Motion drive (the PowerFlex 527) and a CIP Motion encoder like the A-B 842E-CM. You also need a ControlLogix with an Ethernet module that supports CIP Motion (like 1756-EN2T) or a CompactLogix that has the "-ERM" suffix.
To my knowledge, A-B 842E and SICK AFM60A are very similar, but SICK doesn't directly sell an equivalent to the 842E-CM, which supports CIP Motion.