For most of us the term pension seems more like a long lost relic of the past, but for a minority of the working population this tremendous benefit is still available. One of the biggest decisions you will face when you have a pension is whether to take the lump sum, or one of the annuity options with various survivor benefits. Which direction you decide to go depends completely on your unique situation and there are many factors to consider, but for those who are close to retirement right now, one of the most important factors to consider is that interest rates are rising.
Due to rising rates the lump sum option for those retiring in the near future is anticipated to be reduced considerably. The reason is that pension lump sum option represents the present value of the income you would receive over your lifetime if you chose the annuity option. In order to obtain a present value you need what’s called a segment rate. The IRS publishes their Minimum Present Value Segment Rates on a monthly basis, and these are the interest rates companies use to discount your future payments back to their present value today. The table the IRS publishes comes from corporate bond yields and each of the 3 segments represents the segment rate used for different time periods in retirement, 5 years, 20 years, and greater than 20 years.
Companies may take an average of these 3 rates or use them exactly, or they may have another way to determine the rate they will use, the key here is that higher interest rates in general will cause a reduction to the lump sum option because it is being discounted by a larger number.
Currently the Federal Reserve is fighting inflation and the way they do that is by increasing short term rates, but this year we have seen interest rates increase for short term as well as long term bonds. So, the expectation is the reduction to pension lump sums will be considerable as companies adopt the new segment rates.
This does not mean you should retire today simply because you anticipate a lower lump sum if you wait, but it is definitely a good time to review your options and explore whether the lump sum or annuity option is the right for you. The good news is while segment rates will impact the lump sum, they have no bearing on the annuity option as that is determined by a formula your company uses that’s not dependent on interest rates. Additionally, pensions are often one of the most efficient vehicles for generating income in retirement, typically having higher payout rates than what you could get in the bond market or by purchasing an annuity directly through an insurance company, but there can be drawbacks as well.
It’s important to have a broad perspective when making your decision. Do you have health issues? Is it important to leave money behind to your heirs? Are you responsible with money or have trouble maintaining a budget? Are you comfortable with investment risk? Do you have other income sources? These are some of the many questions to answer when considering a lump sum vs. the annuity option.
If you are approaching retirement and have a pension plan that offers a lump sum option, now is a good time to reach out to us to explore what makes the most sense for you.
When you link to the website provided here, you are leaving this site. We make no representation as to the completeness or accuracy of information provided at this site. Nor are we liable for any direct or indirect technical or system issues or consequences arising out of your access to or use of the third-party site. When you access this site, you assume total responsibility for your use of the site you are visiting.