Rising rates pushing early retirement

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Workers with pension plans that offer a lump sum payout watched their balances grow as low interest rates helped push up bond prices over the last few years. Now that the pendulum is swinging in the other direction, those same workers are starting to see the cash value of their pension lump sum fall.

"This is one more way rising interest rates will affect people in ways they don't even realize," said Bob Hapanowicz, president of H&A Wealth Advisors, Downtown. "We are at the beginning of what many think could be a pretty sizable increase in rates over the next few years.

"While interest rates are low, a lump sum payout can be more attractive than a monthly annuity payment from a Fortune 500 company," he said. "But if interest rates go up to 5, 6 or 7 percent, the monthly annuity payment can look a lot more attractive than a lump sum payout."

Interest rates are a major factor in determining the value of a pension lump sum payment because it affects the projected value of future annuity payments. With rates still near historic lows but expected to rise, workers who are close to retirement with a defined benefit pension plan should take a hard look at how their lump sum payout will be affected if rates go higher.

They may wish to retire sooner or choose to take the lifetime monthly annuity payment instead of the lump sum.

Mr. Hapanowicz said one of his clients, a 62-year-old female who has worked for a company for 40 years, stands to lose $90,000 in her lump sum payout if she stays on the job another year due to her age and due to higher interest rate projections being used by the Pension Benefit Guaranty Corp., a federal government agency that oversees pension plans.

After age 60, a worker's age begins to work against them in the lump sum payment calculation because it is based partly on life expectancy. As life expectancy decreases, so does the lump sum amount.

While the 62-year-old worker could opt to receive a monthly annuity of $3,724 a month for life, her lump sum payout in September 2013 is $742,000. By September 2014, it is estimated to be about $652,000. If she waits even another month, Mr. Hapanowicz estimates it will cost her about $48,000 in lump sum payments.

"If she's thinking about retiring this year, she's probably going this month," Mr. Hapanowicz said. "Rising interest rates are causing her to evaluate very closely her options and her retirement plans."

David Woelfel, a manager at the employee benefits firm, Buck Consultants, Downtown, said some clients at the companies his firm works with are retiring earlier than they had planned.

"Many who were considering retiring are jumping at the chance to do so before rates rise even further," he said. "Most participants who have a pension benefit where they are allowed to take a lump sum understand the time to take the lump sum is when interest rates are lowest."

Not all pension plans offer their workers the option of receiving a lump sum. Rising rates would only be an issue for workers who have the lump sum option. Employees who receive a monthly annuity from their pension can expect to receive the same benefit regardless of interest rates.

City of Pittsburgh workers have no lump sum option and can only receive the monthly benefit. Employees at companies such as U.S. Steel can take a lump sum payout from their pension.

Pension administrators calculate the present value of a worker's lump sum payment by adding the projected monthly payments over the worker's remaining life expectancy. The amount of the lump sum is inversely related to the current interest rate because the pension is a stream of cash payments, and rising interest rates reduce the value of those cash payments.

While employees receive a low lump sum payout due to rising interest rates, the flip side is that companies that offer pensions benefit when rates go up. When interest rates are higher, companies do not need to set aside as much money to make monthly pension payments to its workers.

Thanks to rising interest rates used to calculate the cost of future payment to retirees, General Motors reported in its 2012 annual report that each 1 percent increase in interest rates cuts $8.76 billion from the present value of its pension obligation.

Mark Dunbar, an actuary at the actuarial firm Dunbar Bender & Zapf, Downtown, said most employees who have the lump sum option will chose the lump sum instead of the annuity.

"Our experience has been that if a pension plan has a lump sum feature, 99 percent of people will take the lump sum," he said. "Participants will see a reduction in their lump sum payouts as rates go up. They may want to get estimates on how that will affect them and make plans based on that."

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Tim Grant: tgrant@post-gazette.com or 412-263-1591.


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