Have a pension? You might have a huge decision to make

Allworth Co-CEO Scott Hanson explains why the rise in interest rates is encouraging some pension recipients to move up their retirements.

Will you be choosing the lump-sum payout, or a monthly pension payment?

If you’re employed by the healthcare, manufacturing, automobile, or utility sectors (or, for that matter, any industry that offers a traditional pension), when it comes to your retirement, you’ve probably heard the above question before.

To be sure, because everyone’s situation is unique, ultimately, the choice between a lump-sum payout option and a fixed-monthly payment is a decision that should be analyzed and reviewed with a fiduciary advisor who can take into consideration factors such as your overall financial situation, life expectancy, investment options, and savings levels, along with the needs of your family, just to name a few.

The amount of a lump-sum payout, or a monthly payment amount, are both calculated based on factors such as salary history, years of service, your age, the specifics of your plan, and, as I’ll soon cover, current interest rates.

So, when it comes to the decision between a lump sum or ongoing monthly payments, which option do workers typically prefer?

The fact is, that while some people are more comfortable with the security of a predictable monthly payment, according to The Wall Street Journal, depending on company and industry, at least 50%, and perhaps as high as 80% of all workers, choose the lump-sum payout over the prospect of a pre-determined monthly pension. ¹

Some of the reasons workers prefer lump-sum payouts include that, not only do most people believe that with compounding interest, they can achieve a higher rate of return (and therefore, more money overall) by investing the money themselves, or with an advisor, but there are also more available options for passing the money along to their non-spousal heirs. Also, as a bird in the hand is still worth two in the bush, the lump sum amount is cash in hand, as opposed to a monthly payment amount, which may not be fully guaranteed. (For example, even though the Pension Benefit Guaranty Corporation exists to protect consumer pensions, I know of people who have received as little as 1/3 of their promised monthly payout after the employer declared bankruptcy.)  

While there are lots of things to consider, one thing seems clear: For some workers – and with only two months left in 2022 – the answer to the “Should I take a lump-sum payout?” question may never again be as clear as it is right now.

That’s because many lump-sum pension payouts are going to take a substantial hit in 2023.

So, why the decline?

Employers use various calculations to determine future lump sum payout amounts, but chief among them (and little understood) are periodically calculated interest rates. That’s because, as the thinking goes, if interest rates are high, employees will need smaller lump sum payouts to make the same amount of money in the future as they would in a low interest rate environment.  

Everyone knows that interest rates have skyrocketed in 2022. And because there is a calendar year-over-year-interest-rate-lag in determining lump sum payouts, what happens with interest rates this year substantially impacts the amounts of payouts in the future.

After years of low interest rates, virtually everyone now clearly understands how they impact what we pay for the money we borrow. What fewer people realize, however, is that these same interest rates have just as big of an impact on future lump-sum payouts.

How much?

2022’s higher interest rates could lower 2023’s lump-sum payout amounts by as much as 30%.

Depending on the variables outlined above (salary, years of service, etc.), if you can retire in 2022, but you wait until 2023, you could see a hit to your lump-sum payment amount by as much as $100,000, $250,000, or even $300,000. (One person I researched, who would receive a 20% reduction to her lump sum, would lose $320,000 if she waited until 2023 to retire.) ²

These numbers are obviously substantial and bear investigating.

A few things: First, this does not mean you should automatically run out and file for retirement. On the contrary, I hope this serves as a wake-up call to conduct your due diligence so you can determine the best option for your personal situation. Also, it’s important to note that not all types of pensions are affected by this calculation of interest rates. (For instance, cash-balance pensions are not impacted.)  

Next, it’s essential to understand that your employer does not control interest rates; the government does. Further, for some companies, the calculated interest rate portion of the equation that is used to lock in lump-sum payouts for next year were only just published in September, so if the buzz in your industry around moving up 2023’s retirements to this year (2022) is only just beginning to gain steam, that may help explain why.  

While there are certainly more things to consider than interest rates, such as whether you’re emotionally ready to retire, the amount of other savings you have, your debt, your age, and your short- and long-term life and financial goals, a wise man once said, “The most successful person in life is the person who has the most accurate information.”

Simply, should any of the above apply to you, or even to a coworker or friend, after 30 years of working with clients to help maximize their pensions, and because this year is unlike any other that I can remember, with just under two months left in 2022, you owe it to yourself to do absolutely everything you can to make certain you have a complete grasp of all of your options.   

^{1 Should You Retire Early to Get a Larger Lump Sum on Your Pension? - WSJ}

^{2 Retirees' lump sum pension payouts will be hit hard by interest rates (freep.com)}