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Pension calculation for lump sum rollover is 40+% less than it was 18


Guest dpeverhart

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Guest dpeverhart

I had a pension calculation done in

August of 1996 for a lump sum rollover. The lump sum was $8,278. I decided to just leave it alone and not take the lump sum at that time.

Then in July of 1998 I had another pension calculation done for lump sum rollover. The lump sum was $9,232. I decided to just leave it alone and not take the lump sum at that time also.

I just had another pension calculation done for a lump sum rollover fully intending on rolling it over this time into my Schwab IRA. The lump sum for January 2000 came to $5,427.!!??

Why would it go down so over 40%!!? I asked the Benefits Administrator to explain to me why it would decrease so much and was told 'interest rates'. They would not say what interest rates affect pension calculations or give me any other specifics just that 'when interest rates go up, lump sum distributions go down, way down.'

Does this sound right? I need some guidance here. Should I have it recalculated, contact an actuary for assistance or what?

Thanks,

David

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I will try to offer a generic explanation of what I think is going on. I'll start with some basic background and apologize in advance if it seems redundant.

Background

A defined benefit pension plan promises the payment of a monthly income to the participants for lifetime, beginning at retirement, usually age 65. The amount of the monthly benefit is determined by a formula contained in the plan. The formula takes into account the compensation and service of each participant. In the case of most Plans, retiring employees may choose the form in which the benefit is received: several different forms of monthly options, or perhaps a lump sum equivalent. Sometimes this lump sum equivalent is available only for "small benefits", if the lump sum is $5,000 or less. Company contributions are deposited into a trust fund, invested by the pension plan trustees and, based on the instructions of the plan administrator, withdrawn to pay benefits to retirees. The minimum deposit is calculated annually and certified by the Enrolled Actuary. In order to make such calculations the Enrolled Actuary must make several assumptions about future events and patterns, such as the average investment return for the trust, expected salary increases for employees, and expected rates of turnover. Another assumption is that, unless there is evidence to the contrary, the Enrolled Actuary should assume that the Plan will continue to exist. This is important because it forces the other assumptions to be focused on a long-term outlook rather than just a one or two year horizon.

However, due to requirements in the tax laws, the assumptions used for determining a plan's *funding* requirements are usually different from the assumptions used for determining the value of a lump sum actuarial equivalent. This is because the tax laws establish certain procedures for determining the minimum value of a lump sum.

Valuing Lump Sums

A generic description of a lump sum payment is the present value of all future monthly benefits (assumed to commence at Normal Retirement Date, usually age 65) based on a set of assumptions with respect to future investment earnings and future patterns of death. For the purpose of determining lump sums, your Plan probable originally specified the use of assumptions which are generally "conservative". These assumptions were the minimum specified in IRS regulations prior to 1994 (changes after 1994 discussed below). Generally, using these "old" assumptions, a lump sum payment was artificially high when compared to current market conditions.

In 1994, as part of GATT, Congress passed the Retirement Protection Act of 1994. Included in this law is a provision allowing plan sponsors to modify (by plan amendment) the actuarial assumptions used for determining lump sum equivalents to better reflect the current market conditions. Plans *could* adopt such provisions, which are applicable only for determining a minimum, after the law was passed. However, plans *must* adopt such provisions by the 2000 plan year. At the time such assumptions are adopted, "grandfathering" the lump sum amounts immediately prior to adoption is permitted but not required.

Thus, the conservative assumptions are replaced by market assumptions. For example, one of the new assumptions is an interest rate related to a monthly average of 30-year Treasury securities. The rate so specified (in the adopting amendment) can vary either monthly, quarterly, or yearly. The use of the old assumptions may be appropriate if the Company is trying to maximize the lump sum amounts for participants; the use of new assumptions may be appropriate if the Company is trying to minimize such lump sums. Amounts in between are permitted.

Plan Amendment

Based on your statements above, it appears that your Plan has been amended to adopt these provisions without any grandfathering. Thus, the use of market-related assumptions eliminate most of the built-in subsidy for lump sums. My own interpretation of this is to describe it as a desire not to maintain an inherent subsidy to the lump sum form of payment since the primary purpose of a defined benefit plan is usually to pay retirement income in the form of monthly benefits.

[This message has been edited by pax (edited 02-05-2000).]

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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I suspect that you were a victim of GATT. Prior to GATT, minimum lump sums were calcuated using *deferred* PBGC rates. These rates were quite low and were very favorable for the participant. Beginning 1/1/2000 (for most plans), the minimum lump sum is calculated using simple 30-year treasury rates. This rate is substantially higher than the *deferred* PBGC rates. There is no requirement to "grandfather" your old higher PBGC-based lump sum.

Ask your employer what interest rates were used for the various calculations. They must tell you.

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