Need help with calculation of pension benefit.

[Guest Maynard]

I'm told my pension (lump sum) is based on the lower of two rates; 30 Yr. T rates and PBGC. I'm not sure how the lump sum is calculated however! :confused:

I meet the age and/or service requirements to be able to retire without any reduction in my pension. My age is 56 for life expectancy purposes.

The "yearly" pension is equal to 1% for every year of service based on the average of the best five year's salary. Example of the "yearly" pension would be: .35 (35yrs) X $100K (Avg.) = $35K Yr.

Can someone please tell me what the formula or methodology is for calculating the "actuarial equivalent" lump sum payment based on my age and the above noted "yearly" pension option?

There must be a simple way to calculate it, right? Or no?

Thanks!

[RCK]

There is no simple and accurate way. You can have simple or you can have accurate.

Assuming that you know the interest rate, you can get close by using either a financial calculator or a spreadsheet program, and figuring out the present value of a benefit stream. You know the annual benefit, the annual rate of return, and can guess that the period of payments is about 27 years. Plug those into whatever you use, and voila--a present value or lump sum.

RCK

[Guest Keith N]

The fact that you "meet the age and/or service requirements to be able to retire without any reduction in my pension" may not mean anything when it comes to the calculation of your lump sum. Typically the lump sum is the present value of the Normal Retirement Benefit, and not the "value" of the Early Retirement Benefit.

You should ask your benefits person if your lump sum includes the value of the early retirement subsidy. They may not know, but your companies actuary would be able to tell them. Chances are it does not.

There is nothing illegal about this. If you want the lump sum, you can have it. If you want the early retirement subsidy, you must take the annuity. This is very common. But you should know that by taking the lump sum, you are potentially forfeiting your early retirement subsidy.

[Guest Maynard]

Thanks guys!

But "subsidy"? I'm not sure what "value of early retirement subsidy" is! :confused:

I should have explained that retiring at my age and service years is not considered "early" retirement. I have met the companies' full requirements for retirement regardless of the fact my age is less than many companies' require. To explain further, when my age and years of service added up to "80" I met the requirements. Knowing this, is "early retirement subsidy" still in question?

I'll run the numbers on a spreadsheet based on 27 years both both interest rate figures (30 Yr. T and PBGC) to get me close to my lump sum figure. You know, I still can't understand why the rates were lower in say 1998 than they are now. This confuses me... Can anyone explain why this is?

Originally posted by Keith N

You should ask your benefits person if your lump sum includes the value of the early retirement subsidy.  They may not know, but your companies actuary would be able to tell them.  Chances are it does not.  

....But you should know that by taking the lump sum, you are potentially forfeiting your early retirement subsidy.

[Guest merlin]

But you may also be getting a "subsidy" built into the lump sum by the applicable interest and mortality rates required by IRC 417(e).The actuarial equivqlence factors defined in the plan may result in a lump sum of $75,000. The 417(e) rates,which must also be written into the plan,may give $100,000. You're entitled to the higher number.It all depends on the way the plan is written.

[Guest Maynard]

Thanks merlin!

I need to study my plan to see how it is written... Are those figures ($75K and $100K) just examples?

The lump sum figure I'm expecting to receive is in excess of $100K if that makes any difference. How does the possible subsidy situation affect me?

Is the higher of these two figures "in addition to" what I was expecting to receive? You said the subsidy may be "built in" to the lump sum... Can you explain how this figure is "built in"?

Thank you.

[Guest merlin]

They're only examples.Your plan and your particular data will govern.the "subsidy" I referred to is the extra $25,000 generated by the difference in the plan actuarial equivalence factors and the 417(e) rates.But again this is only an example. Sorry, I didn't mean to get your hopes up.

[Guest Maynard]

I understand... Thanks for your help.

[Guest Maynard]

I just saw on the news that the U.S. government will stop issuing 30-year Treasury Bonds!

How will affect various financial calculations in the future?

[MGB]

Although they quit issuing them, there are still over $600 billion of 30-year treasuries in circulation (none have ever matured, they started in 1977). These will continue to be traded and a yield rate will continue to be published for many years to come.

Separately, the Treasury has a buy-back program in place to buy up some of the outstanding 30-year bonds. According to the WSJ on Monday, they will continue to do this buy-back even if we go into deficit spending because they want to keep the interest rates on 30-yr treasuries artificially low. (Note that the interest paid to the trillion+ in the Social Security trust funds is pegged to long-term government obligations, so these low rates mean that the government is paying less in interest to these funds, too.)

The net result is that there is a dwindling supply and a huge demand. This will continue to drive down the yield (it dropped below 5% on the announcement this morning - the largest plunge in a long time).

As these rates continue to fall, lump sum calculations will continue to rise.

There is massive lobbying going on in Congress to remove the reference to 30-yr treasuries from this and other calculations. Up until yesterday, there was little movement towards any change. With the new announcement today, the playing field has shifted and there is a better possibility of something changing next year.

[Guest Maynard]

So with expected lower rates (for 30-yr Ts), lump sum calculations will rise...unless or until 30-yr T rates are no longer used for such calculations. Do I understand this correctly?

Since lower rates make lump sums greater, is your opinion that waiting a while is best to benefit from lower rates? As an aside, I still can't figure out why these rates were lower in 1998 than they are now!

Originally posted by MGB

As these rates continue to fall, lump sum calculations will continue to rise.

There is massive lobbying going on in Congress to remove the reference to 30-yr treasuries from this and other calculations.  Up until yesterday, there was little movement towards any change.  With the new announcement today, the playing field has shifted and there is a better possibility of something changing next year.

[Guest Keith N]

Regarding subsidy:

Lets igonre the "rule of 80" for now and assume your Plan's Normal Retirement Date (NRD) is age 65. Lets also assume that you were hired at age 32 and that your now 56. Lets also assume that your current accrued benefit is $1,500 per month for life, commencing on your NRD (ie: age 65). This benefit would have a lump sum value of approximately $115,000. This is a "standard" lump sum calculation.

Now lets look at the "rule of 80". Since your age (56) plus your service (24) equals "80", you meet the "rule of 80" and are eligible for immediate unreduced benefits. This means that you are now eligible to receieve $1,500 per month for life, commencing at age 56 (as opposed to age 65). The fact that you are actually eligible to receive your benefits at age 56, may not change the lump sum value which was based on a commencement age of 65. IF your plan based the lump sum on the "rule of 80" benefit (ie: 1,500 commencing at age 56), your lump sum would be around $240,000. Thats the value of the "rule of 80" benefit. The value of the subsidy is $125,000 (240,000-115,000).

Please keep in mind that these are purely examples. Your cacluation would be based on your specific plan provisions and your work history. This is only intended to demonstrate the value of the "rule of 80" subsidy. Your benefits department should be able to give you specific details related to your lump sum calculation. Information you obtain on this board can only be general because none of us know the specifics of your calculation. I suggest that you contact your benefits department for specific details related to your calculation.

regarding your interest rate analysis I think you have the concept correct. Lower rates means higher lump sums. I don't think anyone is recommending that you wait, or that your elect your lump sum now. That is purely your call. If YOU think interest rates may be lower in the future, maybe you should wait.

Also, you would need to ask an economist why 30-Yr. rates were lower in 98 than they were two days ago. (today they are lower).

[MGB]

Maynard,

I am not sure whether you can benefit from "waiting awhile" or not. This depends on your plan provisions.

If the lump sum includes the value of the early retirement subsidy, then you slowly lose that subsidy as you wait (it will all go away by the time you reach normal retirement age). That subsidy (as described in the previous post) is huge if you can get it and a decrease in rates won't override that.

Whether you are getting the subsidy or not, you also lose some opportunity cost by waiting. For example, if the discount for one year is 5% and you could have invested the money at 8%, then you lost out on 3% by waiting a year. However, if the lump sum increased by more than 3% by waiting, you come out ahead. (For every 0.1% drop in rates, your lump sum increases in a range of about 0.75%.)

I am only guessing here, but I think 1998 was when the Treasury first announced their buy-back program, so there was an immediate illiquidity premium put on them, driving down rates. That is what drove down rates in the last 24 hours, too. They will become even more illiquid and unavailable with no new issues.

Note that waiting may backfire. The Treasury is not "locked in" to their current policy. They could flood the market with new issues in February (the next sale date that was just called off) if they find out they are spending a lot more than expected in Afghanistan, loss of tax revenues here, etc. There have been many economists that have publicly decried their announcement yesterday, saying this is the time (when rates are low) that they should be issuing long-term debt instead of short-term to lock in the low rates for the future. (It is similar to a house mortgage...do you go with the long-term refinance and pay off short-term debt when rates are low or do you wait until they are high?)

[Guest Maynard]

Thanks "Keith N" and "MGB" for your most helpful explanations. I appreciate it.

[david rigby]

There may be a different problem. The previous comments on the "rule of 80" seem to assume that this is one definition related to Early Retirement under the plan. If instead, the "rule of 80" is an alternate definition of Normal Retirement, the resulting analysis may be different.

[Gary]

The Plan document should make it clear if the lump sum is based on the deferred normal retirement benefit or the subsidized immediate benefit.

My experience is that if you are eligible for an immediate benefit, the lump sum is usually based on the present value of the immediate benefit. And if you are eligible only for a deferred vested benefit the lump sum is usually based on the deferred normal ret. benefit.

It sounds like you are actually eligible for a normal retirement benefit anyway, thus I am pretty sure that your lump sum is based on your immediate benefit.

Is there anything else you need?

With the interest rate, mortality table, monthly annuity, participant's age at benefit commencement, calculating the present value is easy. That is, not time consuming.

[MGB]

Gary,

I am surprised by your experience with the immediate benefit being lump summed out. My experience is the exact opposite - that they have all used the deferred benefit.

However, I've only worked on large plans, I don't know if it is different with small plans.

[AndyH]

I agree with MGB's comments in the small plan world as well.

[mwyatt]

Quick explanation of why 30-year rates were lower in 1998 (mainly in fall of that year):

Remember the collapse of the Russian and Far East markets in the summer of 1998, followed by the averted meltdown of our markets after the failure of Long Term Capital Management? Between Fed intervention and "flight to safety" world-wide to US Treasuries, this forced yield down on the 30-year bill.

This is why 30-year rate dropped dramatically in fall of 1998 (at point getting down to around 4.72%). Definitely not normal circumstances, but a bonus for participants if they were paid a lump sum in 1999 (going on assumption that plan did lookback into fall of 1998 and fixed rate for longer period than a month).