What is the present value of a lifetime pension?

[jlf]

One is entitled, at age 60, to a DB of $50,000 per year for life.

The Retirement System establishes a Reserve of $500,000 in order to guarantee this lifetime benefit. In the event that a lump-sum option is permitted is the $500,000 the lump-sum?

[Larry M]

The answer is "maybe".

If the system allows lump sum payments of benefits, it will /should define, in the plan document, how the lump sum is calculated. This calculation may use assumptions which are different from those used to determine the amount for which the system has established its "reserve."

For example, the system may use different interest (discount) rates and differing mortality assumptions for the two calculations.

One way to find out the answer for this system is to ask the question of the administrator.

If that is not practical, get a copy of the portion of the plan document (or a summary)which defines actuarial assumptions and have a friendly (there are some) actuary make the calculations for you.

[jlf]

The $500,000 Reserve assumes a 7% interest rate factor.

Does that help you in determining whether or not the Reserve equals the lump-sum settlement?

[Guest]

It's not enough to only know the interest rate,and in fact it might even be irrelevant. The lump sum payout (assuming the plan allows lump sums) would be calculated first using the plan's definition of actuarial equivalents. That number would then be compared to a lump sum calc'd based on the interest rate required by IRC 417(e) (which should also be specified in the plan),and the participant would be entitled to get the greated of the two values,subject to the maximum lump sum under IRC 415. I am a "friendly actuary" not too far from you,in Cranford. I'd be happy to help.

[jlf]

Hi "friendly actuary"...in your experience, how far removed from the $500,000 Reserve is the lump-sum distribution?

[Guest]

It's hard to tell because we don't know the relevant plan provisions, but here's a possible scenario:

A reserve of $500000 at 60 to provide a benefit of 50000/year gives a lump sum conversion factor of 10. At 7% this is pretty close to a factor using 1951 Group Annuity mortality projected to 1970-a somewhat out-of-date table.

Assume that the actuary is funding to 7% GA-70 because that's the plan definition of actuarial equivalence,i.e. the plan's funding objective and payout basis are in synch. So far,so good.

Now you have to compare the actuarial equivalent lump sum with a lump sum calculated based on the "applicable interest and mortality" required under IRC 417(e).The interest rate can vary depending on the plan,but the mortality is fixed by Rev. Rul. 95-6. This table is a much more conservative table than GA-70. At 7% the factor at 60 is now 10.93 due to the change in mortality. This increases the lump sum to 541500,a difference of more than 8% over the reserve.Does this help?

[david rigby]

No argument with the comments by Sdolce, but a word of caution.

"...the mortality is fixed by Rev. Rul. 95-6."

Based on earlier posts by jlf, it is likely that his reference to "...the Retirement System" is a governmental plan. The relevant sections of the Internal Revenue Code (and regs) generally do not apply (at least not automatically under federal law) to governmental plans. So, the plan terms, and any relevant state laws, should be reviewed to determine the proper definitions of "actuarial equivalent".

BTW, my guess is that the single premium cost of a $50,000 annuity at age 60, if purchased from an insurance company on the open market today, would be more than $500K. I would guess at least $600K.