The Impact of Low Interest Rates on Your Pension
I have guided a number of individuals working in the Energy Industry, here in Southeast Texas, through retirement planning; and over the years I have gained insight into the unique challenges and opportunities they must navigate.
A retiree’s decision regarding their pension election, a choice that will affect the rest of their life, is often one of the most important (and often confusing) choices they must navigate. Every individual’s circumstances are unique and therefore they must consider many factors in order to make the best selection.
At the highest level, pension options typically break down between the following choices:
1. Income for the rest of your life (single life option);
2. Income for the life of you and your spouse (joint and survivorship option);
3. A lump sum distribution;
4. A combination of a lump sum distribution and income for the rest of your life.
THE RELATIONSHIP BETWEEN INTEREST RATES AND YOUR LUMP SUM PENSION
In today’s interest rate environment, the lump sum option is a popular one due to the relationship between interest rates and pension values. This relationship acts as a seesaw, with interest rates on one end and your lump sum pension on the other; as one end goes up, the other goes down.
mage Source: How To Evaluate The Pension Versus Lump Sum Decision and Strategies for Maximization (Michael Kitces, 2015)
For some, they may be so far out from retirement it’s a moot point. However, those relatively close to their target retirement date may find themselves in a situation where the change in their pension value could offset all, or a majority of the future benefits (income, 401k match, etc.) they’d receive from staying employed with their current company. This phenomenon can come into play in the years leading up to age 60, and especially after age 60, when some employees may see a point of diminishing returns regarding their pension value. I have had a number of clients voice confusion relating to why their lump sum pension essentially flattens out after reaching age 60. While the inputs to your pension benefit are calculated off your specific years of service, individual salary, and interest rates; the short answer is: the formula can often encourage long time employees to move on to greener pastures after reaching a certain point in order to make room for the next generation of talent.
Let’s look at an example:
Fred is 59 years old, works at the Exxon Mobil Beaumont refinery and has the following inputs:
· Target commencement date (retirement date) - January 1 in the year in which he turns 60
· Annual salary - $160k
· Combined lump sum pension estimate with no change in interest rates - $2.1M
· Combined lump sum pension with .50% increase in interest rates - $1.98M
As you can see, his pension value would decrease by more than his salary. Thus, he could find himself “working for free” or even paying to continue working. Does this mean Fred should retire early or, perhaps, separate from service and come back as a contract employee? Maybe, but maybe not… The decision needs to be made on an individual basis and there is no general rule of thumb that I believe adequately answers these types of questions.
CAN I RETIRE “EARLY”?
I’m often asked, “Don’t I have to wait until 59.5 to retire?”. The short answer is no. There are accounts you can draw from and strategies you can implement to bridge the years until you are 59.5. There are, of course, other factors to consider and, as with any other financial decision, it is important not to perform your pension analysis in a vacuum. At Legacy CFO, we create customized financial plans (check out our video here on the importance of a plan) for each client to showcase how each decision will affect their chances of successfully reaching their goals. Some of the other considerations we bring into the analysis include: cost of foregoing the company 401k match/other benefits of staying employed, how drawing from your nest egg earlier affects the plan, Net Unrealized Appreciation (NUA) strategies, the retirement withdrawals you will need compared to what you have accumulated, and so on.
If you’d like to run pension estimates for yourself to see how changes in interest rates impact your pension, many companies offer their employees estimating tools and calculators. For example, here is a link Exxon Mobil employees can use to run pension estimates and manipulate variables such as: future wage increases, interest rate changes, and various commencement dates.
Some of the employer benefits we specialize in include: Exxon Mobil, Valero, Shell, Motiva, and Entergy.
If you have questions or want to learn more about how we help clients navigate these decisions, please contact us here.
Author: Cameron Capriotti