Will Rising Interest Rates Affect Your Pension?
24 Feb 2016
If you’re getting close to retirement and have decided to take monthly payments from your pension, then rising interest will have little impact (today) on your decision. However, if you’re considering or have been offered a lump sum payment, rising rates can make the timing of your decision critical. Or as Donald Trump says, “This will be HUGE.”
Most pensions will use the present value of your future pension checks to calculate your lump sum amount. In the past, the interest rate used was the 30-year-Treasury bond rate. Now, plans can use a higher corporate bond rate. The key to this, and it’s important to understand this, is the amount of your lump sum payment is INVERSELY proportional to interest rates. The higher the rate used, the lower the amount of your lump sum.
As an example, I had a caller to our radio show tell me that 6 months ago, she was offered roughly $350,000 as her lump sum from her pension. Her new offer, after only a .25% increase in interest rates, was 3% less than the original offer! I hate to think what the offer will be if rates continue to go up this year, as some have predicted.
Making the decision to rollout your pension is a big one and should not be based on just the rising interest rate risk alone. Here are 10 questions to ask yourself or your financial professional when weighing your options:
1) Is the pension our primary source of income?
2) Are there solvency issues with my current pension provider?
3) What is my marital status?
4) Do we have children and would we want the pension money to go to them on my (our) death?
5) Does my pension provide for a cost-of-living-adjustment (COLA)?
6) What is my current health situation?
7) Do I believe that either my financial professional or I can invest the proceeds appropriately for my risk and needs?
8) Will I be rolling the money to an IRA to defer taxes?
9) Will interest rates be rising in the future?
10) Will the lump sum offer be taken off the table at some point?