Rising rates increase the appeal of lump-sum pension payouts

Financial advisers will need to become fluent in pension math to properly guide clients

Jul 5, 2017 @ 1:17 pm

By Jeff Benjamin

As the Federal Reserve continues its pattern of gradually raising interest rates off historic low levels, financial advisers will want to start recalculating the way they advise clients when it comes to pension payout options.

There are always multiple variables to consider, but when rates are rising, some advisers believe the simple math favors taking a lump-sum payout instead of locking in for a few decades of monthly pension payments.

"If you think interest rates are going up, take the lump-sum and take it sooner rather than later," said Leon LaBrecque, managing partner and CEO at LJPR Financial Advisors, which manages $707 million worth of client assets.

Defined benefit plans, many of which face billions of dollars' worth of unfunded pension liabilities, commonly offer current and future retirees the option of a one-time lump sum payout over a lifetime monthly pension benefit to get the liability off the books.

Depending on how long a retiree and his or her spouse live to collect benefits, the lump sum payment is typically less money than a retiree would be paid over an entire retirement, which is where many advisers and clients must weigh the options.

But, according to Mr. LaBrecque, the rising-rate environment combined with the Pension Protection Act of 2006 that has driven more companies to offer lump-sum payouts, makes the decision much clearer and cleaner.

By Mr. LaBrecque's calculations, higher interest rates give retirees more options to generate returns on the lump-sum payout.

But, perhaps more significantly, simple math suggests that the size of the lump-sum payout offers will decline as interest rates continue to rise.

"Participants have a choice of what to do, but rising rates pushes down the size of the offers," he added. "You should take the offer sooner rather than later."

Jeff Snyder, vice president and senior consultant at Cammack Retirement Group, which works with employers on the pension side of the business, agreed that rising rates will put more lump-sum offers on the table.

"A rising-rate environment is helping corporate pensions with their actuarial assumptions and valuations," he said. "It's opportunistic, and now is the time to offer these lump sums to help shore up pension plans."

Lump-sum payout offers have been climbing for years as companies try to shed the less-predictable liability of decades of pension payments.

According to the Pension Rights Center, only 90% of state and local government pensions are fully funded, reflecting an average that includes such dire situations as the state of Illinois, which is only about 30% funded.

The situation isn't much brighter on the corporate side, where unfunded pension liabilities continue to rise.

A February report by Russell Investments found that the 19 U.S. public companies with the largest pension liabilities had a combined pension deficit of $177 billion.

As Mr. LaBrecque details, pension math uses a formula similar to mortgage math, which calculates monthly mortgage payments based on an interest rate and time.

For example, a $100,000 mortgage loan with a 4% interest rate, set to be paid off in 30 years, would require a $477 monthly payment.

If the borrower could only afford $477 a month, and the interest rate was instead 5%, the loan amount would have to drop to around $89,000.

With pension math, the lump-sum offer is based on the long-term liability of monthly pension payments, among other factors including life expectancy.

Using the above mortgage example, the lump-sum payment offer to a retiree falls in direct proportion to interest rates, according to Mr. LaBrecque.

While the size of the lump-sum offer might adjust as interest rates rise, that is still just one of the factors advisers are considering when advising clients.

"When we're talking to clients about this, we consider the payout amount along with the financial stability of the organization, the health of the pension plan, and the need for survivor benefits," said Brett Anderson, president of St. Croix Advisors, which has $40 million under management.

"The biggest thing is whether those [pension] dollars are going to be there in 20 or 30 years from now," he said. "You have to run the math, but there is also an emotional side that has to be dealt with."

Part of the emotional and practical side of the evaluation involves weighing the potential to leave an inheritance, which is more likely through a lump-sum payout option.

"Most of the people I work with do cash out because they want the flexibility and a lump sum even though it might be less than what you could get over the full term of a pension," said Daniel Leonard, principal at Marathon Retirement Planning, which manages $45 million.

"It just boils down to whether you want a guarantee or not," he added. "The client that is not going to cash out, they want X number of dollars a month and they are OK with that. They want the certainty over the possibility."


What do you think?

View comments

Recommended for you

Sponsored financial news

Use arjuna-design' to filter and find key information on over 1,400 fee-only registered investment advisory firms.

Rank RIAs by

Upcoming Event

Apr 30


Retirement Income Summit

Join arjuna-design at the 12th annual Retirement Income Summit - the industry's premier retirement planning conference.Much has changed - and much remains to be learned. Attend and discuss how the future is full of opportunity for ... Learn more

Reporter Ryan Neal discusses how investors inside and outside financial advice have become interested in the industry's technology, and introduces us to some top people fueling the trend.

Recommended Video


Latest news & opinion

These funds have gained more than 10% in just a month

And not all of the funds did it with tech stocks

As Finra elder-abuse rule takes effect, advisers will face awkward conversations

Regulation taking effect Monday requires reasonable effort to find trusted contact, allows brokers to stop fund disbursement.

As Trump prepares for State of the Union, 50% of advisers approve of his job performance

Percentage is 10.3 points higher than the general population approval rating.

Morgan Stanley said to be trimming 600 funds from platform

While not confirming the number of funds on the chopping block, the firm acknowledged it is culling its offerings.

As tax season gets underway, clients are looking ahead to how tax bill will affect 2018 returns

Advisers can put strategies in place now to make sure that there will be no hidden surprises this time next year.


Hi! Glad you're here and we hope you like all the great work we do here at arjuna-design. But what we do is expensive and is funded in part by our sponsors. So won't you show our sponsors a little love by whitelisting arjuna-design.com? It'll help us continue to serve you.

Yes, show me how to whitelist arjuna-design.com

Ad blocker detected. Please whitelist us or give premium a try.


Subscribe and Save 60%

Last News

investing for retirement calculator hewitt resources siemens can you contribute to roth and traditional ira ira distribution chart best place to get a roth ira hewitt resources 3m how to choose a 401k provider blackrock global tactical strategies portfolio symbol ira vanguard vs fidelity what is form 5329 turbotax compare prices average rate of return on annuities how many foals did secretariat sire pension lump sum or annuity calculator what is the current fdic insurance limit inheriting an ira from a spouse big brothers big sisters winston salem nc general obligation bonds vs revenue bonds best long term dividend paying stocks td ameritrade self directed brokerage account roll roth 401k to roth ira bank of america health saving account merrill lynch pierce fenner and smith inc mutual of omaha guaranteed life insurance coins wanted by collectors pension plan buyout calculator social security benefits from deceased spouse roth ira over contribution h&r block how much do they charge inherited ira withdrawal calculator t rowe price roth college savings plans mn pimco funds total return american europacific growth r3 inherited ira non spouse