The Smart Take:
Pension lump sums will be much higher in 2021 than 2020. Listen to Kevin discuss timing considerations on how to optimize your pension benefits by understanding the key variables that determine your lump sum. Company pension plans specifically discussed include Akron Children’s Hospital, Bridgestone, FirstEnergy, Goodyear, Mercy Health, and Rockwell Automation.
Whether you have a pension from your company or not, you’ll benefit from this episode. Why? Anyone can invest money with an insurance company and receive a lifetime income in the form of annuity payments. So these considerations are universal in crafting your retirement income plan.
Want more information on pension claiming strategies? Listen to Episode 38. https://www.truewealthdesign.com/ep-38-pension-lump-sum-or-monthly-payment/
Check out Episodes 12 & 13 for more details about annuities. https://www.truewealthdesign.com/episode-12-behind-the-curtain-of-annuities-and-free-steak-dinners/
Need help making sure your investments and retirement plan are on track? Click to schedule a free 15-minute call with one of True Wealth’s CFP® Professionals.
2:58 – What Has Changed With Pension Lump Sums?
8:56 – Why These Changes Matter
10:33 – Segment Rates
16:11 – What To Expect In The Future
20:39 – Engineers & The Spreadsheet Story
25:04 – Closing Thoughts
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Intro: Welcome to Retire Smarter with Kevin Kroskey. Find answers to your toughest questions and get educated about the financial world. It’s time to Retire Smarter.
Walter Storholt: It’s another Retire Smarter Podcast. Walter Storholt here alongside Kevin Kroskey, and he’s the president and wealth advisor at True Wealth Design, serving you in Northeast Ohio and Southwest Florida. You can listen to past episodes of the show and find out more information about Kevin and the team by going to truewealthdesign.com. Kevin, great to be with you today. How are you?
Kevin Kroskey: Walter, I am great. We are firmly in November in the fall, and football season is going. My Pittsburgh Steelers are still undefeated, which is great. The Cleveland Browns actually have a winning record as well, so far so good.
Walter Storholt: Now you’ve jinxed them. Good job.
Kevin Kroskey: Maybe, we’ll see. We’ll see. But yeah, we’re good. We have a lot of meetings in November and December with our clients. We do our fourth quarter, what we call our tax and investment reviews, basically looking current year. We had a plan coming into the year. Where are we at in terms of spending? What additional tax moves might we want to make before the end of the year? And then look prospectively to next year as well and repeat the process. So we’re going through that right now. And had something come up with a client that has a pension lump sum, and we spoke about this. I think it was in February. In fact, I actually went back and listened to the podcast yesterday before preparing for our recording. And February was right before the world changed with COVID-19, so it was interesting.
Walter Storholt: Back to a different time, Kevin.
Kevin Kroskey: Yes. It was like BC, right? Before COVID.
Walter Storholt: That’s right. Yeah, it was.
Kevin Kroskey: So I was listening to it and said, “There’s probably a few things here that we should update. And there’s a big change that’s going to happen in 2021.” So this is something that is, I think if you have a lump sum option, if you have a pension, certainly it applies to you. Even if you do not have that option, it’s still relevant because we’ll talk about retirement income. And you can still buy a lifetime income stream, which is what a pension is. But you can just go out directly to an insurance company to do it, so we’ll talk about some lump sums, but we’ll talk about some broader strokes related to retirement income and what have you. So I figured that’s what we would do for today.
Walter Storholt: Well, I think that’ll be great. And we’ll put a link into that original show back in February just in case you want to go back and hear the original, but it would be good to get some update on some of these things. And I know that we’ve talked about annuities and buying your own pension in the past. And we’ve got plenty of episodes on that as well over the last couple of months. So again, if you want to hear more about the annuity conversation and Kevin’s thoughts and opinions on those as an investment and as part of a portfolio and a plan, I encourage you to go check that out too.
But yeah, pension lump sums, I think, is a good thing to talk about and get some updates. What has changed? What is on the horizon? And what are you looking at as we approach the end of 2020 here?
Kevin Kroskey: Sure, so first, a quick recap. If you have a lot of the pension lump sums, so the local companies in Northeast Ohio, Akron Children’s Hospital, Bridgestone, has a lump sum option now, First Energy, Goodyear, Rockwell Automation, these are all large local employers in Northeast Ohio that we serve a lot of clients at. And they all have both a pension, or they had a pension, a lot of them have been frozen, so maybe they’re not continuing to accrue additional benefit. However, benefits still have been earned, and so what the company has promised to pay is, hey, when you get to a certain age, we will pay you out X amount of dollars for your lifetime, and that’s what they promised.
But then what they also do over and above that oftentimes is they’ll give you some other options. So if you’re married and they can give you a survivor benefit that if I were to be entitled to one of these pensions, and I were to retire from one of these companies, I want to elect, say, 100% survivor benefit, well, I’ll take a little bit less in terms of my monthly pension. But then, if my wife lives longer than I do, that payment will continue for her life as well.
So the survivor benefit is a decision that needs to be made at retirement. How much do we need? It’s somewhat like buying insurance through the pension plan, so that’s something that’s important to be mindful of. But then also, that handful of companies I just mentioned also have a lump sum option. So in lieu of taking a monthly income stream for your lifetime or your and your spouse’s lifetime, you could elect to go ahead and just take a pretax amount, roll that over to your IRA. And then you have the money to go ahead and do what you want with and produce your income stream or keep the money invested, or what have you, over time. So whenever interest rate, and there are two main variables that go into determining these lump sums, it’s really the interest rate assumption, and interest rates are lower, which is what we’ll talk about today, as well as mortality, or how long you’re expected to live. So those are the two big factors that go into it.
But what happened, and the way that this works as it relates to the interest rates, there’s something called the IRS segment 417(e) rates. So yeah, I know people are going to be running out to Google just to read all about it.
Walter Storholt: Let me write that down for reference later.
Kevin Kroskey: But almost all plans will use these rates to go ahead and determine the lump sums paid out under these pension plans. And generally, the way it works is for most plans in our experience; they’ll use the August rates, so we’ll say August 2020 will determine the interest rate factor that is used to determine the lump sums paid out in the next year in 2021. Some other plans, like we have Akron Children’s, they use as late as the November rates, but by and large, most of these plans will use the August rates. Rockwell, it’s August or September, I can’t remember off the top of my head, but somewhere around there.
So they’ll use the rates for this year, and then they will determine the lump sums for next year. And as we’re all probably aware, interest rates were a lot higher coming into this year and coming into 2020. And then with COVID, they … Well, actually even before COVID, and actually even a little bit towards the tail end of last year, interest rates started falling. COVID really accelerated that. But the interest rates are significantly less now versus a year ago. And so when I was going through a meeting for one of our clients that was working at one of those companies that has a sizeable monthly pension, and also has a lump sum option, I had her run a quote for, hey, just run a quote for December of this year, of 2020, and run it for January of 2021.
And so there’s the mortality difference, whether you start a month before, a month later, is negligible. And basically, I just wanted to show her and walk them through what the lump sum … What was going to happen to the lump sum next year because of the lower interest rates this year. And in their case, it was a 10% increase in the lump sum. So just to use round numbers for discussion purposes, let’s say that the lump sum was $1 million in 2020. It was going up to $1.1 million or 10% more, $100,000 more just taking it one month later in the calendar year of 2021. And so they were, of course, they knew that this was going to happen, but it was a surprise, the extent. I mean, it was quite a large dollar sum, so they were pleasantly surprised, of course, because it was significantly larger. And this is really going to happen for all lump sums next year, whether the plans are using the August rates or the November rates. Uniformly, they’re lower this year than last year, and significantly lower.
So you’re going to have, may not be 10% for your pension plan. Maybe it’s eight, maybe it’s 12, there are some other factors that do go into it. But nonetheless, the rates are definitely going to, or the payouts are definitely going to be much higher into 2021. So why this matters is some pension plans, like Goodyear, for example, you have to elect a lump sum at the time that you separate from service. So say somebody’s looking to retire from Goodyear, and they’re saying, “Hey, Kevin. You’re my advisor. When should I retire? Any sort of coming considerations that I have?” And usually, there are a few. Certainly, you want to be mindful of any what’s going on in that tax year if there’s a bonus that they’re eligible for. Maybe they want to make sure that they stay through that eligibility period so they get paid the bonus out, at least to a certain extent, or what have you.
But if the plan is, if we’ve done the analysis and if we’re in agreement that taking the lump sum makes sense, well, because the lump sum’s going to be a lot higher in 2021, we would certainly want to wait for them to retire in 2021 if, as in the case of Goodyear, they have to elect the lump sum at the time of retiring or separating from service. Not all pension plans are like that. Akron Children’s, for example, our client retired from there a couple of years ago. And she’s been able to defer the commencement of her pension, but she can go ahead and elect a monthly amount or a lump sum when she’s ready. So the rules are different between each pension plan. Again, the interest rate and how they work on those two variables as far as the interest rate assumption as well as the mortality assumption are very similar. But every plan has its own rules, and you really need to roll up your sleeves and get into what’s called the summary plan document and understand that.
And it gets pretty technical, but that’s why people like me can help with this. If you really understand how it works, you can make a more optimal decision. So there’s one other thing that I think is important to know. I don’t know if it’s important for me to know. Walter, you can tell me from a casual listenership here perspective in a moment, whether how important it is or isn’t to know, I suppose. But these segment rates, so there are actually three segments. And the way that it works is to think of, just use a case of someone age 65. And I picked 65 because that’s usually when there is an unreduced pension. If you take it before age 65, a lot of these pension plans will pay you a benefit, but it will be a reduced benefit because you started it before 65. It’s very similar to how social security works, where if you start social security at 62, you’re going to get a reduction because you started it before your full retirement age at 66, or 67, or whatever the case may have been, so same thing with the pensions.
But if you have somebody that’s 65 and you look at their life expectancy under these IRS tables, maybe they have, just for discussion purposes, let’s say it’s 23 years of life expectancy. So you go from 65, and it takes them up to age 88. Well, now you look at these segment rates. And these segment rates, if you just chart out the monthly pension each, and just annualize it over all those years, over all those 28 years, there are three different interest rates that come into these segments. So segment one, the interest rate applies to years one through five. Segment two applies through years six through 20, so three times as many years as segment one. And then segment three applies to years 20 plus.
So when you think about how this works, say if you have somebody in this case who’s 65, you have a 23-year life expectancy. And I just mentioned these segment three rates only apply to years over 20, so 21 and further on down the road. Well, in that case, you’re only going to have two or three years that are really going to be discounted at the segment three rates. You’re going to have the majority in that segment two buckets. And then you’re going to have a handful in that segment one bucket. And the way that this works mathematically is these are future dollars. A dollar at your age, if you’re 65 today, a dollar today is worth more than that same dollar at your age 88. So these interest rates are used to basically discount those future values back to today’s dollars.
And when you look at the interest rates, I just pulled off that August rates for 2020, it’s 2.5% for segment one, 2.2% for segment two, and then 3.03% for segment three. And they are all lower, much lower than they were a year ago. And so sometimes clients will ask me, well, and they’ll ask this question in different ways. I had a client like me the other day that’s looking for a house, and they haven’t found anything they want. So they’re actually renting for a few months, and they’re concerned about: Hey, are interest rates going to go up? And is that really going to end up costing me a lot more money if I’m sitting on the sidelines and interest rates go up? And so the way that I answered that was, well, of course, nobody has a crystal ball. But it depends on what interest rates you’re talking about.
So everybody’s heard about the Federal Reserve, and this happens almost every time that there’s an interest rate announcement, where it’ll be on the nightly news. And they say, “Well, the Federal Reserve cut interest rates,” and so everybody thinks interest rates went down. And the Federal Reserve has influence over shorter-term interest rates, whether it’s one-year rates, or two-year rates, or what have you. They don’t have a lot of influence with their interest rate policy over medium-term rates, say like segment two rates, or ten year US bond rates, and certainly not longer-term rates. Those are way more market influence than federal reserve influence. And in fact, even if we go back to March when the Federal Reserve was cutting interest rates, the short-term interest rates had already moved lower, and the Fed was actually just catching up to where the market was.
So the Federal Reserve influences rates, but they don’t necessarily make rates in the market. The market, buyers, and sellers determine that sort of information. So I told my client, I said, “Well, you’re probably going to be … How long are you going to be in this home?” They’re like, “Oh, this is our forever home.” And I’ve been working with them for a while and know their situation. And it probably is pretty much close to their forever home, so they’re going to get a longer-term interest rate because it’s just going to make sense. It’s going to match how long they’re going to be in the home and what have you. And I told them, I said, “Well, the Federal Reserve already stated that they’re going to keep interest rates low through 2022.” And if this economic downturn is anything like what they did going through 2008, they kept rates near zero for five years, so I think we’re probably in somewhat of a similar scenario like that going forward. And they’ve already stated that they’re going to keep it near zero for the next couple of years, so those are the short-term interest rates.
But when you look at the longer-term interest rates, which I mentioned are more market-focused, you look around the world, Europe has negative interest rates. Japan has negative interest rates or near zero. So even though our rates are low, we actually look pretty good and pretty high relative to the rest of the developed world. So our higher rates, relatively speaking, have a lot of foreign money coming in and buying our treasury bills, treasury bonds, and keeping these interest rates low. So it’s probably not going to move anytime soon, is what I shared with my client that was looking to buy the mortgage. But I just explained the difference between the shorter term and the longer-term interest rates.
That same sort of thinking applies to the segment rates and what we can expect for changes in the lump sum over time. So if you’re thinking about retiring in the near term, at least as it relates to the lump sum, certainly 2021 is going to be a better year than 2020. Well, what about 2022? Is it going to make sense to wait even more? We don’t know. We know that the segment one rates should stay really low. The Federal Reserve does have more influence over those rates, and they’ve stated again that they’re going to keep them near zero, so that’s probably going to be there. But if I actually look at this and say, “Okay. Hey, it’s only five years. So how much impact does that really have on the lump sum?” It’s a little bit less than 30%. So that shorter-term rate that we have more certainty on, I would say, is only going to influence about 30% of the lump sum.
If we go to that segment two that again, this is a 15-year band, so three times more years than segment one, here we see it’s probably going to be about … Those interest rates are going to influence about 2/3 of the lump sum value, so it’s somewhere in the mid 60% range, depending on the rates. And that part, we don’t know. Again, it seems likely that rates are going to stay a little bit lower for a while because some of those other developed countries are much lower, and we actually look pretty attractive on a relative basis, so that attractiveness attracts money coming in. And so when they buy bonds at these interest rates that we have currently in the US, it keeps those prices lower, keeps them stable. So that’s how I think about this because some people, maybe they’re getting close to being ready to retire, but they still like their work, and they’re weighing that decision.
So this is definitely maybe not a primary factor for some that are still working, as far as the timing aspect and the lump sum. But it’s certainly something to consider. And if you have a sizeable pension, then $100,000, I mean, it’s not chump change. Right? As in the example that I gave, so these are all things that matter. Again, the segments get a little bit wonkier. We don’t have a crystal ball. But I can make some reasonable deduction and think through about: Well, how is this likely to change over the next couple of years? We have more certainty on the first segment. We have less certainty on the second segment. But with just where we’re at right now, it just seems like the rates probably aren’t going anywhere anytime soon. Higher interest rates, inflation risk, is probably a little bit more of a medium-term phenomenon that we may be dealing with, but that’s where it all shakes out. So, Walter, I’m definitely going to take a pause here. And you may be sleeping right now, but help me sound less egg heady, please.
Walter Storholt: I’m just kidding. I’m still here.
Kevin Kroskey: Oh, no. I got worried there. I was like, “Oh, man. I did put him to sleep.”
Walter Storholt: I thought I’d just joke with you a little bit.
Kevin Kroskey: Oh, goodness.
Walter Storholt: No, still here. Still here. It’s a lot of moving parts for what sounds like a simple equation. Right? But I guess that’s sort of the beauty that you find in the work that you do, Kevin. You always are looking to say, “All right. Well, the world looks at this in a pretty, I don’t know, ones and twos kind of way, yes or no kind of way.” And you just find no matter what the situation is that we talk about here on the show, 15,000 different ways to analyze it. And I think that’s awesome that you are able to do that. So something that just sounds very simple, like deciding to take the pension lump sum and some of the choices that are surrounded in that, you’re looking at interest rates, you’re looking at so many different factors that go into the equation. And I feel like it’s like the last episode where we were talking about the iceberg. This is just another illustration of that, about how you guys just go into such incredible detail in your decision making.
And it’s something that the average person just doesn’t have the time to do or to figure out. And it’s nice to be able to have folks like you who are in your profession to look into the hood on these kinds of things. I’m more just in awe at the level of detail an analysis you can put into each of these decisions for the clients and people you work with.
Kevin Kroskey: I’ll tell a story. I think it’s a funny story. We’ll see if it’s funny the way I tell it, I suppose.
Walter Storholt: I won’t pretend I’m sleeping at the end of it, I promise.
Kevin Kroskey: Thank you. You woke me up by you pretending you were sleeping, by the way. Thank you for that.
Walter Storholt: That’s a shot in the arm a little bit.
Kevin Kroskey: I don’t need coffee. So a few years ago, I was invited to speak to a group of near-retirees at Rockwell Automation. And most of the companies I just mentioned, we have some hospitals in that group, but a lot of engineers at those companies. We have a lot of engineers that we serve. And Engineers love spreadsheets, as do I. And I was giving this presentation about some changes that were happening with both the interest rates as well as the mortality assumption. And none of the engineers in the group were aware of the mortality assumption, and so they challenged me on that. And then I was proven right two weeks later when the IRS came out with a notice for the year about the mortality tables changing because everybody in that room was thinking, “Hey, interest rates have gone up. We should probably be retired before year-end.”
I said, “Well, that’s true. However, there are changes being made with the IRS and these mortality assumptions. People are living longer, so they’re actually going to update this.” And now, because the pension plans have to provide you an income stream for more years, that’s actually going to be more than an offset to what you’re going to lose on the movement in the interest rates. And then I made a comment about in my spreadsheet and my analysis, and I just saw everybody in the room turn to one another and start talking to one another. And I’m like, “What did I say?” And I asked the person that invited me there to give to talk afterward, and they said, “Well, it was just that everybody in the room because they’re all engineers, have their own spreadsheet. And so they’re all comparing how accurate you said your projections were with how their projections were.” And it was like this, I don’t know, I was speaking their language, but it just made me really self-conscious like, “What did I say? I just said spreadsheet in here.” I was just speaking to my people, I suppose.
But these things do matter, and they do. It’s something that, the thing I like about this, it goes with the financial planning, it goes with the tax planning. A lot of this stuff that we’ve talked about in the last episode about the investment selection and paying attention to certain criteria that matter and ignoring others that don’t, looking at these lump sums and just decomposing the formula and understanding the key variables, and then figuring out what really matters and how we can optimize that. I mean, that is when it’s a high probability that it’s going to pay off, for one. You’re going to make your benefits more optimal. And two, it’s not looking at a crystal ball and saying, “Well, I think this stock or this basket of stocks is going to outperform the other one.”
I mean, that is much less certain. That tends not to add much value. And when you look at the things like we’re talking about today and a lot of the things we’ve touched on through the podcast over the last couple of years, we like to focus on those things where we can add value and have a high probability of it paying off for our clients. I mean, it’s why they pay us money, and it’s why they get a return on their investment. So it probably matters more to me than some other people. Certainly, people aren’t going to be diving into these differences. But if you’re paying for financial advice, you want a good advisor and you want somebody that’s both good on the details as well as the relationship and understanding you and what’s important to you. These sort of details that we talk about are incredibly important, at least for some of our clients, not for all of them, but for those that have big pensions, those that have flexibility over their timing decisions, those that as far as retirement or when to commence their pension benefit.
I mean, we’re talking maybe six figures in some cases, so definitely not inconsequential. But the sort of, I would say the thought process is probably even more important. If you have a good critical thinker that can work through these and then explain it, hopefully in plain English, to somebody and help them make a more informed and smarter decision, to me, that’s good advice. So hopefully, that comes through in the podcast, but that’s really what we try to do day in, day out.
Walter Storholt: There’s a method to the spreadsheet madness, in other words.
Kevin Kroskey: Well, there’s a purpose, yes. There’s a purpose behind it, for sure.
Walter Storholt: A purpose behind it, I like that. That’s good. This is helpful, Kevin, I think, to take such one little piece, one little element of financial planning, of retirement planning, and to break it down into such level of detail. It just shows the importance of making the right decisions with your finances, with your money, over and over again. You have the opportunity to make good decisions each and every time you start talking about these kinds of things. And so you’ve got to stay on top of it. You’ve got to stay on the ball if you want to make the most of your life savings and of retirement. And this is a good illustration of that, I think, so very helpful and very cool. Any parting thoughts, or good to go for today’s episode? No burrito stories this week, like last week’s episode.
Kevin Kroskey: No. No burritos.
Walter Storholt: Did you find another good burrito anywhere? Were you able to find a replacement?
Kevin Kroskey: I’m always happy with Chipotle. The problem for me though was the-
Walter Storholt: They do pack it in with a pretty good amount of meat, that’s for sure.
Kevin Kroskey: Oh, yeah. Then I get double meat on top of it, so I’m happy. But I guess in a closing statement, anybody that’s at Akron Children’s, Bridgestone, Firestone, First Energy, Goodyear, Rockwell, all those places have pensions where it makes sense in my view for many, many of those people that work there to take the lump sums over the monthly pension amount. And that 2021 is going to be a very, very attractive year to do so. And it’s probably, we’ll see how 2022 goes, but anything could happen. Interest rates could go lower. Maybe not so much probability wise, but if you are in that group where you have a pension and you have a lump sum, and you’re nearing retirement, if you really haven’t taken a close look at this yet, I mean, now’s really the time. I mean, you need to go ahead and plan. And then you’ll have the clarity and confidence to make a good decision about what’s right for you.
Walter Storholt: Let this serve as a call to action to you if you fit into that category, for sure. Reach out to Kevin Kroskey. He and the True Wealth design team will help walk you through an analysis of your plan, of your financial situation, and look at some of these kinds of opportunities that might be available to you, and help you evaluate all these decisions so that you can achieve any retirement and financial goals that you have. 855-TWD-PLAN is the number to call if you want to get in touch with Kevin. Again, that’s 855-TWD-PLAN. And you can also go to trueweatlhdesign.com. That’s truewealthdesign.com. And click on the are we right for you button to schedule your 15-minute initial call with an experienced financial advisor on the True Wealth team. Very easy to do. Just go to truewealthdesign.com and click on the are we right for you button, and that’ll begin the conversation.
Kevin, I appreciate the help very much so on today’s show. Any big Thanksgiving plans for you guys as we near that holiday and try to navigate the waters of COVID and family gatherings and those kinds of things?
Kevin Kroskey: We’re not sure. My daughter has the whole week of school off, so we’re debating if we want to go somewhere or what we want to do. But we actually just learned that she had Monday and Tuesday off last week.
Walter Storholt: Well, that’s pretty nice.
Kevin Kroskey: Yeah, so we’ll see. So no plans yet, but my beloved Pittsburgh Steelers do play the Baltimore Ravens, or the dirty birds as we call them in our household, on Thursday night on Thanksgiving, so we’re definitely watching that.
Walter Storholt: Oh, we are actually getting a good Thanksgiving game this year. Wow, that’s amazing.
Kevin Kroskey: Yes. Yes, we are. So no more Detroit Lions, or maybe they are playing, but at least we have a good game too.
Walter Storholt: They probably play early. I think they started throwing in that night game because the day games have always been such stinkers with the Lions playing, maybe, so that’s pretty cool. Well, have a great Thanksgiving. We’ll be talking to you again as we approach December and the end of this crazy year that is 2020. But best to you and yours, and we’ll talk again soon. Thanks, Kevin.
Kevin Kroskey: Likewise. Thank you, Walter. Bye-bye.
Walter Storholt: All right. Absolutely. That’s Kevin Kroskey. I’m Walter Storholdt. Thanks for joining us. I hope everybody has a great couple of weeks, and we’ll talk to you soon right back here on Retire Smarter. Thanks for Listening.
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