There may be a unique opportunity for people with a defined benefit pension plan to take an elevated lump sum payment in 2022. You may be eligible to take a lump sum if you are retiring this year, have a deferred benefit from a prior employer, or have a frozen benefit from your current employer that allows in-service distributions.
Where the opportunity lies is how lump sum payments are calculated. Many qualified pension plans under ERISA use interest rates at the end of the prior year to calculate lump sum payments for the current year. Some plans even look back as far as 5 months before the prior year end for setting lump sum interest rates. In this example, interest rates from August of 2021 would be used to calculate lump sum payments made in 2022. The average interest rate for a 65-year-old taking a lump sum payment in 2022 is approximately 2.6% using rates from August of 2021. Using the most recent interest rates available as of September of 2022, we estimate the average lump sum interest rate has climbed to 5.1%. The problem is that when interest rates go up, the value of a pension lump sum goes down.
The chart below shows our estimates for lump sums payments made in late 2022 compared to waiting until early 2023. We show the values at different ages to demonstrate how the difference gets more extreme with younger ages. The calculations assume each person has a monthly pension benefit of $1,000 starting at age 65.
|Current Age||Lump Sum Value if Taken in 2022||Lump Sum Value if Taken in 2023||Dollar Change||Percent Change|
Sources: North River Wealth Advisors, IRS. Notes: Assumes a $1,000 monthly benefit payable at age 65. Interest rates for 2022 lump sum values are based on August of 2021 Minimum Present Value Segment Rates published by the IRS. Interest rates for 2023 lump sum values are based on September of 2022 published rates.
Our estimates above show that waiting until 2023 to take a lump sum rather than taking it in 2022 could cost you about 20% to 50% or nearly $50k! The dollar impact will be even more extreme for people with a monthly benefit greater than $1,000. The significant interest rate increases we’ve seen in the past year make this a unique opportunity for 2022 that we may not see again for a very long time. If you are eligible for a pension plan lump sum, we recommend assessing the potential opportunity of taking a lump sum in 2022. Whether this makes sense to do is highly dependent on a number of factors and a person’s unique situation.
We welcome the opportunity to help determine if this strategy makes sense for you. We are uniquely qualified to help given our deep experience managing pension plan investments. If you would like to learn more, please reach out by clicking the Contact Us button on the top right of our site.
Authored by Stephen Blahovec and Michael Rausch of North River Wealth Advisors. We are an independent, fee-only financial planning and investment management firm located in Pittsburgh, PA servicing clients locally and across the country. To learn more, contact us here.
This content is developed by North River Wealth Advisors from sources believed to be providing accurate information. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.