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The Journey: As rates rise, more pensions offer lump-sum payouts. Now what?

January 4, 2016


The Federal Reserveís move to inch up interest rates for the first time in nine years wonít immediately hand seniors the decent yields theyíve been craving on safe money, but it may prompt some new pension and fixed-income dilemmas.

More companies with defined benefit pension plans ó already reeling from higher pension insurance premiums ó will likely try to entice participants into taking lump-sum distributions instead of keeping their monthly retirement income, said Jania Stout, co-founder of Fiduciary Plan Advisors at HighTower, a consulting firm in Owings Mills, Md.

Thatís because as interest rates rise, companies can assume participants will earn a higher return on their cash-outs over time, and they can thus pay out lower lump sums.

"To retirees I would say, youíre probably going to see companies pull the trigger a little more on these cash-outs," she said. "Youíre going to see more options for taking lump sums and companies being more aggressive about pulling liabilities out of the plan."

And the more rates rise, the smaller the lump-sum offers will become over the next two to three years, said Chris Karam, chief investment officer for Sheridan Road Financial in Northbrook, Ill. In other words, he said, the next lump-sum offer current retirees get could be the best one theyíll see.

"With rising rates, (pension plans) will have a better funded status, but the lump-sum number put in front of a participant will start to decline," he said.

Donít rush out to lock in a lump sum without considering the overall value of an annuitized income stream you canít outlive, however. If a pension you hold represents even a modest percentage of your overall retirement portfolio, consider hiring a financial adviser with expertise in pension valuations to help you sort it out. And donít settle for guidance on this from your former employer, as companies generally donít provide much beyond the printed offer.

Unless you are terminally sick or have other substantial guaranteed sources of retirement income, the value of a pension shouldnít be discounted in your overall income plan. Just for a quick back-of-the-envelope idea, calculate 4 percent of your lump-sum offer. It isnít precise and there are a lot of caveats, but 4 percent is a rough guide to a first-year nest egg withdrawal, and that amount isnít guaranteed, remember.

Itís also a good idea to make sure the fixed income portion of your retirement money is ready for a series of further rate hikes, experts said.

Depending on your time horizon and risk tolerance, it may be time to avoid very short-term bonds, for example, notes Karam.

"If we get this slow and steady rate climb, investing in intermediate-term bonds may not be as big a problem as was once perceived," he said. "Most of those portfolios have issues with five and 10-year maturities. In a rapidly rising rate environment itís harder for managers to reinvest at a higher rate and get that working," he said. But in a more slowly rising market managers can reinvest and reap the benefit of higher yields, he said.

So when will bank savings and certificates of deposit be back to even reasonable levels? Karam isnít holding his breath.

"Itís going to take some time" because banks waived savings and money market account fees as interest rates plummeted in recent years, so they will be looking to recoup those first, he said.

Annuity payout levels should improve, but it will also take time, said Stan Haithcock, author of several short books on annuities, including one on deferred income or "longevity" annuities.

"There will be consumer demand for better pricing" as rates rise, he said. "But the life expectancy tables will change in 2016, so they could offset each other." As life expectancy rises, annuities generally pay out smaller annual installments.

 

 


McClatchy-Tribune Information Services