Ford and General Motors are among some of the largest employers here in Michigan. They also happen to be two of just a handful of employers that offer a pension. However, many employees may not understand that the interest rate hikes by the central bank are having a profound effect on how your pension fits into your retirement plan.
What is a pension? What are my options for taking my pension?
Pensions exist primarily to replace a part of your paycheck once you retire. You and your employer contribute to a pool of money, and at some point upon retirement, you receive a monthly income from that pool. Your pension provider guarantees that income, so you have no investment risk. However, all of that income relies on your provider's financial stability. In most cases, you can log into your retirement accounts online or contact your employer to get an estimate of how much income you can expect to receive in retirement. Note that when you make an income election from your pension, that choice can never be changed, and unless there is an inflation adjustment (which is very uncommon), the amount will never be any more or any less. General Motors and Ford (as well as many other pension plans) also offer a lump sum option. The lump sum option essentially buys you out of the provider's responsibility to provide you with an income. Instead, you end up with a much more significant one-time benefit, which you can then choose what to do with. There are several reasons someone may elect to take the lump sum option over the income from their pension (or vice versa), but the decision depends largely on your unique circumstances.
How are interest rates affecting my pension?
The issue we're seeing now is that interest rates are a factor when calculating how much the buyout will be in a lump sum option. The income estimates are a baseline, and the employer uses those figures and considers life expectancy and interest rates to determine the cost of buying you out. As interest rates increase, the value of your buyout is diminished. Ford and GM employees can expect a 20%-25% decrease in their lump sum by next year! So if you are planning to retire next year and had been expecting a million-dollar pension lump sum, delaying could end up costing you $250,000.
How do I know the right decision for me?
Electing a pension income versus a lump sum is difficult, even without aggressive interest rate hikes. Each person's situation is different and so what is best for your buddy at the shop may not make sense for you. If you are nearing retirement and your employer does offer a pension lump sum, I encourage you to get updated estimates from your pension provider. In most cases, you can project benefits at different retirement dates. You’ll want to have the provider run estimates assuming a sooner-rather-than-later retirement, then compare that to one or more dates in the future. You can see the impact these interest rate assumptions will have on your bottom line. From there, you need to estimate how much income you'll need in retirement and whether or not your social security and retirement benefits will be able to support that (keep in mind that pesky inflation, which makes things more expensive). If you already work with a financial advisor, they likely have software to help project these things. If you do not already have a financial advisor, ask your colleagues who they are working with and interview two or three for yourself.
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Written by: Justin Meyer