Pensions pay out lifetime income to their participants, so it is very important to understand how long people live in order for adequate funding to be in place. One problem that can occur for pension plans is people may live longer through advances in medicine. If money is set aside for people to live until 75, but they live until 85, there will be a gap. Because this is a risk to pension plans, some (including the CRP) offer lump sum payouts in lieu of the annuity stream of payments.
The lump sum payouts from the CRP are a present value of the annuity stream of payments, or more simply, the value of all of the payments you are expected to receive in today’s dollars. We know that if you invest a dollar today, you expect to receive more than a dollar tomorrow. How much do you need to put away today in order to equal a specific dollar amount or a series of payments in the future? This is where segment rates enter the picture.
Segment Rates represent 3 time periods for investment. The first being short term is 1-5 years. The second being intermediate term is 6-20 years. And lastly, the third being long term is anything 21 years and beyond.
Because pension plans are obligated to pay out their recipients, they are limited to very conservative investments, i.e. bonds. Even within the realm of conservative investments, they have to invest in the highest quality securities to ensure payments are always made. For this reason, the Segment Rates represent the top 3 qualities of corporate bonds.
The relationship between segment rates and the lump sum value is this: if corporate bond interest rates are moving up, lump sum values will drop. The pension plan sees that if they can earn more interest, they need to invest less money to make each payment. The lump sum is equal to what the pension plan thinks (regulated by ERISA) they will need to pay out your annuity.
This brings us back to why are people talking about it today. To begin with, interest rates are moving up. 2016 saw some of the lowest segment rates in the last few years, which translated to some of the highest lump sum payouts. In the past several months where rates have risen, lump sum values have dropped. We have seen clients with up to a 5% reduction in lump sum values over the course of November 2016 through January 2017. If you are looking to retire within the next 12 months, the value of your lump sum may change dramatically depending on where rates go. Depending on size, a lump sum value suffering a 5% reduction could be more than a couple months of salary plus benefits.
For those who are several years away from retirement, it’s too early to get wrapped up in the value of the lump sum payout. A number of factors like age, years of service, highest average earnings, etc. all are factored into the defined benefit, and no one knows where interest rates are going to be by the time you are ready to retire.
It is important to review each unique financial situation for those who are close to retirement, in order to determine if the lump sum payout option is the right decision for them. Speaking with one of our knowledgeable planners regarding which decision is right for you is a great first step. All of the planners at Insight are familiar with Chevron’s benefit plans (as we work with hundreds of Chevron clients) as well as how trends and changes can impact you.
