Pensions: The Lump-Sum Gamble (Fleecing)

Posted By on November 27, 2010

More than 90% of employees opt for a lump-sum payout from their pension plan when given the choice.  So the Pension Protection Act was signed in August of 2006 by President George W. Bush.  But who does it protect.  Well certainly not the employee! 

Interestingly, the current change has received so little notice that most people aren’t aware of the new formula…..and unlike other moves that reduce pensions, employers aren’t even required to notify employees of the changes.

Below from Wall Street Journal……..

Employers had complained that the Treasury rate was so low that departing employees were getting a windfall on lump sum distributions and asked Congress for relief. S0 a new law was signed in August 2006 as part of the Pension Protection Act, and is to be phased in over five years, through 2012 .   The difference in payouts are substantial. Consider a 40-year-old who has earned a pension worth $3,000 a month at age 65. If the new rate had been used in December 2008, when the spread between corporates and Treasurys was a steep 3.77 points, his lump sum would have shrunk from $242,839 down to $71,148.

Under new rules that became effective in 2008, many larger companies have been quietly changing the way they calculate lump-sum payouts from their pension plans by phasing out their use of a Treasury-bond rate to calculate lump sums and replacing it with a higher composite corporate-bond rate. The result is substantially lower payouts to employees who are changing  jobs, being laid off or retiring.  In fact the hair cut can be anywhere from 10% to 60% or more, depending on age and other factors.

Younger employees face the largest reductions. A 55-year-old employee who took early retirement or switched jobs would get about 25% less under the new legislation, while a 45-year-old would take a 50% cut, according to calculations prepared for The Wall Street Journal by Beth Pickenpaugh, a pension actuary and financial adviser at Gianola Financial Planning in Columbus, Ohio.

Companies had been using the 30-year Treasury bond rate to calculate lump sums since 1994. Before then, they were using a lower rate, and complained that employees taking lump sums were getting a windfall. Companies persuaded Congress to let them replace it with a then-higher 30-year Treasury rate, which at the time was about 8%.

The change is being phased in over five years, through 2012, so someone contemplating changing jobs or retiring and taking a lump sum might want to evaluate the impact of taking a distribution before the change is fully phased in.  Make sure that your advisor understands the calculations.

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