New Law Can Make Lump-Sum Payments In Early Retirement Programs Less Attractive

A lot is said about how the job market tends to favor the young over older, moreexperienced workers.

Well, here’s a case where younger folks are on the losing end.

Tucked away in the newly passed General Agreement on Tariffs and Trade, also known as GATT, was a new law that will make the payments in early retirement programs less attractive.

Specifically it changes the interest rate assumption employers make when they calculate lumpsum payments for traditional defined benefit pension plans.

“The interest rate definitely will make the lump-sum value smaller,” said Marjorie Martin, a vice president at Sedgwick Noble Lowndes in Roseland, N.J., a benefit consulting firm.

Understanding why requires a little knowledge of the present value of a pension that promises a fixed monthly payments.

The present value is the amount the plan would have to have invested now to ensure the anticipated future payments to workers. The higher the expected return on those investments, the less the plan has to have in hand now to live up to those promises.

In calculating lump-sum payments, many companies use the interest rate set by the Pension Benefit Guaranty Corp., a federal agency that protects employees’ pension benefits in covered retirement plans.

That interest rate currently is 6.25 percent, but it will decline to 6 percent in January.

But the new GATT legislation allows employers to use the yield on 30-year treasury bonds, which was 8.08 percent at the end of November, to calculate present value of the funds. This is the amount paid when companies make a lump-sum payment to settle pension claims by those who quit before retirement.

Companies still can use the PBGC rate, but by the year 2000 that rate will no longer be issued. Benefits consultants said most employers will adopt the treasury bond rate.

“The new law is better than the old law because the old law forced employers to give employees a new windfall” when they received a lump-sum payment, said Norman Parrish, an actuary at the Houston office of Hewitt Associates, a benefits consulting firm.

From a younger worker’s point of view, the change in interest rate assumptions will make a big difference because the PBGC rate is even lower for younger workers.

“The PBGC rate gets lower as you get younger,” Parrish said.

Parrish gave this example:

Let’s take a 45-year-old worker who’s earned a pension benefit of $500 a month or $6,000 a year.

Using the PBGC rate of 6 percent to take effect next month, the smallest lump sum an employer could pay that worker would be $19,300.

However, if the employer used the 8.08 percent treasury bond yield in calculating the lump-sum payment, the smallest lump sum the worker could be paid would be $9,600.

Now, let’s take a 65-year-old worker who’s earned the same pension benefit - $500 a month or $6,000 a year.

If the 6 percent PBGC rate were applied, the smallest lump sum that worker could be paid would be $56,100.

If the 8.08 percent treasury number were used, the smallest payment that worker could get would be $51,600.

“The younger you are - the further you are away from the (lump-sum) payment - the more the interest rate affects it,” Parrish said. “The younger you are, the further away all those benefits that you’re converting into a lump sum and the more deeply discounted they are.”

Here are some things to remember.

This change only affects pension plans that offer lump-sum payment options, and not many employers do that.

Only about 20 percent of employers offer lump-sum options, while most other companies pay a monthly pension at retirement.