Lump Sum vs. Monthly Pension Video

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Lump Sum vs. Monthly Pension

Kevin McCormally: I am Kevin McCormally of Kiplinger's. I am here with Mary Beth Franklin, the Retirement Editor of Kiplinger's Personal Finance Magazine, to talk about a tough new choice for retirees. Mary Beth, I understand some new federal rules are going to affect the choice of retirees who have to choose between a lump sum payment and monthly pension payments when they retire. Can you explain what's happening? Mary Beth Franklin: Right. About half of all pension plans allow workers to choose between taking a lump sum at retirement or a monthly check for the rest of their lives. And when given the choice, most workers choose the lump sum benefit, but new rules take affect this year that it's going to make that choice a little less attractive in the future. Kevin McCormally: What's the change? Mary Beth Franklin: To calculate a lump sum, you have to take into account your life expectancy and prevailing interest rates. If interest rates are low, it takes a bigger lump sum to be the equivalent of those payouts for the rest of your life and conversely, if interest rates are high, it's a smaller lump sum. Kevin McCormally: What's the change? Mary Beth Franklin: The new law changes the way that interest rates are calculated. Up until last year, pension plans use the 30-year treasury bond to calculate the lump sums, but treasury bonds have been very low compared to other interest rates and consequently, resulted in much bigger lump sums. That encourage people to take the lump sums and also cost the pensions plans a lot of money. Kevin McCormally: So, the new formula is going to change the interest rate? Mary Beth Franklin: Right, it's going to gradually move away from the treasury bond to a higher corporate bond rate. It will take five years, but the first phase goes into effect this year, 2008. Kevin McCormally: So, as the rate goes up, the lump sum payment that you'd receive goes down. Mary Beth Franklin: That's right. Kevin McCormally: But is there any effect at all on with the monthly pension payment if you choose the monthly payment versus the lump sum? Mary Beth Franklin: None at all and in fact, as these lump sums will get smaller because of the interest rate change, the monthly benefits are going to look a lot more attractive. Kevin McCormally: Very complicated. Is there anything of work that we can do right now? Mary Beth Franklin: Right, if you are planning to retire soon, ask your HR department to calculate a lump sum benefit under today's rates and also 2009 that's when the next phase of the change kicks in. See if there is a difference that may help you to decide when to retire at the end of this year or early next year. But if you are further down the road to retirement, you probably want to get use of the fact that you will get a monthly benefit rather than a lump sum and that's not a bad thing; guaranteed income for the rest of your life is a pretty good deal. Kevin McCormally: Well, thank you, Mary Beth.

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Kevin McCormally: I am Kevin McCormally of Kiplinger's. I am here with Mary Beth Franklin, the Retirement Editor of Kiplinger's Personal Finance Magazine, to talk about a tough new choice for retirees. Mary Beth, I understand some new federal rules are going to affect the choice of retirees who have to choose between a lump sum payment and monthly pension payments when they retire. Can you explain what's happening?

Mary Beth Franklin: Right. About half of all pension plans allow workers to choose between taking a lump sum at retirement or a monthly check for the rest of their lives. And when given the choice, most workers choose the lump sum benefit, but new rules take affect this year that it's going to make that choice a little less attractive in the future.

Kevin McCormally: What's the change?

Mary Beth Franklin: To calculate a lump sum, you have to take into account your life expectancy and prevailing interest rates. If interest rates are low, it takes a bigger lump sum to be the equivalent of those payouts for the rest of your life and conversely, if interest rates are high, it's a smaller lump sum.

Kevin McCormally: What's the change?

Mary Beth Franklin: The new law changes the way that interest rates are calculated. Up until last year, pension plans use the 30-year treasury bond to calculate the lump sums, but treasury bonds have been very low compared to other interest rates and consequently, resulted in much bigger lump sums. That encourage people to take the lump sums and also cost the pensions plans a lot of money.

Kevin McCormally: So, the new formula is going to change the interest rate?

Mary Beth Franklin: Right, it's going to gradually move away from the treasury bond to a higher corporate bond rate. It will take five years, but the first phase goes into effect this year, 2008.

Kevin McCormally: So, as the rate goes up, the lump sum payment that you'd receive goes down.

Mary Beth Franklin: That's right.

Kevin McCormally: But is there any effect at all on with the monthly pension payment if you choose the monthly payment versus the lump sum?

Mary Beth Franklin: None at all and in fact, as these lump sums will get smaller because of the interest rate change, the monthly benefits are going to look a lot more attractive.

Kevin McCormally: Very complicated. Is there anything of work that we can do right now?

Mary Beth Franklin: Right, if you are planning to retire soon, ask your HR department to calculate a lump sum benefit under today's rates and also 2009 that's when the next phase of the change kicks in. See if there is a difference that may help you to decide when to retire at the end of this year or early next year. But if you are further down the road to retirement, you probably want to get use of the fact that you will get a monthly benefit rather than a lump sum and that's not a bad thing; guaranteed income for the rest of your life is a pretty good deal.

Kevin McCormally: Well, thank you, Mary Beth.

Transcription by: Scribe4you Transcription Services