It’s February 2021 and interest rates are at historic lows. The general rule I’ll be discussing applies to anyone that works for a company that offers a Defined Benefit Plan (also known as a Pension Plan) as part of their overall retirement benefits.
One thing that people seem to disregard when thinking about retirement is how current interest rates affect their pension plans. When interest rates go down everyone flocks to buy or refinance a home but very few ever consider the effect that interest rates can have on their retirement plans.
The one thing I want you to take away from this blog is that interest rates and pension amounts have an inverse relationship. Much like the seesaw pictured above when interest rates are lower, lump sum pension payouts are higher and vice versa.
Interest Rates Are Important To Your Pension Plan
In recent years, people with pension plans that have an option to take the lump sum have seen the amount grow significantly because of low interest rates. Interest rates influence the value of a lump sum because it affects the value of your annuity payments.
If interest rates are low, a lump sum payout looks rewarding, even better than an annuity from a big company. I'm repeating myself but it is imperative you remember that when interest rates are high, lump sums shrink. If they are low, lump sums grow.
Because rates are at all time lows, it could be wise to retire early. If you are close to retirement age or have considered retiring early this might be your chance to do so as we may never see rates this low again. They don't have room to go much lower.
How Much Can Interest Rates Affect My Retirement?
In the current interest rate environment, generally speaking, every one percentage point rise in interest rate reduces a lump sum’s value from 10% to as much as 20%. For example, if your lump sum payout is $1,000,000, a one percentage point rise in interest rates could lower the amount by $100,000 to $200,000. That's a significant dollar amount. Also, on average, every $1 of pension income translates to about $150 of lump sum payment. If your monthly pension payout is about $7000 a month, your lump sum amount would be approximately $1,000,000. (This is a ballpark number. Every plan differs slightly.)
Something else to keep in mind is that plans offering lump sum distributions usually reset the rate they use at least once a year. For example, some companies set workers rates each December. Whatever the rate is in December, that rate will be used the entire next calendar year, depending on who you work for. This means for the rest of 2021 your lump sum payout will be calculated using historically low rates!
Should I Retire This Year?
Before running off early with your lump sum because of low interest rates, there are other things to consider than just the sum amount. Consider what company benefits you will be giving up and if you will need those in the near future. Keep in mind when you’ll be eligible for social security benefits and if you’re willing to live with reduced benefits by retiring early.
Interest rates affect so many things in our world today and it is extremely important to factor in how they can affect your retirement. Deciding on when to retire is never easy but you don't have to do it by yourself. We can help walk you through this decision making process. At 80/20 Financial we don't sell, we help. If you or someone you know is considering retirement, please share this blog with them. It could be worth several thousands of dollars to them.
You Need A Plan
A goal of retiring - without a plan to get there - is simply a plan to never retire. Retirement isn't some magical age. It's a dollar amount. If you're age 50 or over and still in the accumulation phase (pre-retirement) we can help you figure out where you need to go and how to get there. If you are retired or nearing retirement, we can create a plan which will outpace inflation and possibly leave a legacy to your family. The consultation is free and without obligation. Contact us to set up a consultation.
Thanks for reading!
80/20 Financial Services is an independent Registered Investment Advisory Firm. We help clients age 50 and over plan their retirement income and investment strategies. Contact us today for help with your retirement needs.