Pension Discount Rate (Lump Sum Valuation)

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dcw213
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Joined: Sun Dec 16, 2012 3:04 pm

Pension Discount Rate (Lump Sum Valuation)

Post by dcw213 » Wed Nov 06, 2019 8:30 am

I don’t know very much about pension administration or what is standard and have found information regarding standard practices surprisingly hard to find through research. I have a relative asking me some questions.

I recognize that pension plans or those who administer can offer lump sum or buyout offers at whatever terms they want. I do wonder if there is a standard rule of thumb for determining present value of the future pension cash flows. I’m inclined to use a intermediate term treasury but strikes me that this may inflate the value, especially in this low rate environment.

I know it is complex based on expectations for future returns or expected yield on the lump sum but wondering if there is a “standard” practic used to give a standard/fair present value vs terms used by a plan trying to justify as high a discount rate as possible. Any thoughts would be appreciated.

Silk McCue
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Re: Pension Discount Rate (Lump Sum Valuation)

Post by Silk McCue » Wed Nov 06, 2019 8:43 am

I found myself a bit lost in your question. However, in every post where someone is evaluating a lump offer vs lifetime payout we point them to immediateannuities.com to see what the open market would offer today as a head to head comparison.

Please feel free to post the specifics of what is being offered to your relative and folks can provide feedback. There have been many threads on this in the past few months due to GE, AT&T, State pensions etc and each one is very individual.

Cheers

Grt2bOutdoors
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Re: Pension Discount Rate (Lump Sum Valuation)

Post by Grt2bOutdoors » Wed Nov 06, 2019 8:48 am

You are inclined to use an intermediate Treasury as the benchmark rate. What does your analysis show if you used the long term treasury or long term A corporate bond rates instead? The duration of the bond should approximate the duration of pension payments, why would you use an intermediate duration of 5 or 6 when average pension payments far exceed that in years?
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

RubyTuesday
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Re: Pension Discount Rate (Lump Sum Valuation)

Post by RubyTuesday » Wed Nov 06, 2019 9:03 am

dcw213 wrote:
Wed Nov 06, 2019 8:30 am
I don’t know very much about pension administration or what is standard and have found information regarding standard practices surprisingly hard to find through research. I have a relative asking me some questions.

I recognize that pension plans or those who administer can offer lump sum or buyout offers at whatever terms they want. I do wonder if there is a standard rule of thumb for determining present value of the future pension cash flows. I’m inclined to use a intermediate term treasury but strikes me that this may inflate the value, especially in this low rate environment.

I know it is complex based on expectations for future returns or expected yield on the lump sum but wondering if there is a “standard” practic used to give a standard/fair present value vs terms used by a plan trying to justify as high a discount rate as possible. Any thoughts would be appreciated.
My emphasis added above... if this is a qualified plan, they are not allowed to offer “whatever terms they want.” Cash-outs are restricted by Internal Revenue Code section 417(e) (I.R.C. § 417(e) Restrictions On Cash-Outs). Basically it restricts cash-out to a present value of vested accrued benefits using certain interest rates and mortality tables.

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Watty
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Re: Pension Discount Rate (Lump Sum Valuation)

Post by Watty » Wed Nov 06, 2019 9:08 am

One thing that you should suggest that your relative should do would be to get a good physical before deciding to take the lump sum or pension. They should ask their doctor if there are any additional tests that would be good to take even if their insurance will not pay for it. If they find out they have health issues or in better than average health that could make one of their choices more favorable because of their life expectancy.

Unless there is a specific genetic issue then their family medical history is a lot less important than many people assume. This is because many things like cancer and heart attacks are much more survivable now then they were 30 years ago. Smoking is also a lot less common now than it was a generation or two ago.

dcw213 wrote:
Wed Nov 06, 2019 8:30 am
I recognize that pension plans or those who administer can offer lump sum or buyout offers at whatever terms they want. I do wonder if there is a standard rule of thumb for determining present value of the future pension cash flows.
I am not an expert but I think you are incorrect. A quick Google found these articles.

https://www.forbes.com/sites/ebauer/201 ... b7fe729fd5

https://www.forbes.com/sites/ebauer/201 ... 613d7b240a

Where they mentioned the "417(e) rate" so you could Google that. The rules may be different for private and public pensions so watch out for that.

In prior posts people have mentioned that if companies expects that this rate will change in a way that is unfavorable to them they they may make a limited time lump sum offer before that rate changes.

RubyTuesday
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Joined: Fri Oct 19, 2012 11:24 am

Re: Pension Discount Rate (Lump Sum Valuation)

Post by RubyTuesday » Wed Nov 06, 2019 9:18 am

also, bear in mind that even with section 417(e) restrictions, my understanding (maybe my belief is more accurate) is that the lump sum values typically are not actuarially as valuable as the annuity payment options.

As others suggest I would compare annuity options to what you could buy at immediateannuities.com to determine whether lump sum is a good offer.

Other things to consider:
- health of beneficiary
- survivor benefits
- PBGC coverage of benefits in event sponsor fails

Topic Author
dcw213
Posts: 158
Joined: Sun Dec 16, 2012 3:04 pm

Re: Pension Discount Rate (Lump Sum Valuation)

Post by dcw213 » Wed Nov 06, 2019 9:24 am

Thanks for the responses and references. Upon rereading my post it is definitely not super clear, apologies. My thoughts behind the questions were basically:

1) What is the standard practice used by plans (thanks for the links, definitely helpful)

2) How would you think about the right rate to use with a 20 year horizon and considering investments available to you upon receiving a lump sum.

Thanks again.

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