If you’re planning to retire at the end of this year, and your pension has both an annuity and a lump sum payout option, you may be confused as to why you can’t look at the lump sum value for your planned retirement date.

First, some background.

A 403b or 401k is a type of retirement benefit known as a “defined contribution plan”. That means that an employer contributes a known quantity to an employee’s retirement plan, such as 50% on the first 4% of the employees contribution (eg up to 2% contributed by the employer). This plan is pretty low risk to the employer, the match can be suspended at will (such as many employers did during their worst financial difficulties during COVID-19), and there are no long term financial committments for the employer. Most of the responsibility, and all of the risk at retirement, fall upon the employee/retiree.

On the other hand, the former style of retirement benefit was a pension. This was typically offered as a life time annuity type benefit, where along the lines of Social Security, employees contributed nothing towards the retirement plan during their employment, and at retirement the employer faced all of the financial responsibility and risk of providing for the retiree fall upon the former employer. As people lived longer and longer, employers have been either abandoning pensions due to the large risk, or watering them down so much as to be an advertising ploy without any real substance.

Let’s talk about what an advertising ploy pension might look like. If your pension annual contribution dollar amount (such that you might find in your Total Compensation Statements) is less than 5% of your salary, that’s a clue the benefit won’t be worth much. Another clue is if the pension will not have any cost of living adjustment (COLA). This means that your pension real value will shrink over time, making your pension less and less valuable as you age.

The defined benefit of a pension typically takes two forms. The first is a typical lifetime annuity, of several flavors, all of which are supposed to be actuarially identical (of course, your own situation means they won’t be identical, but we can’t tell which one is best without our crystal ball or the benefit of hindsight). The second is a lump-sum payout, that is also supposed to be actuarially identical.

If your pension has both an annuity and a lump sum payout option, there is a calculation made once a year on what the interest rate that is used to convert between the two types should be. November is when your company may re-calculate this interest rate, and so you can’t look into the future beyond November to see what the December retiree interest rate impact would be. On the flip side, come December, someone planning to retire after mid-March raises hit (for having maxed out that year’s 403b contributions, and pay out all of your saved up PTO days at the new post-payraise increased value) can look ahead at what that value might be.

The actuarially identical calculation is an interesting one. It’s not based on long term rates of anything, nor are investment return rates of stocks considered. It’s based purely on the corporate bond return rate (here’s an article by an actuary on the calculation), and the rate employers have to use is then published by the IRS. This means that when corporate bond return rates (which typically parallels interest rates) are low (like they are now), the value of the lump sum is higher than it would otherwise be.

Note that most retirees aren’t going to stick their entire lump sum in bonds, and stock and bond returns haven’t been highly correlated in recent times. Meaning while the bonds won’t give a retiree much of a return on their larger-than-usual lump sum payout, their stock return rates might have been outsized, yielding that much larger of a portfolio from which to create their own lifetime income.

When bond (interest) rates go back up, the values of lump sums will decrease again. And if stock returns are low, this can penalize a pending retiree’s retirement plans, subjecting them to sequence of return risks if they take the lump sum (never mind that the annuity value may never have worked for them either).

Have you checked on the lump sum value of your pension recently? How does that number make you feel, given the number of years you’ve been with your employer, and how far away you are from retirement?