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We’ve all been hearing about the volatility in markets all around the world. Everyone has an opinion as to why the markets are down. Whether it’s the covid effect, supply chain issues, inflation, geopolitical conflicts, or bad government policies, the results are the same. Our wealth is being eroded. For those approaching retirement, this is more concerning than ever. This demographic of Americans has been a large part of the economic engine for decades and, when they should be enjoying the fruits of their labors, they are faced with the uncertainty of their future. The question is, why is this happening and what can be done to solve the problem?
How do bond values affect my pension value?
The current market conditions have created a lot of questions for retirees and pensioners. Questions like “What do these numbers mean? How will they affect me?” The truth is, understanding how it all happened doesn’t solve the problem. Here’s a simple explanation as to why things are the way they are: The reality has always been, when the stock market is up, bond rates are typically down.
The inverse is also true… and that’s where we find ourselves today. So how does that affect pensions? The interest rate used to calculate most pension payouts is the Composite Corporate Bond Rate. This rate is the average of two bond indices: the Citigroup High-Grade Credit Index rated 10+ years, and the Merrill Lynch US Corporates AA-AAA rated 10+ years. In November, the rate was raised to 2.271%. One year earlier, the rate was 1.98%. Here’s a simple example: If you wanted a lump sum payout in 2021 and your pension was valued at $500,000, waiting one year to receive that payout would’ve reduced it to $485,000.
So, should I draw out now or wait? That depends on how you feel about the direction of the current and future market conditions.
What are my pension payout options?
When it comes to pensions, there are two ways to receive your benefit payments: lump sum or annuity. A pension annuity is typically a series of monthly payments that you’ll receive over time. A lump sum payment is a one-time payout of your benefits. As retirement approaches, if you have a pension, figuring out whether to take your benefits as a lump sum or annuity payment over time is a decision that requires careful consideration. As interest rates rise, the decision becomes more urgent. Simply put, the higher the interest rate used to calculate lump sum, the smaller your payout. If you are considering a pension annuity payout, keep in mind that these annuities are subject to inflation risk over time since they typically don’t include an annual cost of living adjustment. To share a simplified illustration: If the rate used is 4%, a pension benefit of $5,000 monthly ($60,000 a year) over 20 years would yield a lump sum of approximately $815,419. At 6%, the one-time payout would be about $688,195. That is a difference of $127,224—about 16% lower!
How long should I wait to decide on my pension options?
It’s no secret that the economy is changing rapidly, and experts are talking about a looming recession. Inflation is at levels we haven’t seen in over 40 years, and the Federal Reserve plans to continue raising interest rates to combat inflation. This means that we may be paying more for goods and services than we have in the past, which could erode the value of your pension. Advent Strategies offers a free consultation to help answer questions you may have regarding your personal situation. Reach out to an advisor today and find a strategy that will allow you to make the choice that best meets the needs of you and your family.
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