What is a lump sum benefit?
Your pension plan benefit is designed to pay a monthly annuity for your lifetime beginning at your normal retirement age (NRA), as defined in the plan (typically age 65). The plan may offer one-time payout options with your spouse’s consent like a rollover to an IRA or another qualified plan (e.g., 401(k) or 403(b)) or a cash payment to you. These additional options may be called a lump sum payment or lump sum equivalent that represents the actuarial present value* of your retirement benefit. The lump sum is paid instead of the anticipated future monthly payments.
Types of DB Plans
There are two types of defined benefit (DB) plans.
- A traditional plan that uses a formula to determine your benefit at retirement or
- An account-based plan such as a cash balance plan.
How interest rates affect your traditional plan benefit
The lump sum equivalent of your pension plan benefit is recalculated every year (or sometimes more often). This calculation uses interest rates and age-specific life expectancy as defined in your plan and by the IRS.
Because interest rates change, your lump sum amount will also change, even if your monthly benefit did not. If interest rates increase, the lump sum will decrease and vice versa. Additionally, as interest rates change, younger participants will see larger changes in their estimated lump sum compared to older participants.
Below are examples showing the potential impact of different interest rates on lump sums
Cash equivalent of a $1,000 per month annuity payment | |||||
Current Age | |||||
Interest Rate* | 30 | 40 | 50 | 60 | 65 |
3.00% | $62,000 | $83,600 | $113,000 | $154,800 | $184,100 |
5.00% | $26,100 | $42,700 | $69,900 | $116,100 | $152,000 |
7.00% | $11,400 | $22,500 | $44,500 | $89,200 | $128,400 |
*and 2023 required IRS mortality for lump sum payments
It’s important to note that while changing interest rates may affect the actuarial equivalent lump sum amounts, changes in interest rates do not impact your monthly benefit at normal retirement age.
Lump sums from Cash Balance plans are not subject to the same kind of large swings in value.
This is because a traditional plan converts your lifetime benefit into a lump sum, as described below, but account-based plans such as a cash balance are defined by the total current total value of your account, much like a defined contribution plan (e.g., 401(k) or 403(b)).
For more information
Log in to principal.com to review your plan details and see if the plan offers lump sum options at the time you elect your benefits.
*Actuarial Present Value utilizes average expected longevity and interest rates as defined in the plan document to calculate the lump sum equivalent. The value of any payment form (including a lump sum or monthly payments) to you depends on your situation; your needs, any other sources of retirement income you may have, your health, and how long you and your co-annuitant live, among other factors.
The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment or tax advice. You should consult with appropriate counsel, financial professionals, and other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.
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PQ13569 | 3063023-082023 | 7/2023
