In this article we provide an analysis of a specific de-risking issue for 2024: how higher 2023 interest rates may affect sponsor decisions to de-risk (or not de-risk) defined benefit plan liabilities via a lump sum window in 2024. This will be the first of three articles on defined benefit plan finance – our next article will cover Pension Benefit Guaranty Corporation premiums and the standard vs. alternative election, and our final article will discuss funding challenges in the context of rising interest rates.
Interest Rates
Between 1984 and 2020, long-term interest rates declined from all-time highs (above 13%) to all-time lows (below 3%), creating, for more than 35 years, a persistent headwind for anyone involved in managing DB pensions.
Since 2020, however, rates have moved higher, briefly exceeding 6% in late 2023 before ending the year at around 5%, the highest rates seen in more than a decade. The chart below shows the behavior of long-term rates between the end of 2013 and the end of 2023:
Interest Rates and Lump Sums
One impact of higher interest rates is to reduce the value of pension liabilities, including the cost of lump sums.
This plays out differently for different DB plan sponsors. Plans that include an ongoing lump sum provision (or other accelerated form of payment) must specify a “lookback month” (used to determine the lump sum valuation interest rate) and a “stability period” (to determine the period over which that rate will apply) in their plan documents.
At one extreme, a “1-month lookback” and “1-month stability period” means lump sum rates change monthly, based on the most recent rates available. For plans using this method, lump sum values declined during 2023 as rates rose (similar to annuity purchases, which are always marked to market). And lump sums in 2024 will increase/decline as 2024 interest rates (month by month) decline/increase.
At the other extreme, a (calendar year) plan using a “5-month lookback” and “1-year stability period” used August 2022 rates to calculate lump sums for all of 2023 and will use August 2023 rates to calculate lump sums for all of 2024. These plans will see a sharp drop in lump sum values between December 2023 and January 2024.
For purposes of 2024 lump sum windows, sponsors should understand what constraints, if any, apply to the choice of “lookback month and stability period” in connection with the window.
Higher Rates, Lower Lump Sums
The table below summarizes the five sets of PPA segment rates (in effect, monthly spot rates) available for calendar year plans (August, September, October, November, and December) for 2023 and 2024 with a “1-year stability period,” and the “delta” (increase in rates for 2023 vs. 2022 lookback months) for each lookback month. (Note, “1st segment” rates are generally not significant for most lump sum calculations.)
The table below translates these rates into lump sum values for a 50 year old participant with a life annuity benefit of $100 per month payable beginning at age 65:
For calendar year plans with a 1-year stability period, 2024 lump sums for this participant are 6%-17% lower than 2023 lump sums. This is on top of an even larger drop in lump sum values between 2022 and 2023.
For plans contemplating a 2024 lump sum window that have latitude with respect to lookback month and stability period, it’s worth noting that interest rate volatility during late 2023 means different lookback months produce very different 2024 lump sum values (the October lookback month produces a lump sum 20% lower than the December lookback month).
Looking Ahead
Higher interest rates mean lower pension liabilities. The foregoing sketches out how higher rates will be expressed for plan sponsors that pay lump sums and considerations for sponsors contemplating a lump sum window in 2024.
In the next article, we will discuss PBGC premiums – a critical cost of doing business for DB plans – how the standard vs. alternative method for determining a plan’s underfunding (technically, its unfunded vested benefits or “UVBs”) will affect the calculation of premiums in 2024, and options sponsors may have with respect to that calculation.
FAQs
A retirement plan consultant takes the weight off your shoulders when it comes to implementing, administering, and fine-tuning your company's retirement offerings. Advisors can help with long-term planning, saving goals, tax strategies, investments, and personal wealth administration.
What is the difference between a benefit plan and a retirement plan? ›
A defined benefit plan (e.g., a pension) is one where you know what to expect in terms of a payout when you retire. A defined contribution plan (e.g., a 401(k) or IRA) is one where you choose how much to pay in without knowing what the retirement benefit will be.
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Regular financial planners offer their services to people of all ages. Retirement planners, on the other hand, deal with clients in or near retirement. This distinction can prove important if you are specifically looking for a professional to get your retirement affairs in order.
What is the role of a benefits consultant? ›
Benefits Consultants Overview & Description
Benefits Consultants conduct programs of compensation and benefits and job analysis for employer. May specialize in specific areas, such as position classification and pension programs.
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A financial advisor is worth paying for if they provide help you need, whether because you don't have the time or financial acumen or you simply don't want to deal with your finances. An advisor may be especially valuable if you have complicated finances that would benefit from professional help.
What are two disadvantages to having a defined benefit plan for retirement? ›
The plan disadvantages include higher fees, conservative investment growth, permanency rules and mandatory contributions. Employees may choose between a lump-sum payment or an annuity stream upon retirement. These plans can have significant risks for both employees and employers.
What are the three main types of retirement plans? ›
To help you navigate your options, here's a comparison of five of the most common types of retirement plans:
- 401(k)
- Traditional IRA.
- Roth IRA.
- SEP IRA.
- Solo 401(k)
Defined benefit plans carry more investment risk for the employer, while 401(k) plans transfer the investment risk to the employee. However, the higher risk might make sense if the goal is to make very large pension plan contributions and to offer guaranteed benefits at retirement.
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Bill Tremko - USI Consulting Group | LinkedIn.
The average BTA Deloitte USI base salary at Deloitte is $120K per year. The average additional pay is $11K per year, which could include cash bonus, stock, commission, profit sharing or tips.
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USI is one of the largest insurance brokerage and consulting firms in the world, delivering property and casualty, employee benefits, personal risk, program and retirement solutions to large risk management clients, middle market companies, smaller firms and individuals.
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If you have considerable wealth and require a long-term estate plan with multiple moving parts, such as preservation of capital, income generation, taxes, insurance and legal issues, a financial planner is likely the better choice.
Is a fiduciary better than a financial advisor? ›
In many cases a fiduciary may be a better fit for you as fiduciaries are ethically bound to act in your best interests, providing more assurance that your financial plans align with your goals and needs. However, there are also regular financial advisors who are also excellent.
What is a retirement consultant? ›
Retirement plan consultants are financial professionals who help businesses with their employer-sponsored retirement plans. They are equipped to handle the wide and complicated span of retirement plan tasks and responsibilities, from start to finish.
How do retirement planners make money? ›
In the financial world, advisors and planners are compensated in one of two basic ways: by earning flat fees or by earning commissions.
How do retirement plan providers make money? ›
The vast majority of 401(k) providers make huge sums of money from kickbacks from the mutual funds in the plans they sell. This payment for “shelf space” is a legal but opaque process called revenue sharing.
Why work in retirement consulting? ›
Independent consulting is unique because it gives you the ability to home in on a specialty area of focus, pursue projects that you care about, and provides freedom over creativity—all while giving you the autonomy, flexibility, and control of being your own boss.
What is a retirement plan specialist? ›
What Is a Retirement Plan Specialist? A retirement plan specialist works with individuals to plan out their financial needs for retirement. Financial-planning is essential throughout life, but it becomes increasingly crucial in retirement when you aren't taking in the funds that you were during your working life.
