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Rick Ferri

Retirement Planning > Saving for Retirement

Why Nov. 1 Might Be a Smart Retirement Date for Your Older Clients

By John Manganaro

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What You Need to Know

  • Interest rates have gone up significantly this year and are set to continue their upward trajectory.
  • The broader interest rate landscape affects IRS minimum present value segment rates, which are used in pension plan operations.
  • Substantially higher rates in 2023 could significantly reduce lump-sum pension payments claimed during the year.

Rick Ferri, founder and CEO of Ferri Investment Solutions, is well known for his emphasis on passive investing and his focus on calling out what he sees as fundamental flaws in the way most people invest.

According to Ferri, most long-term investors will do best by selecting a few low-cost index funds that match the returns of the markets and doing whatever it takes to remain disciplined.

Ferri also has a passion for financial planning, and he works with clients to incorporate family needs, tax considerations and distribution decisions into the investment process. In a moment when interest rates are surging and the financial markets are gripped by volatility, he is taking time to warn near-retiree clients about a potentially overlooked consideration that could rob them of significant retirement wealth.

The consideration applies to any client who would answer the following question in the affirmative: “Are you retiring next year taking a lump sum from a pension?”

If so, Ferri warns, the client should figure out when their employer changes the IRS-specified “minimum present value segment rates” used in the operation of the pension plan in question— and why both the date of the change and the rate itself matter for their financial future.

What Are Minimum Present Value Segment Rates?

As noted on the IRS’ website, for a pension plan to qualify for tax-exempt status, the plan sponsor must arrange sufficient funding for the plan’s future liabilities, including future pension benefits. Determining sufficient funding requires calculating the present value of future benefits which is, in part, based on discounting those benefits with interest.

The IRS, on its website, provides the interest rates a plan actuary must use to apply this discounting for a single employer defined benefit pension plan. Generally, for single-employer plans, for funding purposes, the rates for discounting are three 24-month average segment rates, though special rules apply in certain cases.

The three segment rates, in turn, are determined by averaging the yields, over different blocks of maturity periods, of the Treasury high-quality corporate bond yield curves as measured over the prior 24 months. These rates are subject to additional criteria and have been affected by several amendments to the Internal Revenue Code, including recent changes under the American Rescue Plan Act.

However, as a general rule, the rates move in tandem with broader movements in Treasury yields. Given the significant increases in rates measured this year, Ferri says, it is reasonable to expect substantial upward movement in the minimum present value segment rates used by a given pension plan for 2023.

Why This Matters for Clients

As Ferri points out in written comments shared with ThinkAdvisor, among their various uses in pension plan operations, the determination of these rates has a direct impact on the calculation of lump-sum payouts. Ferri says the impact of year-over-year rate changes, in fact, can be much more significant than many near-retirees may realize.

“This is important because higher interest rates may cause a large negative impact on the calculated lump-sum amount,” Ferri says. “Retiring employees should discuss the options with their employer’s HR department to see if retiring in 2022 would provide them with a greater lump sum than waiting until 2023.”

And, as interest rates continue to rise, the possible impact on lump-sum amounts can be expected to grow through the end of the year.

“Different companies have different defined benefit plans,” Ferri notes. “Some may be affected and others not [depending on the plan design].”

In any case, it is worth looking into. Ferri points to one investor he worked with recently who would lose about $150,000 in lump-sum value if he retired as planned, on March 1, 2023, rather than on Nov. 1, 2022.

John Manganaro

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