Electing how to take your pension is a major decision and requires you know the facts about how each of the different options could impact you. Capstone Wealth Advisors is dedicated to keeping you up to date on the ever changing interest rates, forecasting future rates and helping advise you as to what your best option is.
On a monthly basis we provide updated pension figures as well as our expectation for where interest rates are heading so you can make the most informed decision about your pension at retirement. If you would like to receive our monthly email commentary along with updated pension figures, please add your name to our email list.
If you worked for one of the companies BP acquired in the past you are likely considered to be a “Heritage employee”. Heritage employees are given special treatment when it comes to their pension accounts and receive the benefit of either taking the better of their old company’s pension benefits or the pension benefits offered under the BP Retirement Accumulation Plan (RAP) calculation. Most Heritage pension plans were structured as a traditional Defined Benefit Plan where the BP RAP is a Cash Balance Plan. The difference between these two plans is essentially the way they are calculated.
Defined Benefit Plans
Employee benefits are calculated according to length of service, age, salary earned at the time of retirement, and corporate interest rates. The primary benefit you accrue is a lifetime annuity, but you are also offered several other options including a single lump sum payment. The overwhelming majority of people elect to take their pension as a lump sum payment for a variety of factors.
Cash Balance Plans
Like a traditional defined benefit plan, a cash balance plan provides employees with the option of a lifetime annuity. However, unlike defined benefit plans, cash balance plans create an individual account for each employee which includes a specified lump sum. When the employee retires, they are given the option to take either the lump sum amount or they can convert that lump sum into an annuity payment. Under cash balance plans, higher interest rates generally mean larger annuity payments and larger lump sum payments.
Lump Sum Option
Offered under both heritage and non-heritage employees, a lump sum distribution is a one-time payment from your pension available at retirement or separation from the company. By taking a lump sum payment, you gain access to a large sum of money, which you can spend or invest as you see fit. Here’s a simplified explanation of how the lump sum is factored. The stream of annuity payments have an identifiable value based on the recipients life expectancy and current interest rates at the time of retirement. Think of it like this, if the company is obligated to pay you $1,000 per month for the rest of your life and you are expected to live for 25 more years then the company will be paying you $1,000 x 12 months x 25 years, equaling a total of $300,000 over that time period. The company looks at it from the perspective of if it is obligated to pay you $1,000 per month for 25 years, they will likely invest an amount of money today into high-grade bonds which will provide you with that monthly cashflow. If bond rates are low the company will need to invest a larger amount of money today to make the payments versus if rates are higher. In simple terms, the lump sum payment is essentially equal to the amount of money the company needs to invest to make that payment. This is why traditional defined benefit plans produce a larger lump sum payment when interest rates are low and a lower lump sum when interest rates are high. The lump sum option allows you the greatest amount of flexibility and control versus the annuity options. Lump sums are eligible to be rolled over to an IRA, deferring taxes and giving you control of when and how much you wish to withdraw from the IRA. They also allow you to make whatever investment decisions you feel are necessary to fit your individual situation, goals, risk tolerance, time horizon’s, etc. Lump sum rollovers are by far the most widely elected option for retirees.
Under the Heritage plans, the annuity options available to you in your RAP are calculated based on five main factors including your service history, age (this includes your spouse’s age if married), interest rates at retirement, final average earnings and a social security based calculated factor. Together these components comprise the value of your monthly annuity payment. The annuity option also comes with some specific rules that once enacted cannot be undone. Most notably is the absence of a Cost Of Living Adjustment (COLA). A COLA is essentially the equivalent to getting a raise when you were working. Imagine working at a job that never gave you a raise, doesn’t sound very attractive does it?
A COLA annual increase generally coincides with inflation in an attempt to keep your annuity payment increasing as prices of goods and services you regularly use also increase over time. Because there is no provision any longer for a COLA within the RAP, your annuity payment will never be more than what it is when you begin collecting it. This is one of the most significant deterrents to selecting the annuity option because as your bills go up over time your income does not.
Another major issue with taking the annuity option is once you elect to take it you give up your ability to convert it into a lump sum at a later date and you cannot pass it along after you die except under very limited circumstances. Meaning if you were to become sick and needed special medical care, you could not use the annuity’s value to pay the medical bills and once you pass away there is no money passed to your estate.