Rather than receiving a monthly
check upon retirement (annuity payments), many people
think of taking out a lump sum distribution (a one time
distribution) of their retirement assets. If you do decide
to take out a lump sum distribution of your 401k assets,
consider the Pension Protection Act of 2006 which could
severely reduce the amount of money you actually withdraw
from your lump sum payment.
A monthly check that covers
your living expenses and gives you some savings thereafter
always sounds good right? You can just check your mail
every morning for those checks to roll in, or check your
bank account for a credit balance to appear. However,
other retirees decide to take out a lump sum distribution
because of some of these reasons:
i) The employer may face
tough economic times ahead of the future and may not be
financially stable, or even go bankrupt. In any case,
the Pension Benefit Guaranty Corporation (PBGC) makes
sure that you receive your pension benefits even if your
employer goes bankrupt. However, in most of the cases,
you will end up with a smaller amount of your pension
benefit than you thought, because of the charges and expenses
incurred by the PBGC. You might therefore have lesser
money upon retirement, and possibly not enough money to
survive through retirement!
ii) If you want to open your
own business upon retirement, a lump sum distribution
of your 401k assets is the best choice for most retirees.
iii) The retiree thinks he
is a better investor than the pension managers and decides
to take the investment into his own hands.
The Pension Protection Act
of 2006 affects lump-sum 401k distributions in 2 ways:
i) It alters the way corporations
calculate the amount of pension benefit for their employees.
ii) It caps out the amount
of lump sum distribution you can take out
Upon retirement, your employer
will use your pension benefit or annuity payments to calculate
the present value of your lump sum distribution. The calculation
will factor in your life
expectancy rates and future return on investments.
Here's an example:
| Monthly Payments Upon Retirement: |
$2500 per month |
| Life Expectancy: |
25 years |
| Interest Rate: |
6% |
| Present Value of Lump Sum Distribution: |
= $383,501 |
Therefore, if you are eligible
to receive $2500 per month for the next 25 years at an
interest rate of 6%, using Financial Analyst BAII Plus
calculator, the present value of your lump sum distribution
is $383,501.
Let's consider another scenario
where the interest rate achieved on the investment is
higher, lets make it 8%.
| Monthly Payments Upon Retirement: |
$2500 per month |
| Life Expectancy: |
25 years |
| Interest Rate: |
8% |
| Present Value of Lump Sum Distribution: |
= $320,243 |
As you can see from the above
example, if your pension manager can get you higher interest
rates, you will receive a lower lump sum payment. Therefore,
the mathematical relationship is:
Lower Interest Rate
= Higher Present Lump Sum Payment
6% = $383,501 lump sum payment today.
Higher Interest Rate = Lower
Present Lump Sum Payment
8% = 320,243 lump sum payment today. |
