Illustration by Donna Racer
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The Pension Panic
By Russell Wild, January & February 2005
Could rising interest rates shrink your nest egg?
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For workers nearing retirement and expecting a big, fat lump-sum pension
payout, 2005 could be a year of dwindling expectations and dwindling cash. The
reason: interest rates, after plummeting to historic lows, have been slowly
creeping up—and most experts predict the trend will continue.
Why the interest angst for up-and-coming retirees? Because employers use the
prevailing interest rate to calculate the present value of your pension. In
general, a 1 percent jump in long-term rates drops your lump-sum payout by 10
to 15 percent. So if your lump-sum payout today is worth, say, $100,000, it
could be worth $85,000 to $90,000 if interest rates rise 1 percent.
No wonder some older workers are wondering if they should take the lump sum
now while the going's good. Yet tempting as that may be, most financial
planners argue against making any hasty moves. "It hardly makes financial
sense to leave, say, a $60,000-a-year job to potentially save $10,000 to
$15,000," says Sheryl Garrett, a certified financial planner and author of
Just Give Me the Answer$. "And a lump-sum payout is usually a
terrible idea to begin with. You're usually much better off getting your
pension money as a monthly check for life."
The benefits of the monthly payout: the rate of return is often highly
competitive with other fixed-income investments, you have the security of not
outliving at least a portion of your retirement assets, and there's no
investment risk. The lump sum makes sense only if you're in bad health and
don't expect to live long in retirement, or you're so wealthy that
you're unlikely to outlive your assets, says Garrett. "And that's
true," she adds, "regardless of whether interest rates are rising or
falling."
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