Lump Sum - OMM or not?

[fishndad42]

It looks like I will have an opportunity to take advantage of a special retirement program. It's an interesting transition program where I'll work 20 hours a month for 6 months, get paid full salary for that time and then retire. I was planning on going at the end of the year anyways, so this came at a very opportune time!

I have an option that I need to decide on now however - start the program June 1 and retire Dec. 1 this year, or start July 1 and retire Jan. 1, 2017.

For reasons I spelled out in my "Hi, I am..." post (longevity isn't likely to be in the cards for us), we're very likely taking a lump sum payout on my pension.

At least for my megacorp, 2016 is a special year. Previous years the lump sum was calculated (government formula) based on the previous year's October rates. Those retiring in 2017 will see lump sums calculated on August of the previous year. For 2016 the lump sum is the greater of October or August 2015. That means that I already know the lump sum for any retirement date this year (assuming the benefits site is doing it right), and I won't know for the Jan. 1 retirement date option what the lump sum will work out to be before I have to decide (this week!). There seems to be no way to make my retirement date Dec. 31 instead - I'm stuck with the two options.

The OMM (one more month) syndrome plays here as well. If I retire on Dec. 1 the lump sum payout will be over $17K (2.4%) less than the Jan 1. number - that is, if the Jan. 1 calculation is favorable.

I believe the lump sum calculation is based on the interest rates - higher rates mean lower payout. Since the fed raised interest rates in December 2015 already (which is after the August and October calculations), and they could bump again before the August adjustment, it seems there is risk waiting the extra month. Still, $17K is 25% of one year's retirement budget for us.

So will the current interest rate increases and the possibility of another rate increase wipe out that $17K anyways? I'm not sure how to calculate that. It isn't hard to think about working the one extra month - after all, it is December and between holidays and people scrambling to spend their vacation days, it's an easy month to w*rk.

I'm leaning toward the earlier timing, as it's a known factor (and I get out a month earlier). I'd just rather not leave money on the table if I can help it.

Any thoughts out there?

 

[MichaelB]

Any thoughts out there?

Is there a tax advantage to waiting until 2017? Another year of tax deferred contribution and perhaps a lower marginal rate might make a difference.

 

[pb4uski]

I guess that one question to ask your pension or benefits people would be what the interest rate is based on and what it would be today given whatever that base is today. I agree that it seems more likely that rates will go up rather than down so the lump sum would go down rather than up so without more information it seems that the known 2016 lump sum is the better choice. You might also ask what the lump sum would be if the interest rate was 50 bps higher than what was used for the 2016 lump sum to get an idea as to how sensitive the lump sum is to change in the interest rate.

Where does the $17k come from? Is it the result of one additional month of service?

Also, even if your last day of work is Jan 1 will you have any significant unused vacation or sick leave that would then be paid to you in 2017? If so, it might be more tax efficient to wait all else equal. Another small positive to waiting until January 1 is that you would probably get a few more days of paid holiday for Christmas and New Year's holidays and your health insurance benefit usually would extend until the end of January.

 

[fishndad42]

Where does the $17k come from? Is it the result of one additional month of service?

Also, even if your last day of work is Jan 1 will you have any significant unused vacation or sick leave that would then be paid to you in 2017? If so, it might be more tax efficient to wait all else equal. Another small positive to waiting until January 1 is that you would probably get a few more days of paid holiday for Christmas and New Year's holidays and your health insurance benefit usually would extend until the end of January.

Yes, the $17K is one more month of service.

To clarify, last day would be Dec. 31, which in their program means retirement benefits start Jan. 1. Fortunately I get health insurance as well, until age 65 when I have to convert to Medicare. Christmas Eve through the end of the year are paid holidays, it is part of the temptation for OMM but not at the risk of a lower final payout.

 

[fishndad42]

Is there a tax advantage to waiting until 2017? Another year of tax deferred contribution and perhaps a lower marginal rate might make a difference.

I hadn't thought about tax considerations, I'll have to do some investigating. Thanks for the tip.

 

[pb4uski]

Yes, the $17K is one more month of service.

To clarify, last day would be Dec. 31, which in their program means retirement benefits start Jan. 1. Fortunately I get health insurance as well, until age 65 when I have to convert to Medicare. Christmas Eve through the end of the year are paid holidays, it is part of the temptation for OMM but not at the risk of a lower final payout.

In that case I guess a key piece of info to make a decision is the sensitivity of the lump sum to changes in interest rates.... if a 50 bps increase in the interest rate would cause the lump sum to decline much more than then $17k combined with the value of the paid holidays then I would go with Nov 30 rather than take the risk associated with Dec 31 and the impact of the revised interest rate on the lump sum.

While I suspect that Big Hitter will weigh in once he gets off the golf course, if he doesn't weigh in then you might PM him and get his thoughts.

I suspect that even if your last check was Dec 31 that your unused vacation might not be paid until 2017 either way so the tax angle may be a moot point.

 

[Big_Hitter]

Where does the $17k come from? Is it the result of one additional month of service?

I would guess that would be for being a month older, one more month of service and the use of the 2017 mortality table (mortality may be 0.2% of it) but that seems like quite a big difference?

It's an important question. Edit: oh I see that was answered above.

The reason that the OP gets the "greater of" for one year is that Mega changed what's called the "stability period" for choosing the interest rate. It's required to grandfather the rate for one year after making the change.

 

[Big_Hitter]

While I suspect that Big Hitter will weigh in once he gets off the golf course,

Big dice roll for sure - we have no idea what August, 2016 corporate bond rates will be until we get there. This is what we call a known unknown.

Here is a link to the published rates: https://www.irs.gov/Retirement-Plans/Minimum-Present-Value-Segment-Rates

Another issue is that it's possible that the IRS will require the use of an updated mortality table (based off of RP2014) for minimum lump sum calculations. No news on this yet though. This is what we call an unknown unknown.

If I were making the decision I would want to see the effect of a XX basis point change in the segment rates. Maybe the OP can get another calc from the plan administrator?

Please don't construe any of my comments as legal or financial advice.

 

[fishndad42]

Big dice roll for sure - we have no idea what August, 2016 corporate bond rates will be until we get there. This is what we call a known unknown.

Here is a link to the published rates: https://www.irs.gov/Retirement-Plans/Minimum-Present-Value-Segment-Rates

Another issue is that it's possible that the IRS will require the use of an updated mortality table (based off of RP2014) for minimum lump sum calculations. No news on this yet though. This is what we call an unknown unknown.

If I were making the decision I would want to see the effect of a XX basis point change in the segment rates. Maybe the OP can get another calc from the plan administrator?

Please don't construe any of my comments as legal or financial advice.

Thanks for the input. I happen to have a calculation for the same retirement estimate (Jan.1 2017) from July 2015, before the August and October dates, which would then have used Oct. 2014 rates. Looks like the segment 1 rate changed from 1.29 to 1.61. Segment 2 was a bit less of a bump, and segment 3 was even smaller. The difference between the July 2015 and Feb. 2016 calculations was -$14.5K. So it seems with another bump upward by August of this year, most of that $17K could go out the window anyways.

Of course my DD, an underpaid teacher thinks giving up a month's salary is nuts. But for me, when it comes to salary, OMM and OMY are the same temptation. Perhaps I should just be using the same philosophy - if $17K is going to make a difference between retiring successfully or not, I shouldn't be retiring.