True "pensions" are becoming a thing of the past for private sector employees. There was a time when most employees received a guaranteed monthly pension benefit for as long as they lived. Their retirement was secure. Now, by contrast, most employees just get a pot of 401(k) money. As we have seen recently, that pot of money can lose a huge chunk of its value in the stock market, or for any host of other reasons, it can become depleted within a few years after retirement. So much for retirement security.
If you are fortunate enough that you still participate in an employer-sponsored pension plan with guaranteed monthly benefits for life, the benefit plan probably provides a "lump sum" benefit option. That is, your "normal form" of benefit is an annuity, a monthly payment for the rest of your life or for the joint lives of you and your spouse; the plan, however, also provides the option to take your benefit in one lump sum. To pay lump sum benefits from a traditional "defined benefit" pension plan, the plan administrator must perform an "actuarial conversion" of your monthly benefit you would otherwise receive for the rest of your life to determine the "actuarial present value" of your immediate lump sum benefit. That actuarial conversion is essentially a mathematical formula that takes into account your age, your expected "normal form" benefits over your lifetime based on "mortality tables", and the "present value" of receiving a lump sum of money immediately rather than having to wait to receive benefits each month. Federal regulations place restrictions on the most crucial aspects of the formula, including the mortality tables and the annual interest rate used in the present value calculation. The plan itself can provide for a formula that is more favorable than the requirements of federal regulations. If so, the plan administrator must follow the requirements of the plan in determining lump sum benefits.
Plan administrators sometimes miscalculate lump sum benefits in one of three ways: 1) they use a factor in the conversion equation that is less favorable to employees than the one required by regulations (such as the mortality table required by IRS regulations); 2) they fail to use a factor in the conversion equation that is dictated in the pension plan itself (such as a "present value" interest rate required pursuant to the terms of the pension plan that is lower than the present value interest rate provided for in IRS regulations); or 3) when calculating the lump sum benefit, they fail to account for the prospective "cost of living adjustments" that the plan provides for in the "normal form" of benefit that the employee would receive as part of an annuity.
Don't let a good thing--your pension benefits--get watered down in the calculation of a lump sum benefit when you retire. If you are fortunate enough to participate in a defined benefit pension plan, make sure your lump sum benefit option is calculated in compliance with both the law and the terms of the plan itself. A small difference in the lump sum formula could make a huge difference in your lump sum retirement benefits.
