Ford tells employees the score on how higher rates hit lump sum payouts

An email sent this September to some retirement-eligible Ford Motor salaried workers captured the lump sum pension dilemma of 2022 rather bluntly.

The Ford email — subject line "Important Information Regarding Your Pension" — specifically pointed out that anyone who is considering retiring and opting for a lump sum payment needs to look at the numbers.

Interest rates increased dramatically in 2022 and will trigger a dramatic drop in the potential payout ahead for those who choose the lump sum pension option next year. The lump sum for 2023, according to the Ford memo, would decrease by an estimated 20% to 25% relative to the lump sum values that a Ford employee who retires would see if they took the lump sum in 2022.

"If you are considering retiring and choosing the lump sum option, it is important to understand the impact of higher interest rates on your individual lump sum amount, should you retire after Dec. 1, 2022," read the Ford memo, which also included a brief survey to help the company plan for employee retirements.

So, for example, if someone is looking at $500,000 lump sum payout in 2022, the loss in 2023 could be in the range of $100,000 to $125,000. It's not chump change.

Thousands of people in their late 50s and 60s who still work for big companies with traditional pensions are discovering that higher interest rates triggered a ton of talk about pension payouts. Some are even wondering if they should retire in 2022 instead of waiting until next year.

The lump sum debate

Should you or shouldn't you take a lump sum?

Do you trade in the opportunity to take a steady pension check each month when you retire for a one-time shot at six figures or more in cash immediately? Especially if you know that the lump sum would be drastically smaller if you wait until next year?

How much money you'd get in a lump sum typically would vary based on your years of work at any company, earnings history, age and the terms of your plan.

Some employees at local automakers who worked decades there and had higher salaries could be looking at million-dollar payouts; others might be looking at $300,000 or $400,000.

As interest rates have soared during 2022, people understand pretty quickly that many are paying much more to cover a new mortgage, credit card payments and new auto loans.

But most don't realize that higher interest rates influence the size of a lump sum pension payout and could drive some workers who are considering retiring soon to leave this year instead of next.

Simply put, the higher the interest rate environment, the lower the lump sum payout.

To be sure, if you opt for the traditional monthly pension, the amount that you'd get each month isn't going to change based on higher interest rates or inflation. Many pensions don't include cost of living adjustments that would boost your monthly pension check based on inflation, like Social Security does.

But choosing a lump sum option — and it is an option, not a requirement — means you'd look at a far different lump sum if you retire later.

More: Social Security to go upHow benefits will increase based on inflation

Lump sum payouts can be somewhat controversial. You're giving up a stream of income each month — which some might argue is a safer play — to control a large amount of money throughout your retirement years.

Will you invest wisely? Will you have enough cash to live on 10 years or 15 years from now? Many people might do better with a steady monthly pension check.

We heard quite a bit about lump sum payouts back in 2012 when special lump-sum buyout pension offers were made to existing retirees by General Motors and Ford as a way to "de-risk" the pension obligations of the automakers. Three out of 10 eligible General Motors salaried retirees selected the lump-sum pension option, instead of continuing to receive a monthly check, back in 2012, according to GM at that time.

The latest buzz involves those who have yet to retire, not those who are already retired.

What are the risks

Make no mistake, you are taking on extra risk when opting for a lump sum. It can be harder to live through a volatile stock market and make up losses when you're no longer drawing a paycheck and you're withdrawing money from a nest egg.

A married couple who each expect to live well into their 90s, some experts say, might end up being better off with collecting a monthly pension for decades.

"Some people should be on a fixed income for retirement because they can make mistakes with that money and that would be disastrous," said Sam G. Huszczo, a chartered financial analyst in Southfield.

To be sure, he said taking a lump sum is an individual choice that must be carefully reviewed and not simply driven by the direction of interest rates or fear that a payout would be smaller in the future.

Typically, financial advisers noted the standard practice is to roll the lump sum over directly into an IRA to avoid any tax headaches.

It is optional for individuals who have yet to retire at this point. First off, someone has to quit their job at the company to take the lump sum. Anyone who wants to keep working at the company for the next two to five years, Huszczo said, probably shouldn't rush into retiring simply to grab a larger lump sum in 2022.

Lump sums aren't being offered to all

All pension plans don't offer a lump sum payout option at retirement.

The UAW hourly workers at Ford, General Motors and Stellantis who continue to be covered by a pension aren't offered a lump sum payout option at retirement. It is not an option in the UAW contracts. 

And Stellantis, for example, said FCA pension plans that cover nonbargaining unit or salaried employees do not include a provision to elect a lump sum in lieu of monthly pension payments.

At Ford, its general retirement plan applies only to employees hired before 2004. It was replaced with a defined contribution plan for those hired afterward. The lump sum payment is an option under that plan for salaried employees who are electing to retire.

At this time, there is no plan to offer lump sum payments to existing retirees, said Marisa Bradley, a spokesperson at Ford.

She noted that the number of people who elect to retire varies from year to year.

"Choosing when to retire is an important decision," Bradley said, "and we aim to provide employees with the necessary resources to make an informed decision."

More: Ford severance packages detailedFord lays off up to 3,000

Know how interest rates will influence lump sums

The changing landscape for lump sum payouts clearly must be addressed as part of any conversation if it's an option and someone thinks they might choose a lump sum benefit.

How interest rates factor into the math really hasn't been talked about much during years of low or stable interest rates.

"In general, the lump sum is impacted by the general level of interest rates," said Timothy Wyman, managing partner for the Center for Financial Planning in Southfield. The company has worked with clients at Ford Motor, AT&T and Johnson Controls recently regarding the option of the lump sum payout.

The higher the interest rate environment, the lower the lump sum payout. Companies use a very specific set of interest rates published by the Internal Revenue Service, which reflects corporate bonds, as part of the calculation. The rates are known as the IRS Minimum Present Value Segment Rates.

Wyman said three variables come into play in the lump sum calculation. First, there is the monthly pension amount for the individual; second, the life expectancy of the employee, and third, the interest rate used to calculate the lump sum.

For many years in a lower interest rate environment, Wyman said, the lump sum looked attractive to some retirees after they did the math. But he expects that's increasingly going to be less the case if rates remain high.

"Technically, you're taking a net present value of the monthly pension and coming up with a lump sum that is needed to produce that same monthly income," he said.

When interest rates climb higher, the theory is that you're more easily able to replicate that pension payout with reduced lump sum. If you could, for example, get 3% on your money you'd need a bigger lump sum than if you could get 5% on your money.

"You need, in theory, less money to produce the same monthly income," Wyman said.

"It's a significant difference."

How one employee sees things

Wyman has a client, a 58-year-old woman who has been at Ford for close to 35 years as a salaried employee. She has been contemplating retirement this year or next.

"Ideally, she would like to wait until February 2023 but because of this reduction, there's no way she can justify waiting until 2023," he said.

If she takes the lump sum in 2022, the payout would be $1.6 million. If she waits until 2023, it's going to be $320,000 less at a 20% reduction.

"She absolutely is going to retire in 2022 because she wants a lump sum payment and the cost to wait until 2023 is too great," Wyman said.

Some salary employees often want to delay retirement into the next year to claim any bonus that they're due. For some, though, it may be a wiser financial decision to retire in 2022 to claim the larger lump sum, depending on how much money they're looking at and whether a lump sum makes sense for them.

The rates are set by the IRS

Companies don't get to pick their interest rates for how they're going to calculate the lump sum.

"Ford does not control the interest rates used so it’s not their 'fault,' " Wyman said. "However, as a company looking to reduce employee count, this may accelerate some retirements and be viewed as a positive from their perspective."

Ford noted in its memo that the interest rates used to determine lump sum payments for the next calendar year are published in September and based on high-quality corporate bond indices provided by the IRS.

Huszczo, who has worked with GM salaried employees on this issue, stresses that the change in the lump sum payout is based on the direction of interest rates, not GM. Many GM employees, he said, essentially had before Oct. 1 to make a decision about retiring in 2022 in time to collect the higher amount for a lump sum if they were selecting a lump sum option under that plan.

At GM, the salaried employee pension plan moves, effective Sept. 30, to the 2022-23 plan year. That's the typical time frame for such changes. The new plan year at GM refers to the July 2022 interest rate as published by the IRS in August for calculating the lump sum in the future. GM employees eligible for the pension plan can select a lump sum option at any time they wish when they are retiring or after they have left the company. But again, the payout would vary based on rates used at that time.

"The reason these lump sums are changing has nothing to do with GM. It has everything to do with just the interest rates changing," Huszczo said.

Most people still need to review whether they're prepared to retire before just chasing that lump sum in 2022.

How do you know if you're ready to retire?

Anyone considering opting for a lump sum should take time to make sure they're working with the right financial planner who has the retiree's interests, not the planner's interests, in mind, said David John, senior strategic policy adviser at AARP and senior fellow in economic studies at the Brookings Institution.

John, who focuses on pension and retirement savings issues, said it's essential that those considering a lump sum determine if they're ready to retire now in general. Those looking at retirement should take time to work on a budget and understand what they might actually end up spending once they stop working.

"That's a painful process to do. I can say that from personal experience," John told journalists attending a National Press Foundation fellowship on aging.

He used a spiral bound notebook to write down what he was buying.

"I was kind of surprised on what I was spending money for — and it helped me focus a little bit better on what I actually needed to do."

You really want to consider if you can afford to retire based on your own financial situation. Rushing retirement because a co-worker is talking about lump sum payouts isn't the best way to go.

"This doesn't help them fast forward retirement," Huszczo said, acknowledging that some could impulsively want to just take the money before it goes away.

A lump sum can be attractive if someone is financially well off, perhaps with substantial savings in a 401(k) plan or elsewhere. Maybe they do have a chance to work elsewhere once they retire from a big company.

But it's not always the best move to take a lump sum in 2022 if you're not ready to retire now, unless you knew you could find a good-paying job somewhere else. After all, working longer would mean you'd have more years to set aside money in your 401(k) and fewer years to cover your bills in retirement.

Contact Susan Tompor: stompor@freepress.com. Follow her on Twitter @tompor. To subscribe, please go to freep.com/specialoffer. Read more on business and sign up for our business newsletter.