Company-Specific Retirement Planning
May 23, 2022

How Will Changes in Interest Rates Affect Your Chevron Lump Sum? | Baird Retirement Management

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  • How Will Changes in Interest Rates Affect Your Chevron Lump Sum? | Baird Retirement Management

With the Fed manipulation of short-term interest rates, it is important for Chevron employees to understand how changes in rates will affect their lump sum. The lump sum calculation of the Chevron Retirement Plan (CRP) has many moving parts, but this article aims to make sense of them and help you spot patterns in the segment rates that could lead to making a better decision on the timing of retirement.

To understand how changes in rates impact the CRP lump sum, you must first understand the basics of how the lump sum calculation works. The calculation is complex, but focusing on single life annuity amount, segment rates, and applicable interest rate will allow a general understanding of the calculation.  We will then look at the concept that could be called “back-heavy rates” and how this can impact the lump sum.

Your age-65 single life annuity amount is calculated based on your highest-paid years of service and your total years of service. A composite of corporate bond yields known as “segment rates”, discussed below is used in the calculation to project the return expectation. Interest rates do not affect the monthly annuity amount which is determined by the combination of age, years of service and your highest paid years of service, but they do impact the lump sum calculation, which is why rising interest rates are bad for your lump sum, but do not change your monthly annuity payments.

The segment rates are three interest rates calculated from corporate bond yields.  They are published monthly by the IRS and can be found here https://www.irs.gov/retirement-plans/minimum-present-value-segment-rates.  For the purposes of this article, it is not as important to understand where they come from, but how they are used to “discount” or calculate the present value of your lump sum.  Present value is used to figure out how much something in the future is worth today given an assumed rate of return, in this case, your annuity payments.  The capital set aside to fund your annuity payments is expected to earn a return, so the IRS releases the segment rates to allow for a uniform assumed rate of return for pension plans. A lower interest rate benefits someone choosing the lump sum because the return they would receive on their investment would be less, meaning their starting value would need to be higher.  The three segment rates are used to discount three different time periods.  The first rate discounts the first five years of your retirement, the second discounts years 6-20, and the third discounts years 21+.  Life expectancy for a typical retirement age Chevron employee is around 22-27 years.  Therefore, the second segment rate will affect the calculation the most, and the third segment rate the least because the second rate covers most of the calculation and the third covers only years that are further away and much fewer.

The applicable interest rate is which months’ segment rates the CRP lump sum will use for a specific benefit commencement date (BCD), which is the first day of the month that you receive benefits, not the day  you actually retire.  For example, if you retired January 15th, your first available BCD would be February 1st.  The CRP uses the average of the rates from the fifth, fourth, and third months preceding the BCD.  Therefore that February 1st BCD would be calculated using the rates from September, October, and November.

With the basics out of the way, let’s look at a real-life scenario from the past with the rates for a February 1, 2016 BCD.  Below are the actual rates used to calculate the lump sum.

Segment 1

Segment 2

Segment 3

November 2016

1.79

3.8

4.71

October 2016

1.57

3.45

4.39

September 2016

1.47

3.34

4.3

Average

1.61

3.53

4.47

As you see, each consecutive month in the calculation has increased from the previous month.  This white paper will refer to this directional change in interest rates as “back-heavy rates” because the higher interest rates are in the back months of the calculation. It is important to understand the effect of these increasing segment rates as it relates to the lump sum.  If we take a hypothetical retiree with a single-life annuity payment of $7,000 and a 22-year life expectancy and perform a basic present value calculation using the February 1st BCD segment rates, we get a lump sum calculation of about $1.278 million.

If we want to compare the February 1st BCD lump sum to a March 1st BCD lump sum we must consider how these back-heavy rates change the lump sum amounts.  We know that the September rates will no longer be in the calculation and the December rates will replace them for a March 1st BCD.  In order for the average of the segment rates to stay the same, not only must the December rates not rise, they must go down to where the September rates were to keep the average the same as for a February 1st BCD.

We will now look at a hypothetical scenario where the December rates are unchanged from November as seen in the table below.

Segment 1

Segment 2

Segment 3

December Hypo.

1.79

3.8

4.71

November 2016

1.79

3.8

4.71

October 2016

1.57

3.45

4.39

Average

1.72

3.68

4.6

Using these rates, but all the same variables as before, the March 1st lump sum comes out to $1.26 million for a decrease of 1.4% from the $1.278 million in February.  Even if the segment rates were to stay the same for a third consecutive month, you would still see a drop in the lump sum for April because the October rates would fall out of the three-month average.  These examples illustrate how back-heavy rates can erode a lump sum even if rates are not necessarily increasing every month.  The structure of the lump sum calculation creates this wave-like effect of erosion because new segment rates are constantly being added and removed from the three-month average.  On the bright side, a quick spike in interest rates will only make up one-third of the three-month average, but once momentum gets going in one direction, it is hard to stop the lump sum from continually changing.

Front-heavy rates are the opposite of back-heavy where the older rates are higher than the newer rates.  The CRP experienced this in 2020 and it caused the wave-like momentum to be positive for lump sum receivers over that period of time.

There is a saying that one of our retired partners used to use when someone used to ask what the market was going to do: “My crystal ball is a little fuzzy on that one.”  No one knows exactly what is going to happen in any market, and at best, the “experts” are making educated guesses.  This white paper aims to educate a Chevron employee on what possibly could happen if the consensus is correct. We do not want you to plan on your lump sum eroding, but to plan for it.

RB2022-0523

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