In the first part of this series, I shared how a career in finance involves much more than numbers. Did you know that in addition to that, training in finance has benefits way beyond your career. In Part II, I’d like to give you a recent real-life example of how I used my MS degree to my financial benefit.
AN UNEXPECTED WINDFALL … OR JUST HOT AIR?
I received a letter from a former employer a couple of weeks ago. It began:
“Congratulations! As a term-vested former employee you are eligible to participate in a voluntary one-time program, allowing you to receive the value of your vested pension right away”.
My initial reaction was whoever drafted this must be the same person who writes those emails I receive about my Nigerian inheritance. My next reaction was: Should I be happy to be term-vested? What does that actually mean? As I read through the accompanying material, I found that I had three options:
- Keep what I had (a monthly pension payment for life, beginning at age 65).
- Take a monthly pension beginning now at about 60 percent of the value of that first option.
- Take a lump sum payout now.
What to do? What is the best choice?
DEATH AND TAXES
Almost immediately, my finance side kicked in, and I was curious about the assumptions they made to calculate the lump sum. The monthly annuity payments were based on a formula of earnings and time served. But that lump sum — where did that come from? On page 16 of the letter, I found this gem:
“Your lump sum was calculated using the following assumptions, which meet the requirements of federal law: Interest rates: 1.24% for benefit payments occurring within 5 years, 3.86% for payments occurring the subsequent 15 years, and 4.96% for payments occurring more than 20 years in the future.
Mortality is dictated by federal government regulations. “
So, the calculations and my mortality are established by federal laws — what could be wrong with that?!? OK, sarcasm aside, I now knew their assumptions. My finance experience — or possibly yours if you had a Master of Science in Finance — would help you understand the choice of what to do is based on three factors:
- My rate of return assumptions
- My mortality assumptions
- Income taxation
Simply, if I think I can get a better rate of return than their assumptions and live shorter than their assumptions — I should take the lump sum. However, if I believe the opposite then I should keep my pension beginning at age 65. By the way, taking the monthly pension now is tempting but a really bad idea. Taxes will be due when the money hits my hands on top of penalties if it hits my hands before age 59½. But I can defer taxation by rolling the lump sum into a tax deferred option such as an IRA.
CALCULATING THE BEST RETURN
I broke out my HP 10Bii financial calculator and found my best option was to take the lump sum and roll it into my IRA. The paperwork is in the mail.
And I found out that term-vested means an employee who is terminated, a former employee, and is vested in their pension plan.
Trust me, in this case, being both terminated and vested is a good thing.
Johnson & Wales University offers an online Master of Science in Finance degree and a Master of Business Administration in Finance. For more information, complete the "Request Info" form on this page or call 855-JWU-1881.