Why Optimizing Your BP Pension Comes Down to Timing

After decades of hard work, your retirement is just around the corner. The next few months require thoughtful planning, along with decisions that can affect your long-term financial future. This new chapter is a significant time in your life. You may not have considered why the actual date you choose to retire can be significant, too.

As a BP employee, it’s essential to understand the savings and investment options available to you, as well as the various effects they can have on your pension. The BP Pension Retirement Accumulation Plan (RAP) presents two options: annuity and lump sum payout. In our recent webinar, “How to Balance Your BP Retirement Options, we described these options, as well as why your benefit start date is critical.

A matter of a few months can be all it takes to significantly affect the total pension amount you receive. In this article, we’ll explain how your RAP lump sum is calculated and distributed, so you can select a retirement date that’s strategic and profitable.

 

What data is used to calculate your BP RAP pension?

Your pension is based on your last date of employment and benefit start date. The IRS regularly releases spot segment rates that are used to calculate the RAP lump sum — and have an inverse relationship with a lump sum pension. When interest rates increase, lump sum pension values will decrease, and vice versa.

While other factors are involved in calculating your pension, it’s useful to review recent interest rates to begin to estimate how your lump sum might be affected. How rates are trending could be a definitive — and lucrative — factor in the date you choose to retire.

Note, if you were a participant in the BP RAP before January 1, 2014, your lump sum pension is determined by the segment rates.

 

How does BP calculate the lump sum amount you should receive?

The calculation is fairly complex, but the following charts will give you an idea of the rates used to calculate your BP RAP pension lump sum, and how they can affect the total pension funds available to you.

Once BP employees choose the date they would like their pension to begin, BP refers to the rate from four months prior to calculate the pension disbursement.

For example, if you retired and began taking your pension in March 2021, BP would have used the rates posted for December 2020 (three months before your retirement month).

Segment Rates for March 2021 Retirement from BP

If you plan to retire this April, BP will use the rates posted for January 2021.


Segment Rates for April 2021 Retirement from BP

The segments refer to distinct periods of pension distribution:

  • The first segment rate is used to discount (calculate the present value) the first five years of pension cash flow.
  • The second segment rate is used to discount years six through 20 of pension cash flow.
  • The third segment rate is used to discount years 21+ of pension cash flow.

Together, these rates and terms are used to calculate the lump sum pension value.  

 

Why do these rates matter?

As shown above, making even a slight adjustment in your retirement date, or electing a month with historically lower segment rates, can significantly impact your lump sum pension calculation. These differences could mean choosing to wait longer to retire and begin taking your pension.

Consider this example:

  • Your estimated monthly RAP benefit is $7,000.
  • You retire at 65.
  • The life expectancy BP uses to calculate your pension is age 85.

Below is your estimated lump sum based on the month you choose and using the segment rates listed above. (This does not include the five percent annual crediting to your pension benefit.)

Lump sum in March 2021: $1,405,423*
Lump sum in April 2021: $1,390,244*

What a difference a month can make approximately $15,000!

*Reference example is based on assumed actuarial factors and actual 2020 segment rates. Actuarial Factors for the BP RAP pension will likely vary. Specific illustrations should be obtained from your NetBenefits portal.

 

How can you plan strategically to select the most advantageous pension calculation time frame?

There are various trends you can evaluate to help you plan the best date for your retirement, including reviewing rates published by the Treasury Department.

  • Segment rates correlate with U.S. Treasury rates. When Treasury rates are on the rise, segment rates will increase accordingly. And, as mentioned, rising interest rates mean a lower pension calculation.
  • By looking back over 12 months and reviewing predictions, you may be able to get an idea of which direction rates will head in the future. As an example, if during the past several months, rates have trended upward, pension calculations are negatively affected.
  • Time your retirement date to take advantage of the best rate/pension scenario. The look-back window allows you to set a time that’s most financially appealing to you. For example, if you intend to retire during the summer, you can review rates from March 2021 or April 2021 to determine if and when it’s financially advantageous to retire.

IRS Segment Rates January 2020 to January 2021


What's the outlook on segment rates, and how should you choose your retirement date?

Several factors affect the direction of interest rates, and segment rates in particular. In addition to U.S. Treasury rates, another major influence is the short-term Federal Funds Rate established by the Federal Reserve. 

Back in the spring of 2020, the Fed significantly increased its spending (approximately $2.9 trillion in less than three months) to shield the economy from the devastating chaos caused by COVID-19. After initial efforts didn’t bolster the economy, the Fed announced its intention to continue spending if that's what it takes to get the U.S. economy back on track. As we look to the future beyond the coronavirus, the Fed has also announced its intention to push the average inflation to be about 2% to maximize employment and price stability across the nation as part of its strategy for a post-pandemic economic recovery. Additionally, Federal Reserve Chairman Jerome Powell announced that keeping interest rates low was a part of the same strategy. Segment rates are based off broad market interest rates, which have declined sharply since late 2018 -- whether you’re looking at short-term rates (segment 1) or long-term rates (segment 3).

For many executives at BP, taking their lump sum pension in November could mean a substantially higher payout than if they decide to wait until December or into 2021

We believe rates will remain depressed (as compared against 2019’s rates) for the foreseeable future until we reach the Fed's targeted long-run inflation rate of 2%. In response to hopeful beliefs of an economic recovery, we've seen a temporary uptick in inflation, though the Fed is unlikely to raise rates to abet the increase due to numerous short-term factors causing it. In the first few months following inauguration and announcements of multiple COVID-19 vaccines, we've seen our first big jump in interest rates under the Biden administration. President Biden obtained guarantees from Pfizer to double COVID-19 vaccinations as part of his proposed vaccine rollout which gave many Americans confidence that an economic recovery is on the horizon. This accelerated vaccine rollout comes alongside the possibility of another Coronavirus fiscal relief package which has many giddy at the prospect of returning to normality almost a full year after the initial transition to quarantine.

 The 10-year treasury rate is typically a leading indicator of where segment rates are headed. In the months surrounding the presidential election and following the inauguration, we've seen the 10-year treasury rate continue its upward trend, pushing close to its one-year high of 1.4% as of 2/22/2021. Since the 10-year treasury rates have started climbing upward in recent months, we believe it’s likely for segment rates to begin trending upward in coming months as well.  If this continues, it's likely beneficial to choose a retirement date earlier in 2021 than to wait until the summer and fall months. Remember, segment rates and lump sum pension amounts have an inverse relationship.

Segment rates are lower than we've seen in over a decade, but trends and leading indicators point to an upcoming climb. It’s crucial to be keeping an eye on these rates to determine which retirement date can maximize your lump sum pension amounts.

Making your lump sum election is not your only decision when it comes to retirement planning. There are many factors involved in deciding when to retire and how you elect your benefits. Our expert wealth advisors are experienced in counseling BP professionals and executives. We provide clarity and confidence so you can make the best overall choices for you, your family, and your legacy. Allow us to guide you through your savings and investment options so you’re financially prepared for your retirement.

 

 

Willis Johnson & Associates is a registered investment advisor. Information presented is for educational purposes only. It should not be considered specific investment advice, does not take into consideration your specific situation, and does not intend to make an offer or solicitation for the sale or purchase of any securities or investment strategies. Investments involve risk and are not guaranteed. Be sure to consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed herein. Corporate benefits may change at any point in time. Be sure to consult with human resources and review Summary Plan Description(s) before implementing any strategy discussed herein. Willis Johnson & Associates is not a CPA firm.