How Low Can Interest Go?
By: Marvin Snyder
The Fall 1991 issue of DIVTIPS discussed interest and values of pensions in divorce cases. The first sentence of that issue said that interest rates currently in use by the Pension Benefit Guaranty Corporation (PBGC) are at an all- time low. Now, less than a year later that statement is repeated for a level of interest rates that is lower yet.
The PBGC originally published 21 sets of rates, labeled from A to U. Each set has a primary or immediate interest rate coupled with a structure of lesser internal rates to combine for a composite factor. Set A starts at 6.00%, Set B is 6.25%, Set C is 6.50%, and so on to the final published set, Set U is 11.00%.
As interest rates change, the present value of a pension changes in inverse relationship to the interest rate. The lower the interest rate, the higher the present value; the higher the interest rate, the lower the present value.
In November of 1991, Set D at 6.75% was in use. That was thought to be a low interest rate at that time, and it resulted in higher values than at prior times when interest rates were higher. That's right: when the interest rate was higher the value was lower.
PBGC has announced for the month of August 1992 that set A at 6.00% will be in use. This, so far, is absolutely the all-time low in such interest rates. It happens to be a coincidence that the prime rate now is also at 6.00%.
What does this mean in terms of the present value of a typical pension? Take the example of a male aged 45 with retirement age 65 who has an accrued monthly pension benefit of $1,000 (or $12,000 of annual pension). Using the August 1992 PBGC Set A rates, the current present value in this example is $36,900. In November of 1991 it would have been $31,500. The $5,400 increase in the value is due solely to interest rates.
The following table shows how the values of the pension in this example would vary by the date of valuation using the then existing PBGC rates.
So, what is the present value of a monthly pension of $1,000 payable at age 65 for a man now aged 45? It depends on when the valuation is done. If the question had been asked in January or February of 1991, the answer would have been $28,400. If the question had been asked in July 1992, the answer would have been $35,000. If the question is asked in August 1992, the answer is $36,900.
This variation does not make a valuation unreliable. On the contrary it makes sure that a valuation is timely, so that it fairly represents the worth of the pension as a marital asset available for consideration as property in equitable distribution.
Marvin Snyder is the author of Value of Pensions in Divorce. Second Edition 1992 available from Wiley Law Publications by calling (800) 225-5945.