Last Month's Rate Spike Could Be This Year's Biggest Pension Opportunity

In April, we wrote about how interest rate volatility can create real opportunities for pension plan sponsors, and specifically how the gap between lump sum calculation rates and accounting liabilities can generate meaningful arbitrage. That opportunity is no longer hypothetical. 

Rates climbed 35 basis points from late April through May 18, briefly pushing the 30-year Treasury to 5.197%, its highest level in roughly 18 years. You have to go back to the months before the 2007 financial crisis to find a comparable print. The move was driven largely by inflation fears tied to the ongoing conflict with Iran. Since that peak, rates have pulled back 21 basis points. If you read our April post, you know exactly why that sequence matters.

As we explained then, lump sums use IRS segment rates that are set in advance with a lookback period and stability rules. Those rates stay locked in during the window. Accounting liabilities use current market rates at the measurement date. That difference is the whole ballgame. Sponsors who open a lump sum window now may be able to settle obligations using segment rates that were set when yields were closer to that 18-year high, while their accounting liability reflects the lower rates that have followed since.

We walked through this in detail in April using the 2023 to 2024 cycle as the clearest example we have seen in recent memory. Rates peaked in October 2023 and then fell more than 100 basis points by September 2024. Sponsors who moved during that window settled at the higher locked-in segment rates even as their accounting liabilities were growing with the rate decline. The current move is smaller, but the mechanics are exactly the same.

There is also a scenario worth keeping an eye on. If a resolution to the conflict with Iran reduces energy price pressure, inflation expectations could ease and rates could decline further from here. As we noted, that kind of reversal is precisely what widens the gap between locked-in segment rates and accounting liabilities. Sponsors who are already set up to move would be in a strong position to capture that.

A question we have been getting: how do you actually lock these rates in?

This is where the technical design of the window matters, and the good news is that sponsors have more control here than many realize.

As long as lump sums are not already an available form of payment under the plan, a lump sum window is added through a plan amendment as a new form of payment. Because it is being written into the plan fresh, the sponsor gets to specify both the stability period and the lookback period at the time of the amendment. Those elections determine which IRS 417(e) segment rates will be used to calculate participant lump sum values.

For a plan targeting a Q3 or Q4 distribution window, the plan selects a quarterly stability period and elects a lookback period of up to 5 months. Under that structure, either window could access May 417(e) segment rates. The IRS publishes monthly 417(e) segment rates with a short lag, so May rates will be available in mid-June. Given that the 30-year Treasury averaged near its 18-year high throughout much of May, those segment rates are likely to be among the highest monthly averages in nearly two decades.

One nuance worth understanding is that an existing lump sum provision does not eliminate this opportunity. Many plans already provide lump sums in limited situations, such as through a mandatory cash-out provision for benefits below $7,000. A plan can be amended to adopt a new stability period and lookback period for a future lump sum window. Participants already eligible for a lump sum remain protected and receive the greater of the benefit determined under the old basis or the new basis, while the newly elected rates apply to participants becoming eligible under the window. As a result, plans that already contain a lump sum provision may still be able to capture the same arbitrage opportunity.

We said it in April and it is worth repeating: the sponsors who benefit most from these windows are the ones who are already prepared. If rates continue to fall from here, the arbitrage only widens. But the window will not wait.

Want to walk through whether your plan can be structured to capture this? Let's talk.