Some companies offer their employees defined benefit pension plans. Under these plans, employees are promised a fixed monthly payment after they retire. The federal government regulates some aspects of these plans. A reporter for the Wall Street Journal wrote that under a former employer’s pension plan, she was to receive $423 per month beginning in 14 years, when she turned 65 years old. She received a letter from her former employer offering a one-time payment of $32,088 in exchange for her agreeing not to receive the monthly pension payments.
a. Suppose that the reporter’s former employer expects that the reporter will live to be 85 years old. That means she would receive the pension payments for 20 years. The total amount she would receive would be $423 per month × 12 months per year × 20 years = $101,520. Because the one-time payment her former employer offered her is less than one-third of this amount, is it obvious she should turn down the one-time payment? Briefly explain.
b. The reporter also noted: “Regulations that took effect in 2012 … allow companies to use corporate bond interest rates, rather than the lower ones of Treasury bonds, to calculate the discounted present value of an employee’s future pension.” If employers were still using the Treasury bond interest rate in offering employees one-time payments for giving up their right to a monthly pension, would her former employer’s offer have been more or less than $32,088? Briefly explain.