How 417(e) Segment Rates Affect Your Pension Payout

Many individuals with a traditional defined benefit pension plan face a choice upon retirement: receive a steady stream of monthly payments for life, known as an annuity, or take a single, large lump-sum payment. The calculation for this lump sum is strictly governed by the Internal Revenue Service to ensure consistency across all plans.

The specific interest rates used for this purpose are known as the 417(e) segment rates. These rates are used in the formula that translates a future stream of pension income into a current lump-sum value. Understanding how these rates work is important, as their fluctuations can substantially alter the amount of money you receive.

The Minimum Present Value Calculation

The 417(e) rates exist to establish a standardized method for calculating a pension lump sum. This method is centered on the financial principle of “present value,” which recognizes that money promised in the future is worth less than money held today. This is because money on hand can be invested to earn interest.

To determine a lump-sum payout, a pension plan must calculate the present value of all future monthly annuity payments an individual is entitled to receive. This calculation requires a “discount rate” to translate future payments into today’s dollars. Internal Revenue Code Section 417(e) mandates the use of specific segment rates as these discount rates, which creates a “minimum present value,” or the lowest lump sum a plan can legally offer.

The use of these prescribed rates and a specific mortality table from the IRS ensures the conversion is performed consistently for all participants. This framework was solidified by the Pension Protection Act of 2006, which replaced the previously used 30-year Treasury rate with the current segment rate system to better reflect market conditions. The calculation projects the promised monthly benefit over a person’s lifespan, discounts each payment using the segment rates, and the sum of these discounted payments equals the minimum lump sum.

Understanding the Three Segments

The term “segment rates” means the calculation does not use a single interest rate. Instead, the IRS provides three distinct rates, and each applies to a different period in which your pension payments are expected to be made. This approach allows the calculation to better reflect that the value of money can differ over short, medium, and long durations.

The first segment rate applies to payments expected to be received within the first five years of retirement. This short-term rate is used to discount the value of pension payments scheduled from month one through month 60.

The second segment rate covers the intermediate term. This rate discounts all pension payments scheduled to be paid out from year six through year 20. This period represents a large portion of many retirees’ payment streams, making this rate a significant factor.

Finally, the third segment rate applies to all payments expected more than 20 years in the future. For a younger retiree with a long life expectancy, this long-term rate can have a substantial impact on the total present value of their pension.

How Rate Fluctuations Affect Payouts

The segment rates have an inverse relationship with your payout: when the 417(e) segment rates increase, the value of a lump-sum payout decreases. Conversely, when the segment rates fall, the resulting lump-sum offer will be higher. This occurs because a higher discount rate more heavily reduces the value of future payments.

Consider a retiree entitled to a $3,000 per month pension. If the blended segment rates used for the calculation are low, around 3.0%, the total lump sum might be calculated at approximately $650,000. However, if rates were to rise to 5.0%, that same monthly pension could result in a lump sum of only about $540,000. This demonstrates the financial consequence that interest rate movements can have on a retirement decision.

A detail for retirees to understand is that plans do not use the current month’s interest rates to calculate a payout. Instead, plan documents specify a “stability period” and a “lookback month.” The stability period is the timeframe during which a single set of rates is used for all calculations, often the full plan year.

The “lookback month” is the specific month from which the rates are pulled to be used for the entire stability period. For example, a plan might specify that rates published in November of the prior year will be used for all lump-sum calculations for the following year. This means someone retiring in March and someone in October of the same year would have their lump sum calculated using the exact same rates, providing predictability.

Locating and Interpreting the Rates

The IRS publishes the official 417(e) segment rates monthly, and the data is publicly accessible on the IRS website. You can find this information by searching for “Minimum Present Value Segment Rates.” The rates are released in a formal document called a Revenue Ruling, typically issued around the third week of each month.

On the website, you will find links to each Revenue Ruling, which is identified by a number format such as “Revenue Ruling 2024-XX.” To find the rates for a specific month, you locate the ruling for that month. Inside the document, a table explicitly titled “Minimum Present Value Segment Rates” lists the rates for Segment 1, Segment 2, and Segment 3.