Pension Lump Sum Windows: Are they right for you?

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Need help? We’re hosting an information webinar on September 25, 2014. For details, and to register to attend (or, if you can’t attend, to view it on demand), click here.

Defined benefit plan sponsors have been considering and implementing de-risking investment strategies in the wake of interest rate and market turbulence over the last 20 years. As plans begin to return to being fully funded again, you may want to consider permanent risk transfer options including administrative and design alternatives.

Very recently, interest in one such option has escalated – offering terminated vested participants a payout through lump sum windows. Over the past two years especially, a substantial number of companies have done just that. Since 2012, the regulatory IRS interest rate used to calculate lump sums has been phased in from the old 30-year Treasury basis to a high-quality corporate bond basis. The phased-in interest rates are considerably higher than the old basis, making lump sum values historically closer than ever to the accounting liability basis.

Opportunity to Eliminate Costs, Improve Flexibility
This presents some interesting opportunities for you to transfer risks out of pension plans without incurring the same level of liability losses as would have happened in the past. And there are other potential benefits. You’ll eliminate the administrative costs and PBGC premiums associated with those who take these lump sum distributions. And because a lump sum option can be a new provision in some pension plans, you’ll be giving terminated vested participants the flexibility to take the value of their pension and invest it immediately.

Many sponsors expect to provide a Terminated Vested Lump Sum Window in 2015, for several reasons.

  • Funded status improvement – Equity markets rebounded in 2013, and (in spite of some fluctuation earlier this year) pension funding ratios have generally improved. That may have triggered an increase in fixed income allocation or a hedging portfolio based on some glide path strategies. For some plans, that increase may have removed funding restrictions that limit the ability to settle liabilities by paying lump sums or buying annuities. Continued improvement in funded status into 2015 could move companies closer to considering risk transfer options.
  • Plan wind down glide path – Sponsors of closed and frozen pension plans will be considering eventual plan termination and other wind up activities. If you’re in this situation, paying lump sums might very well be considerably less costly than purchasing group annuity contracts to settle pension liabilities.
  • Higher PBGC premiums – Congress has increased PBGC premiums again. The base premium is $49 per plan participant with automatic increases to $57 next year and to $64 in 2016. Sponsors with underfunded plans pay additional risk premiums of $14 per $1,000 of plan underfunding (up from $9 in 2013). That will jump to $24 next year and $29 in 2016.
  • Updated mortality tables Potential mandated use of updated mortality tables that reflect longer life expectancies will translate into increased retirement plan contribution obligations for employers, larger liability values for accounting statements, and larger lump sum payments.
  • Administrative costs – If your administration is outsourced you’re paying costs on a per participant basis. It makes sense that reducing participant counts can lead to direct cash savings. Even if you self-administer, the reduction in participant counts will lead to internal cost savings and the freeing up of resources to concentrate more on core business needs.

A Good Time to Get Ready
To prepare for a Terminated Vested lump sum window, and to meet ERISA obligations, as a plan administrator you should:

  • Design an effective window program with the goal of maximizing the number of terminated vested participants who elect a lump sum.
  • Perform a cost/benefit analysis. Substantial savings and the movement towards derisking are valuable positives, but there are potential adverse results: settlement accounting costs, reduction in funding ratios, and elimination of asset arbitrage gains for example.
  • Store legacy data electronically in a searchable format.
  • Find missing participants and identifying deceased participants.
  • Validate accrued benefits if final calculations have not been performed.
  • Determine the expected timeframe and cost for completing individual benefit certifications for affected participants and available resources.
  • Establish the administrative process for a cashout window.
  • Develop a participant communications strategy (keeping in mind that the option isn’t easy to understand, and spousal consent is required for married members).
  • Request pro forma funding and accounting costs from the plan’s actuary.
  • Identify specific plan document changes that will be needed to allow the lump sum window.
  • Communicate with senior management about the realistic timeframe for completing various tasks (they might have an expectation that is shorter than actually needed).

Need help?
To help you untangle all the legal and administrative requirements surrounding the offer of a Terminated Vested lump sum window, we’re hosting an information webinar on September 25, 2014. For details, and to register to attend (or, if you can’t attend, to view it on demand), click here. Thomas Mosher and Philip Parker

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