Does your defined benefit plan have a lump sum option?
Nearly forty percent of U.S. employers who sponsor defined benefit
pension plans are at least "somewhat likely" to offer
lump sums to retirees and vested terminated participants in 2013,
according to an Aon Hewitt survey released earlier this month.
It is safe to say that an even larger group of defined benefit plan
sponsors is considering whether to offer lump sums after hearing
about the lump sum offers implemented by General Motors and Ford
The attraction of these lump sum payouts is that once these
participants have been cashed out, they will no longer be an
obligation of the plan. Therefore, the consideration of lump sum
elections for terminated participants is part of the larger trend
of de-risking pensions and reducing balance sheet liabilities.
That same Aon Hewitt study also indicated that 60% of the
surveyed plan sponsors intend to adjust the plan's investments
to better match liabilities, such as through liability-driven
investing, and 7 percent were somewhat likely to purchase annuities
for terminated participants in 2013, compared with 1 percent in
Why Lump Sums?
Why the difference between the percentage interested in lump sum
options and the percentage interested in annuities? Annuities are
relatively more expensive, because they use lower interest rates
than are used to calculate lump sum values. According to Aon,
annuitization is also more expensive because the insurer uses its
own mortality tables and has a profit margin built in.
What to Keep in Mind
What are some of the considerations plan sponsors need to take
into account in considering whether to add a lump sum option?
A plan must be at least 80 percent funded to offer unlimited
lump sums. IRS funding rules restrict "prohibited
payments", which include lump sums, once the funding
percentage falls below that level.
IRS issued private letter rulings in 2012 clarifying that lump
sums could be offered during a defined window period to
participants who were already receiving pension payments.
Before those rulings, many questioned whether plans could offer
any lump sums to this group, so there is no clear authority for
allowing an ongoing lump sum option to participants who have
already begun their pension payments. Further, private letter
rulings are not binding authority for taxpayers who didn't
receive them. Plan sponsors considering offering a lump sum to
those participants currently being paid should think about whether
to ask for their own private letter ruling.
The communications explaining the lump sum option should be as
clear as possible and take into account current IRS regulations on
explaining the "relative value" of optional forms of
Spousal consent should also be required of married
Since these elections are not easy to understand, plan sponsors
should plan on making special assistance available.
Implementing any lump sum option should be a team effort with
the plan's actuary, legal adviser, accountants and investment
professionals taking part.
A plan amendment will be required to implement any window
period election, and the plan will need to have sufficient cash to
make the lump sum payments. Accounting treatment may depend on the
size of the group offered the lump sum election. No one
professional can deal with all of the ramifications.
Will you defer the decision? Consider the possibility that the
law could change.
Osler will be offering a complimentary webinar, "Managing
Risk in Defined Benefit Plans: What U.S. Sponsors Have Done and
What's Next?", which will focus on the U.S. de-risking
experience, on March 13. I will discuss legal issues and our guest
speaker from Mercer will provide insight into the actuarial and
investment aspects. For further information, please contact Vaughna
MacKenzie, Meetings & Conferences Planner at firstname.lastname@example.org or click
here for the invitation.
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guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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