Lump Sum Offerings Lead De-Risking Efforts

Terry Dunne, managing director for the Millennium Trust Rollover Solutions Group, tells PLANADVISER that an unprecedented number of lump sum payouts have been offered by corporate pension plans in recent years. Dunne’s firm explores the trend in a new whitepaper, “Managing Risk and Opportunity: Trends and Challenges in Defined Benefit Plans,” and finds several causes for the popularity of lump sum payouts.

One cause is the final stages of implementation of the Pension Protection Act of 2006, which in 2012 changed the basis for calculating lump sum offerings to be more favorable to employers. Additionally, the Moving Ahead for Progress in the 21st Century Act (MAP-21) recently created a floor for the discount rate used to value plan liabilities, which had the effect of lowering what many plans must pay to participants when doing a lump sum settlement.

Those factors, along with increasing per-participant insurance premiums assessed by the Pension Benefit Guaranty Corporation (PBGC), have made lump sum offerings especially attractive to corporate employers, Dunne says (see “Premium Hikes Shake Up Buyout Landscape”). Citing a Towers Watson study, the Millenium Trust report finds nearly six in 10 corporate plans have offered or plan to offer a lump sum benefit payout to some or all participants. And among those plans that offer a lump sum, acceptance rates by eligible participants often exceeds 60%.

In general, a lump sum offering can help sponsors of defined benefit (DB) plans reduce risk by decreasing the assets and liabilities in their plans—which in turn means lower operational costs and less financial risk to the sponsoring organization.

Dunne points out there may be both favorable and unfavorable tax implications for participants in accepting lump sum offerings, so it's not a fit for every plan or participant. And while it’s usually a somewhat simpler operation than engaging with an insurance company to annuitize pension liabilities, offering a special lump sum distribution to participants still requires careful consideration on the part of plan sponsors and advisers to ensure all the stipulations spelled out in plan documents and applicable regulations are met.  

Many companies using lump sum distributions turn to automatic IRA rollovers to transfer participants who can’t be located or who are non-responsive. Dunne says there are many firms, including his own company, which can deliver strong service in this area and prevent many sponsor and adviser headaches.

“We’ve found that there are going to be people that are missing or just don’t respond during the process,” he says. As long as the balance for lost participants is under $5000, Dunne says sponsors can usually roll those assets over into an IRA. "That’s actually how we became interested in this whole conversation in the first place—by getting involved at the tail end of these operations at major corporations, trying to find the lost participants.”

“One of the considerations for employers is that, you want to do something that meets the requirements of the plan documents and the law, but is also attractive to participants,” Dunne says. “We’ve found that many participants see the lump sum option as very attractive.”

Dunne says participants simply like the idea of controlling their own retirement savings, despite the fact that it means they will have to take charge of asset allocation decisions and all the other intricacies of retirement planning. Participants also like the idea of being able to pass on their retirement savings should they die earlier than expected, he says.

“They want to know that, if they were to die in four months, a lot of that money will be left to be passed on to a spouse or family, rather than just going to the insurance company,” Dunne says. “Participants know that an annuity is gone when you and your spouse are gone, but a lump sum allows you to hold the assets. You can use that money as an estate gift or whatever. There’s a lot of interest here from the participants.”

Dunne is quick to acknowledge the library of industry research suggesting the opposite approach may be the best—that when given control of their retirement savings, large numbers of workers don’t make informed decisions and may even harm their retirement readiness. Dunne says DB sponsors should consider these dangers when doing a lump sum payout.

“The obvious other side of that coin, and a wider question for the industry and America, is what happens if the individual gets their hands on that money too early or they invest it poorly?” Dunne says. “That’s the wider problem we’re seeing today. Individuals by and large just don’t have enough to save well enough for their own retirement.”

Dunne says it should only be a matter of time before the other options that exist for corporations to offload pension liabilities gain as much traction as the lump sum distribution—especially buyouts from insurance companies.

“The biggest reason there is just the market,” Dunne explains. “The investment markets have just picked up so much in 2012 and then again in 2013. That means the asset levels within these plans are much higher than they have been in recent years, so plan sponsors really have the opportunity to do a buyout simply because they have the assets again.”

But even with strong market improvements over the last few years, most corporations are still in a holding pattern on pension buyouts, Dunne says.

“I think that a lot of organizations are still waiting to see how the frontrunners are doing,” Dunne says. “They go to conferences, they meet people and they talk about it, but they're still waiting. Given the market conditions and the rising interest rate environment, I would imagine that within the next few years, many of the major corporations will be taking some action. That’s clearly what our study and other studies show. Almost all organizations that you poll say they are committed to do something within the next couple years.”

The report stresses that appropriate strategies for de-risking will depend on the current financial environment and relevant discount rates, as well as the plan’s objectives, funded status, and the size of the obligations. Having accurate participant census data is critical, the report explains, especially if a plan sponsor has decided to pursue more substantial settlement activities.

Information about how to obtain a copy of the Millennium Trust study on trends and challenges for DB plans is available here.