(MEP) Reducing retirement plan risk with lump-sum payouts

Game changers are events, ideas, inventions, or factors that have profound effects on the status quo. In the retirement plan arena, the Pension Protection Act of 2006 was a game changer for defined benefits plan sponsors. The PPA altered the way in which the value of lump-sum offerings was calculated, making lump-sum payouts a more attractive solution for plan sponsors seeking ways to reduce the risks associated with their DB plans.

Before the PPA passed, plan sponsors were required to calculate lump-sum amounts using a 30-year Treasury-rate basis. This often made lump-sum payouts expensive relative to funding or accounting liabilities. When the PPA passed, a corporate-bond basis could be used, which improved the viability these payouts.

Since the change in basis was fully phased in during 2012, some DB plan sponsors have begun to reduce plan risk by making lump-sum payouts available to select participants and/or retirees. Others, who were limited by issues like plan funding ratios, developed de-risking plans that included lump-sum options. Of the 400 or so plans that participated in a recent study by Aon Hewitt, more than two-thirds have offered lump-sums or plan to do so soon.

• 12 percent have completed a lump-sum offering
• 13 percent have permanently offer lump-sums to participants
• 43 percent are very or somewhat likely to offer a lump-sum option during 2014

Lump-sum offerings provide clear advantages to some plan sponsors. They can be a less costly choice when compared to other risk management strategies. A senior retirement consultant with Towers Watson explained it like this:

“…Lump sums can also be viewed as a fixed income investment that’s superior to anything the investment market offers. The lump sum investment strategy offers AA rates, with zero risk, and eliminates operating costs. In contrast, market bonds either pay Treasury yields or carry default/downgrade risk, without providing the additional benefit of lowering such operational costs as the ever-increasing Pension Benefit Guarantee Corporation premiums.”

When deciding whether to offer a lump-sum option, plan sponsors should carefully consider interest rates, potential changes in pension expenses, settlement accounting impacts, and other factors. A lump-sum strategy can be a valuable tool if the plan sponsor’s objective is to reduce the size of its pension obligation. It is also important for the lump-sum strategy to align with a firm’s overall financial and human resources strategies.

Since lump-sum payments are rarely available through traditional DB plans, the opportunity to receive one may be attractive to plan participants. A lump-sum offering confers control of assets to the participant or retiree who can then invest, access, and distribute the assets as he or she chooses. On the other hand, if participants do not manage their pension money effectively, the assets may not provide income throughout their retirements. It’s also important that participants and retirees who are offered this option understand that there may be tax implications when a lump-sum is taken.

Successfully implementing any de-risking strategy requires careful planning and thoughtful execution. Plan sponsors should be certain they understand and can address the challenges that often accompany the implementation of a de-risking solution, such as having accurate plan participant data.

Source: Employee Benefit News