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Pension Plan Law Change Helps Employers Decrease Their Risk Profile

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Traditional pensions could soon be falling by the wayside with the help of the federal government.

On March 6, the U.S. Treasury Department issued a notice that will allow employers to buy out current retirees from their pensions with a one-time lump sum payment. In doing so, it reversed its 2015 guidance that banned the practice of lump-sum payments after officials determined it shortchanges most seniors.

Drexel law professor Norman Stein, who is also a senior advisor to the Pension Rights Center, said that because of interest rate assumptions, loss of legal protections and insurance of benefits, retirees will lose a significant part of the value of their pension plan by taking a lump sum.

It is worth emphasizing, however, that electing to take a lump sum is optional.

Elliot Dinkin, CEO and president at Cowden Associates Inc., said organizations are increasingly undergoing efforts to decrease their risk profile when it comes to pension plans. One way is that organizations are handing off their pension plan obligations to insurance companies. Another is offering deferred vested participants — those who are previous employees of a company that are still entitled to future benefits — a lump-sum payment for a benefit that’s not payable until sometime in the future.

The law change now grants employers permission to exercise the same practice with current retirees to perhaps further mitigate their financial risk. There are strict Internal Revenue Code guidelines for how the lump sum is calculated, Dinkin said, so plan sponsors can’t manipulate the figure.

“Retirees would be sent a communication with the option to take a lump sum and have a date to respond by,” Dinkin said. “If they don’t respond, then the status quo of monthly payments remains.”

The option of a lump sum might be appealing to some retirees who are confident they could better manage their assets, but there is some risk involved, Dinkin explained. This includes forfeiture of the assurance that, if the pension plan went under, the Pension Benefit Guarantee Corporation (PBGC) would step in and provide relief.

“The risk is changing from a fixed monthly distribution to having to manage a lump sum and with the associated investment risks and mortality risk,” he said. “If I think I’m going to live until I’m 85 and I live until 100, I’m going to be assuming that full mortality risk by managing my lump sum. If I just left it as is, the pension plan assumes that risk forever.” 

Pensions still cover 26.2 million people across 23,400 single-employer plans. However, that number has been shrinking faster than it would naturally as companies close their plans to new hires. WorldatWork’s “2018 Inventory of Total Rewards Programs & Practices” survey found that 39% of employers offered a defined benefit plan. 

“Most of our members still have pensions, but there have been a lot of disincentives for sponsoring pensions,” said Jan Jacobson, senior counsel for retirement policy at the American Benefits Council. “So, we do see plans freezing and some plans terminated, but more of them freezing because of the additional regulations, the increased premiums. They increased considerably over the last few years.”

In its response to the Treasury notice, the Pension Rights Center said participants who take lump sums often have to pay high fees to investment advisors and to mutual funds “who take no responsibility if the market dips and their investments lose value.”

The Pension Rights Center said they will be challenging the “ill-advised” reversal.

“Not everyone agrees with what was done, but it puts plan sponsors in the position to figure out what’s best for their plans and their participants,” Jacobson said. “The notice points out that they’re going to continue to study that issue of retiree lump-sum windows, so this isn’t the final word. Although, they’re not going to issue something under the minimum required distribution regulations.”

About the Author

Brett Christie is a staff writer at WorldatWork.


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