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Administration preparation for lump-sum cashout windows

August 12th, 2015 No comments

Yu-LynnMany plan sponsors have offered lump-sum cashout options to vested terminated participants (VTs) for a specified period of time, or window. While this strategy provides pension risk management opportunities, it is important to note that a large number of administrative tasks are necessary before offering such a window. Some of the key steps include:

• Create a timeline that lists target mailing dates, intermediate due dates, and responsibilities of each party involved in the window project. Set up biweekly or monthly calls to update status of each task.
• Estimate the total lump-sum value for all VTs and select a threshold for the lump-sum cap, if any.
• Identify which VTs are eligible for the window. The plan sponsor may want to exclude VTs with a qualified domestic relations order (QDRO) and alternate payees under a QDRO.
• Amend the plan. The amendment should include definitions for the window period, eligible VTs for the window, lump sum and corresponding annuity calculation basis. The treatment of early retirement subsidies, if any should also be addressed.
• Perform death and address searches.
• Find copies of benefit calculations for eligible VTs. This task will take a lot of effort if the eligible VT population is large. Some calculations may need to be revised or newly prepared and will require the rapid availability of data from the plan administrator.
• Prepare communication package including announcement letter, election packages, reminder postcard, etc.

The plan sponsor should coordinate all tasks with the human resources department, the actuary of the plan, and legal counsel before offering the lump-sum cashout window. Advanced planning along with a flexible timeline will allow for a successful window campaign.

Milliman Hangout: Pension Funding Index, August 2015

August 11th, 2015 No comments

The funded status of the 100 largest corporate defined benefit pension plans worsened by $16 billion during July as measured by the Milliman 100 Pension Funding Index (PFI). The deficit rose to $261 billion primarily due to a decrease in the benchmark corporate bond interest rates used to value pension liabilities. Pension asset gains during July helped to dampen the funded status decrease. The funded ratio declined from 85.5% to 84.8%. This breaks the upward momentum from the second quarter of 2015 where the funded ratio had increased for three consecutive months.

PFI co-author Zorast Wadia discusses the index’s latest results on this Milliman Hangout.

Corporate pension funded status drops by $16 billion in July

August 6th, 2015 No comments

Milliman today released the results of its latest Pension Funding Index, which analyzes the 100 largest U.S. corporate pension plans. In July, these pension plans experienced a $16 billion decrease in funded status based on a $10 billion increase in asset values and a $26 billion increase in pension liabilities. The funded status for these pensions decreased from 85.5% to 84.8.

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We finally saw an interruption to the streak of improving pension funded status in July. Interest rates drove up pension liabilities last month, but fortunately the discount rate remained above four percent. Interest rates remain the big story this year, contributing to a $66 billion decrease in the pension benefit obligation.

Looking forward, under an optimistic forecast with rising interest rates (reaching 4.39% by the end of 2015 and 4.99% by the end of 2016) and asset gains (11.3% annual returns), the funded ratio would climb to 90% by the end of 2015 and 103% by the end of 2016. Under a pessimistic forecast (3.89% discount rate at the end of 2015 and 3.29% by the end of 2016 and 3.3% annual returns), the funded ratio would decline to 82% by the end of 2015 and 74% by the end of 2016.

Will the proposed overtime pay changes affect your retirement plan compensation?

July 30th, 2015 No comments

Smith-SuzanneThe U.S. Department of Labor (DOL) announced a proposed rule on July 6, 2015, that would change who qualifies for overtime pay.

Today, only 8% of salaried workers qualify for overtime pay—those workers who earn less than $23,660. The proposed rule will extend overtime pay to salaried workers who earn less than about $50,440 next year. The proposed change is estimated to cover 4.6 million workers, more than the current regulations.

What does this mean for the retirement plans of employers that will be affected by this proposed rule?

While many employers use gross compensation or total pay for retirement plan purposes, some employers provide retirement benefits only on base pay, excluding additional pay such as overtime, bonuses, or premiums for shift differentials.

Generally, excluding overtime pay for retirement plan purposes is OK if the plan’s definition of compensation passes nondiscrimination testing.

Nondiscrimination testing on compensation is done by comparing the average includable compensation for highly compensated employees (HCEs) to the average includable compensation for non-highly compensated employees (NHCEs). If the HCE average percentage exceeds the NHCE average percentage by more than a de minimis amount, the plan will fail the test. A de minimis amount is generally thought to be no more than 3%, but there is no formal guidance so plan counsel should be involved.

2015 example: Plan excludes overtime pay and bonuses from plan compensation

HCE Average Includable Compensation 95%
NHCE Average Includable Compensation 93%
PASS

Because the HCE average inclusion percentage exceeds the NHCE average inclusion percentage by no more than 3%, the plan passes the test.

But what happens next year if many of the NHCE participants are suddenly eligible for overtime pay? The increase in excludable overtime pay will cause the NHCE inclusion ratio to drop, and the disparity between HCE and NHCE includable compensation will exceed 3%—and thus fail the test.

2016 example: Plan excludes overtime pay and bonuses from plan compensation

HCE Includable Compensation 95%
NHCE Includable Compensation 86%
FAIL

Because the HCE average inclusion percentage exceeds the NHCE average inclusion percentage by more than 3%, the plan fails the test.

Failed testing is never good. More complex testing would have to be done, and the plan may have to take corrective action if the complex testing doesn’t pass.

Employers with salaried workers who would qualify for overtime under the proposed changes will want to check their retirement plan compensation definitions and keep an eye on what happens with the proposed overtime regulations.

Interested parties can submit comments on the proposed rule at www.regulations.gov (RIN: 1235-AA11) on or before September 4, 2015. The DOL is expected to make a final rule next year.

Paying a lump sum to retirees in a lump-sum window? “Not so fast my friend”

July 23rd, 2015 No comments

Herman-TimOn July 9, 2015, the Internal Revenue Service (IRS) announced that the U.S. Department of the Treasury and the IRS intend to amend regulations to prohibit qualified defined benefit plans from paying lump sums to retirees and beneficiaries in a lump-sum window. In Notice 2015-49, the IRS reported that its intent is to have the amendments to regulations apply as of July 9, 2015, except in certain situations described below.

What does this mean?
Many pension plan sponsors have provided a lump-sum window offer to deferred vested participants, and some of these sponsors have included retirees and beneficiaries in the window. After July 9, 2015, plan sponsors will not be permitted to offer lump sums to retirees or beneficiaries in a lump-sum window unless the amendment satisfies one of the exceptions below. However, there is nothing included in the IRS Notice that would preclude offering a lump sums to deferred vested participants.

Exceptions
The amendments to the regulations are intended by the IRS to apply as of July 9, 2015. However, the amendments will not apply to a plan amendment for a lump-sum window in one of the following four situations:

1. If the amendment is adopted or authorized prior to July 9, 2015.
2. An amendment where a private letter ruling or determination letter was issued by the IRS prior to July 9, 2015.
3. Where written communication to participants stating an “explicit and definite intent” to implement a lump-sum window was received by participants prior to July 9, 2015.
4. Adopted pursuant to a collective bargaining agreement between the plan sponsor and a union prior to July 9, 2015.

If the amendment satisfies one of these four exceptions, then a lump-sum payment in lieu of future annuity benefits for retirees and beneficiaries appears to be allowed.

Plan termination
It is not clear whether or not the IRS intends to prohibit defined benefit plans from paying lump sums to retirees and beneficiaries when a pension plan is terminated. This issue will need to be clarified when the amended regulations are published by the IRS.

Observations on regulatory action
Earlier this year, the U.S. Government Accountability Office (GAO) issued a report entitled “Participants need better information when offered lump sums that replace their lifetime benefits,” and the Pension Benefit Guaranty Corporation (PBGC) announced its plans to begin collecting data on pension plan de-risking measures. In a surprising move, IRS Notice 2015-49 was issued on July 9, 2015, with an intended effective date of July 9, 2015. There was little or no indication of pending guidance from the IRS or any indication that the IRS is open to feedback on the notice. This is unlikely to be the last step in the regulation of lump-sum windows.

Please contact a Milliman consultant to discuss how this notice might impact your intentions to offer a lump-sum window.

Corporate pension funded status improves by $36 billion in June

July 9th, 2015 No comments

Milliman today released the results of its latest Pension Funding Index, which analyzes the 100 largest U.S. corporate pension plans. In June, these pension plans experienced a $36 billion increase in funded status based on a $28 billion decrease in asset values and a $64 billion decrease in pension liabilities. The funded status for these pensions increased from 84.1% to 85.6%.

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These pensions cleared an important hurdle this month, with the discount rate that determines pension liabilities climbing above 4% following a seven-month streak of flirting with all-time lows. It’s no coincidence that we’ve seen a related decrease in pension liabilities, with rising discount rates reducing liabilities by $92 billion year-to-date and contributing to a strong quarter for the 100 largest corporate pensions.

Looking forward, under an optimistic forecast with rising interest rates (reaching 4.55% by the end of 2015 and 5.15% by the end of 2016) and asset gains (11.3% annual returns), the funded ratio would climb to 92% by the end of 2015 and 105% by the end of 2016. Under a pessimistic forecast (3.95% discount rate at the end of 2015 and 3.35% by the end of 2016 and 3.3% annual returns), the funded ratio would decline to 82% by the end of 2015 and 74% by the end of 2016.

Five things to consider for a lump-sum sweep

July 8th, 2015 No comments

Sent-StephanieWith changes in the mortality tables pending, along with lower interest rates, many plan sponsors may decide to go ahead with a lump-sum sweep of a defined benefit plan for vested terminated participants. Having helped a number of organizations with their lump-sum sweeps, we can offer a few tips that may make a lump-sum sweep more successful. These five important organizational and administrative items should be taken into account by any plan sponsor conducting a lump-sum sweep for vested terminated participants:

1) Communicate, communicate, communicate. Build lots of communication into lump-sum projects. Lump-sum projects that see the most success are those that include communications, such as a postcard mailing to announce the beginning of the lump-sum window and alert participants to look out for the benefit election packet to come in the mail. Midway through the project, a reminder postcard to those who have not returned benefit election paperwork is helpful to remind participants that the deadline is rapidly approaching. Once a participant returns benefit election paperwork, either a confirmation that it has been received and is complete, or a letter describing what is missing and still needs to be completed, can go out next. When the deadline of the lump-sum project is close, a call to participants with incomplete paperwork is beneficial to get everything completed.

2) Prepare employees to make the right decision. The U.S. Government Accountability Office (GAO) recommends increasing communications. In addition to the typical benefit election information sent to employees, additional communications may be useful, discussing the pros and cons of electing a lump sum, as well as information on how defined benefits are insured through the Pension Benefit Guaranty Corporation (PBGC). This helps explain to employees that they don’t need to take a lump sum because of a belief that their pensions benefits may be going away.

3) Establish a timeline with a grace period following the deadline. Sweeps that enjoy the most success are those that build in a grace period following the cutoff date of the lump-sum window. Inevitably, a large number of elections will arrive on or near the cutoff date. Some forms will be missing either information or proof of age. A grace period allows time to work with the participants who want a lump sum in order to get all of their information completed on time, expediting payout of lump sums (this step also cuts down on denials).

4) Spend time on the design of benefit election forms. Even if your benefit election forms are super clear, reject rates may be higher than expected. Most employees don’t work with these forms every day so they may not understand how to fill them out, given the length and large amounts of information required (often 20+ pages). Add small touches to ease filling them out, such as simple and easy-to-understand instructions and deadline information on each page. Also, be clear about the forms for proof of age that the employee needs to provide.

5) Work with your trustee’s timeline. As the end of the year approaches, be sure to confirm with the trustee that the number of checks can be fully executed before year end, because they will be the ones actually cutting the checks. Note that the values of payouts typically change on the first of the month, so trustees will need enough time to cut and mail the checks before the amounts have to be recalculated and reissued.

To take or not to take, that is the lump-sum window question

June 26th, 2015 No comments

Milliman’s John Ehrhardt was quoted in a recent Wall Street Journal article entitled “Should you take a lump-sum pension offer?” (subscription required). The article highlights one individual’s experience with a former employer’s lump-sum window.

Here’s an excerpt:

One of the simplest ways to evaluate a lump-sum offer is to find out the extent to which the money compensates you for the loss of your pension. I asked New York Life Insurance how much it would cost me today to buy a deferred annuity that will pay me $423 a month, starting in 14 years.

The answer: $45,896, which means my lump sum falls $13,808 short of what I would need to replicate my pension’s guaranteed income with an annuity.

Along the same lines, New York Life says my $32,088 lump sum will buy a monthly income of $296.13 starting at age 65, which is 30% less than my $423 pension benefit.

Of course, I can always invest my lump sum myself. But is it realistic to think that over the next 14 years I will be able to turn my $32,088 into $127,000? That is the amount I would need, starting at age 65, to generate $423 a month using the 4% withdrawal rate that long has been considered a “safe” level of spending over a 30-year retirement.

The answer: probably not, since I will need to earn 10.35% a year, net of investment fees. A portfolio evenly divided between U.S. large-cap stocks and bonds has returned 7.7% a year, on average, since 1926, according to investment-research firm Morningstar.

With a 7.7% annual return, my $32,088 would appreciate to $90,650 by the time I turn 65. Applying the 4% rule yields an initial monthly withdrawal of $302 that, with annual inflation adjustments of 2%, would grow to $423 by the time I am about 82.

…”It’s important to find out whether there are benefits or features that are available to you with the pension that you’d leave on the table if you take the lump sum,” says John Ehrhardt, principal at actuarial consulting firm Milliman.

Every participant’s situation is different. Milliman’s David Benbow offers some perspective in his blog “Lump-sum windows: Too much information?

Longevity plans can benefit employers and employees

June 25th, 2015 No comments

A supplemental defined benefit (DB) longevity plan may be able to reduce pension costs for employers and offer employees an annuitized source of income during their later years in retirement. In their paper “Longevity plans: An answer to the decline of the defined benefit plan,” Milliman consultants Bill Most and Zorast Wadia provide an example of these advantages.

Let’s take a look at a cost example of a 2-percent-of-pay career average plan for a participant hired at age 45 and terminating at age 65. We’ll further assume a starting salary of $60,000 and a 2.5 percent salary scale. This would result in a salary of roughly $106,500 just prior to termination.

The participant’s life annuity benefit commencing at age 75 would be about $31,000 per year. If the participant’s benefit were to be funded over that person’s working career of 20 years, the annual employer cost to fund this benefit would be about 1.8 percent of pay. By comparison, if the participant’s retirement benefit were to commence at age 65 under current Internal Revenue Service rules, the annual employer cost to fund this benefit would be about 2.5 percent of pay.

Thus, by limiting benefit eligibility until age 45 and by not allowing benefits to commence earlier than age 75, the cost of this plan would be relatively low to fund. Using this same example, while extending benefits commencement to age 80, the employer’s cost would be significantly lower at about 1.5 percent of pay.

Having a longevity plan with a simplistic design in which only life annuities can be offered directly addresses the issue of longevity risk… Aside from single life annuities and 75 percent joint and survivor options for married participants, no other types of benefits would be allowed. Lump-sum amounts will presumably be available via a retiree’s defined contribution plan and personal savings.

Collecting an annuity benefit from the supplementary defined benefit plan would not preclude a retiree receiving a lump-sum benefit from the defined contribution plan. It would just make it easier for the retiree to make decisions on how best to manage his or her lump-sum benefit from a withdrawal and consumption perspective; the participant would know exactly when his lifetime annuity benefit would start, no earlier than age 75 in our proposed plan. Early retirement would be restricted from the proposed longevity plan because the concern is for the latter years of retirement and the understanding is that other sources of savings should be enough to get retirees through the initial years of retirement.

IRS guidance on favorable determination letters for individually designed plans expected this summer

June 19th, 2015 No comments

Smith-SuzanneEvery summer we look forward to nice weather, vacations, picnics, and barbecue. And Internal Revenue Service (IRS) guidance.

Yes, this summer we are expecting IRS guidance relating to changes in the determination letter program. The IRS has informally communicated a possible halt, beginning in 2016, to the issuance of IRS determination letters for individually designed retirement plans except for new plans or terminating plans. A formal announcement with details and an opportunity for comment is expected this summer.

Initially, this may sound like a beneficial change for employers because it eliminates a burdensome and costly process that individually designed retirement plans must generally undertake every five years.

But the potential negative impact of such a change is very concerning. While there is no federally regulated requirement to have favorable determination letters for each retirement plan, there are many good reasons for employers to seek them:

Reliance on audit: By having a current determination letter, an employer has assurance that its plan language is tax-qualified. If a plan is audited, the employer can rely on the determination letter to prove the plan’s tax-qualified status.
Approval of amendments to plan: Most plans are amended from time to time to incorporate new laws and optional plan provisions. A determination letter is important to demonstrate that the amended plan language meets the tax-qualified rules.
Due diligence for corporate restructuring transactions: When corporate restructuring transactions such as mergers, acquisitions, or divestitures occur, it is prudent to obtain current determination letters to review the tax qualifications of the plans involved in the transaction.

Without the ability to secure a current determination letter, plan sponsors would not be able to confirm the tax-qualified status of their plans, thereby leaving them unprotected in the event the IRS finds the plan language to be noncompliant during a future audit. Such a finding could result in severe penalties.

Two types of plans that have been considered individually designed and for which an employer would generally seek a favorable determination letter are employee stock ownership plans (ESOPs) and cash balance plans.

Perhaps recognizing that it will be limiting the availability of determination letters for individually designed plans, the IRS has recently released guidance that would expand the preapproved plan document program to include ESOPs and cash balance plans. If an employer uses preapproved language without modifications, an employer would have reliance on the IRS opinion/advisory letter without the need for a favorable determination letter. Thus, employers with individually designed ESOPs and cash balance plans may want to consider converting their plans to preapproved plan documents in the future.

So, as we kick off summer, we are anxiously awaiting IRS guidance on the future of the determination letter program as well as watermelon, fireworks, and pool parties.