Tag Archives: Bart Pushaw

Planning key to avoiding pension termination data pitfalls

Pushaw-Bart“Data! Data! Data!” Sherlock Holmes cries impatiently in a story by Sir Arthur Conan Doyle. “I can’t make bricks without clay!” Nothing could be truer, especially when it comes to a pension plan termination. However, this might easily be forgotten in the preparation process.

Plan sponsors can get bogged down with all the actuarial numbers, all the cash and accounting charges, all the corporate approvals, all the regulations. It’s a lot. Yet a pension plan and its termination remain at the mercy of the data. And there is a lot of data because there are a lot of participants. And properly dealing with it is a lot of detailed work.

First, plan sponsors will need to calculate final benefit amounts. Second, they will need to get this information into the hands of the participants—each and every one of them. Third, they’ll need participants to return completed election forms. And fourth, they’ll need to deliver the benefits to participants in either a lump sum (rollover) or annuity certificate. This may sound easy, but don’t count on it. These steps will not be successful without good data. When determining if your data is up to snuff, consider these factors.

At first blush, management might simply think of plan participants as current employees. However, former employees who retain a vested benefit in the plan and former employees who are retired and receiving monthly pension checks, are also plan participants. While active employee and retiree data is most likely current and accurate, the same may not be true for former employees.

Benefit calculations
To calculate benefits, plan sponsors need final, complete, and accurate data. We’re talking data going back maybe 30 to 40 years; that’s before desktop computers, back when file cabinets were filled with index cards containing employment history. Consider these questions:

• How complete and accurate are your files?
• Do you have historical information on groups that came in via corporate acquisitions?
• Do you have applicable prior plan documents?
• Is the data in an electronic format?
• Can you verify benefit distributions that might have been made many years ago?
• Can you verify the details of benefit calculations that were prepared many years ago for former employees or for when benefit accruals were frozen for current employees?

Finally, take a look at the location of your people. Where are they—and can you find them? Think about things like name changes, cross-country relocations, divorces, deaths. Ask yourself:

• Do you have current mailing addresses? How do you know?
• How many missing people can you locate? How do you do that?
• If a former employee died, do you know if there is a surviving spouse who is due a benefit?

Once the decision is agreed upon, the work falls on plan committees and assigned staff. One large job, the single largest probably, is dealing with the plan participant data. So it’s important to understand and assess data issues early with assistance from your actuary or pension plan administrator.

The big bang theory and pension plan terminations

Pushaw-BartNuclear fission1 and pension plan termination. You’d be surprised at how much they have in common. In other words, left alone, fissionable material decays on its own, eventually distributing its last. On the other hand, with a little help, it can go away in one very big bang. It’s the same result in the end. Pension plans behave the same way. Left alone, they pay out monthly benefits along with lump sums, eventually distributing their final payments. The big bang version for a pension plan is a total termination. In either case, the result in the end is the same.

For a pension plan, these are the two extremes. Between these extremes is a continuum along the termination spectrum, which is controlled by the plan sponsor. We can accelerate the plan’s normal, slow rate of decay up to and including a big bang, total termination. This slower decay we ought to refer to as a termination, too, just not the big one, total termination. Today, such fractional terminations are popularly referred to as de-risking. Nothing new, mind you, just an updated moniker. Of course, with enough fractional terminations, we end up with a total termination just the same.

One type of fractional termination is a lump-sum window or cash-out initiative. Lump-sum windows usually refer to a plan which is offering lump-sum distributions to a vested group of former employees who otherwise would not have access to their benefits until retirement. The window of opportunity usually exists for a few months, then closes. Cash-out initiatives are slightly different in that the former employees already have access to a lump sum distribution but now are getting a friendly reminder. After declining the original offer, their lump sum may have grown and is perhaps now a bit more desirable. Both types of project can be regulated toward a manageable administrative size or with an eye toward avoiding unwanted accounting repercussions. Target groups are made up of those former employees who retain a vested benefit under the plan. Retirees in pay status are off limits. These groups may require administrative sleuthing if mailing address information is out of date.

Another type of fractional termination is off-loading plan obligations to an insurance company through the purchase of an annuity. This is the principal means of removing retirees from the plan. Carriers may want the business enough to drive the purchase price of the annuity down sufficiently to make the opportunity very attractive to a sponsor. These annuity placements may also be sized to fit the sponsor’s financial needs.

This leaves us with those plan participants who are still employed by the sponsor, which brings us back to the big bang total termination. We need to be a little clearer about this. A total termination is a big bang because you can distribute lump sums and place annuities for everyone left in the plan all at once. It also requires a high level of rigor as it falls under focused scrutiny by the U.S. Department of Labor, the Internal Revenue Service (IRS), and the Pension Benefit Guaranty Corporation (PBGC). A big bang total termination is just a whole bunch of fractional terminations bundled up to occur all at once under a formal regulatory framework.

Nuclear fission can happen bit by bit over time or can be speeded up with sudden and dramatic results. Working a series of fractional terminations, perhaps leading up to a total termination, allows greater flexibility of timing and financial control for a plan sponsor.

1If your physics is a little rusty, nuclear fission is “the splitting of an atomic nucleus into approximately equal parts, either spontaneously or as a result of the impact of a particle usually with an associated release of energy. Collins English Dictionary, 12th ed. (2014). “Nuclear fission.” Retrieved January 18, 2016, from http://www.thefreedictionary.com/nuclear+fission.

Weighing income options can prepare individuals for retirement

Pushaw-BartPension plans are providing an ever-decreasing portion of retirement wealth as wave after wave of Baby Boomers reach retirement. In and of itself, this is neither surprising nor remarkable. What is remarkable, though, are two typical characteristics of what we are being left with regarding retirement wealth.

First, the jettison of pension plans means relying on defined contribution plans as the provider of principal retirement wealth. This is suboptimal inasmuch as these plans are typically 401(k) savings plans, originally introduced as a sideline fringe benefit scaled for purposes less than what they’re now required to deliver on. This is mostly a benefit-level issue of which we have seen recent hints of amelioration—namely, the industry recognizing that in an all-account-based retirement world, saving 16% of annual pay is in the ballpark, not the historical mode of 6% employee deferral (plus maybe 6% employer match totaling 12%). This relates to the second endangered characteristic, which needs to be brought into brighter focus: an in-plan solution for generating guaranteed retirement income.

Pension plans are wonderful for participants in that everyone is automatically a participant, automatically earning benefits on a meaningful trajectory, and automatically having the ultimate retirement wealth delivered on a lifetime guaranteed basis. Yes, 401(k) plans are trending this way on the first two, and the third is quickly emerging as another area where we need more pension-like alternatives.

One may generalize by saying that retirees take their 401(k) balances and roll them over when they retire. An economic conundrum baffling academics is that none or very few of these folks take advantage of insured annuities even in the midst of robust studies identifying them as an optimal solution for retirement income in face of investment uncertainty and longevity risks. This raises two subtle yet important points.

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Preparing for a pension plan termination

A plan sponsor’s decision to terminate a defined benefit pension plan requires significant due diligence and research. This Milliman paper, authored by actuary Bart Pushaw, addresses several items a plan sponsor should consider, including the difference between a freeze and a termination, types of terminations, the path to termination, and the termination process. Figure 5 below highlights the process of terminating a pension plan.

Terminating pensions

Cash balance plans: Why they may be a good opportunity for business owners, professionals, and executives

Pushaw-BartNew opportunities for owners and key staff to save for retirement on a tax-favored basis bring with them popularity and value. For this reason, a cash balance plan may be worth considering.

Owners and professionals
Cash balance plans have the potential to substantially provide for solid retirement security and shelter greater income from taxation to increase retirement wealth. These programs will not fit each and every owner’s situation, but a range of programs has been used to meet significant needs and concerns.

The typical case is one where the organization already contributes to an all-employee profit sharing or 401(k) plan. Oftentimes the program can be modified with a cash balance plan, extending it for owners who can then annually contribute amounts in excess of the profit-sharing-only maximum of $51,000. Additional annual tax-deferring contributions can range up toward $250,000.

The details of the programs can be worked out with advisors to custom fit most financial situations.

Executives at large corporations
The opportunities mentioned above are even better for corporate executives wishing to enhance their retirement wealth and financial security as well. Large corporations often sponsor nonqualified Supplemental Executive Retirements Plans (SERPs) for key management. Cash balance programs allow vastly stronger security arrangements, moving these benefits from the nonqualified arena to qualified status.

Adopting a cash balance plan could further strengthen the retirement promise, allowing monies to be put into trust for the sole benefit of the executives. No insurance contracts or long-term commitment would be needed. Investments would be controlled by management and allow access to institutional pricing of funds.

Again, every situation is different, but for executives, owners, and professionals the incorporation of a cash balance plan may be a great asset in the ongoing effort to secure a well-funded retirement.

Pension accounting conjectures

From far away, we conjectured that the headline-grabbing stories about companies moving to “mark to market” pension accounting that occurred in the past 18 months were woefully incomplete in key details. At that time, the stories talked about changes companies made to their Financial Accounting Standards Board (FASB) financial reporting under Accounting Standards Codification (ASC) Topic 715. These changes, for the most part, meant that the annual gains and losses that plans experienced because of interest rate declines and poor equity returns would hit earnings immediately rather than be deferred. This was resulting in some pretty big numbers. Part of our conjecture was that these companies were first-movers in adopting what some believed were going to be mandates once international accounting standards became the rule.

Furthermore, our numero uno on the conjecture list of why they were doing this was that they would implement an investment approach based on liability-driven investing (LDI) to protect against those nasty interest rate and market declines, with their resulting losses. When we saw repeat headlines about some of those same companies again taking massive hits to earnings because of their pension accounting, I was dumbfounded. I hate being wrong but admit I was.

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The question of portability (part 2)

I recently wrote, in The question of portability (part 1), about how portable defined contribution (DC) retirement plans, such as the 401(k), aren’t always the best option for employees. Now let’s look at how the urge to create a portable benefit by converting to a 401(k) may not necessarily always be working in the best interests of employers.

The chicken or the portable nest egg

Since the idea of portability entered the retirement plan arena, academics have looked closely at the question of employee mobility. One study stated the question very directly: Which came first—mobile employees or plans that encouraged employee mobility? Did the plans altruistically provide a solution to a changing demographic, or did the mobility solution actually open a door to problematic mobile employees?

The research indicated that employee mobility picked up only after 401(k) plans became widespread. Aside from the business reasons for retaining good employees, the portable 401(k) also raises questions about unintended consequences for the plan itself.

Spreading the wealth

More monies tend to be accumulated by the young and recently hired employees in 401(k) plans than in pension plans. This is balanced out in later careers as long-service employees eventually tend to receive more annually from pension plans compared to 401(k) plans.

The irony for some employers is that even if a career-average structure is adopted for portability’s sake, the benefit often could have been delivered much less expensively in a defined benefit (DB) pension plan than via a DC plan. Even if benefit levels established under the benefit policy are kept constant in order to maintain competitive and adequate income levels, a DB plan could cost the company less and increase shareholder returns.

There’s no doubt that the 401(k) plan has a place in tomorrow’s retirement landscape, as long as people understand the real intrinsic differences of DC and DB plans. It’s fair to say that portability is not actually one of those differences. Plan sponsors are in a position to reverse this misconception, and should not be swayed from pursuing an effective DB strategy only in the name of portability.

The question of portability (part 1)

In the late 1980s defined benefit (DB) pension plans were firmly entrenched as the foundation for an employee’s retirement security planning. But 401(k) plans had just been awarded long-overdue IRS regulations and were gaining in popularity as a differentiator for companies in their quest for talent.

Among the key selling points for employers reviewing 401(k) plans was that employees were more likely to change jobs than they had been previously and because of this they were served well by benefit portability. It was a feature most pension plans were not positioned to provide as well.

You can take it with you

The portable 401(k) plan looked, to some, to be the best solution. Yet, in some cases, it may be a mistake to assume that portability in and of itself is necessarily the best option for employees or employers.

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How DB plans became DC plans: An introduction

Bart Pushaw

At some point the popularity of defined benefit (DB) pension plans gave way to defined contribution (DC) plans. This is perhaps best exemplified by the numbers of 401(k) plans, which so many employees are now (or should be) contributing to on a regular basis. We looked into some of the factors behind this shift.

Q: What were the main reasons the landscape of retirement plans changed during the 1980s and 1990s?

A: For very small plans, those set up mainly as temporary tax shelters by small business owners such as doctors and dentists, the Tax Reform Act of 1986 changed rules sufficiently to cause them to get out of the game. For larger plans, there was a mantra emanating from performance-oriented compensation strategies about portability and paternalism: both uprooting pension plans in favor of DCplans such as the 401(k).

Q: What is it about portability or paternalism that made DB plans so ill fitting?

A: Many consultants were decrying how the workforce had become more mobile over the years. Mobile workers, it was said, couldn’t take their DB plan benefits with them when they left; they were not easily portable to the next employer. The mantra was so quick to pick up steam and repeated so often that I’m afraid there were reactions to it that clearly indicated misunderstanding or confusion.

Q: What kind of confusion could that have caused?

A: Once you look at it, portability was all about being able to cash out a prior employer benefit and roll it over to the next employer. The notion that DB plans could not accommodate this is nonsense. There is no reason why a DB plan could not allow it—and there can even be DC plans that do not. As a matter of sponsor choice, you deal with it that way. It was not and is not a matter of plan type, DB better than DC. And because people really didn’t stop and think about it, the main problem with portability (i.e., job-hopping employees) was not that the money could or could not follow you around (so what if it couldn’t?) it was because of how career benefits can be radically affected by job-hopping. If five companies have the same retirement plan, DB or DC, and I take my turn at employment at each over my career, then my benefit can be significantly less than if I stay with the first employer my entire career.

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Basic questions and answers about lump-sum distributions

Bart Pushaw

The ins and outs of lump sum distributions, and whether to take them or not, are among the most common conundrums facing new retirees. Here are a few questions about the basics that I hear frequently and the answers I offer to them.

Q: Shouldn’t I take a lump sum distribution when I retire?

A: In general, people and their spouses should review what’s best for them. If a retiree has sufficient income to live without using their savings immediately, the lump sum can provide flexibility in spending and a potential estate. Or if a monthly income is most advantageous, then an annuity makes more sense.  Everyone needs to think what’s best for them and their family. From a purely mortality-neutral point of view, the answer for most of us is NO.

Q: But I’m told I can beat the returns and have more flexibility if I take a lump sum. What’s that about?

A: If you take a lump sum, you still need to earn monthly income from it. How to go about getting that monthly income is the problem. You can buy an annuity, self-annuitize by withdrawing some amount each year, or hire a financial planner and work out a plan. More often than not, these are suboptimal alternatives that can sometimes lead directly to personal financial crises.

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