Is the “window” closing for lump-sum windows?

Offering lump-sum windows to terminated vested participants has financial pros and cons for defined benefit plan sponsors. The regulatory environment in 2016 presents sponsors with a unique opportunity to de-risk pensions through lump-sums. However, sponsors may miss an opportunity to capitalize on the financial advantages of offering lump-sums if they defer to later years. Milliman’s Zorast Wadia provides perspective in his article entitled “De-risking your pension plan: Do new regulations make 2016 the best time to offer lump-sum distributions?

Here is an excerpt:

A golden opportunity—perhaps the last of its kind—for lump-sum windows is coming up in 2016. After that, the window may close for quite some time.

The issue, in brief, stems from a disagreement within the actuarial profession. In October 2014, the Society of Actuaries (SOA) published its updated Mortality Tables Report. The new tables included much more optimistic assumptions about longevity than anything that had come before. If these assumptions are correct, employees would live longer, and the cost of funding their retirement benefits would increase in the 6 to 10 percent range for many plan sponsors.

Many in the actuarial community responded critically to the report, based on the table’s construction methodology and conclusions. At the same time, plan sponsors were concerned because the new longevity assumptions would have the effect of increasing funding requirements, pension expense, and PBGC premiums. Implementation of the new SOA mortality tables would also significantly reduce the accounting gains that are one of the key economic benefits associated with lump-sum distributions.

On July 31, 2015, the IRS stepped in and eliminated the controversy—and uncertainty—at least through the end of 2016 with IRS Notice 2015-53. As Milliman stated in its Client Action Bulletin of August 13, 2015:

For defined benefit plan sponsors (including multiemployer pension plan trustees), the updated tables provide certainty that the [new SOA tables] will not be required for 2016. The use of the IRS’s updated tables will have a more modest effect … on actuarial valuation results, including minimum funding, benefit restrictions, lump-sum calculations, and PBGC premiums.

Looking ahead to 2016, plan sponsors know they can benefit from the accounting gain traditionally received from lump-sum transactions. Furthermore, the US Federal Reserve continues to signal that an interest rate increase will take place before the end of 2015, with additional small rate hikes throughout 2016. Moreover, through the first nine months of the year, corporate bond interest rates, which are the benchmark interest rates used to calculate statutory minimum lump sums, are already up about 35 basis points. In fact, plans using a three-month lookback period for interest rates can already lock in this interest rate basis for minimum lump-sum distributions in 2016. The basic math of lump sums means that lump sums due employees will be smaller because of higher benchmark interest rates.

Additionally, it is rumored that, in 2017, the IRS will adopt a new table reflecting longevity improvements, which may be the SOA table6 or something similar. In other words, plan sponsors considering a lump-sum distribution may want to take advantage of the clearly favorable environment in 2016.