Tag Archives: lump-sum distribution

Administrative tips for lump-sum window offerings

Lump-sum windows can present a “win-win” scenario for both defined benefit (DB) pension plan sponsors and participants. Sponsors can decrease their PBGC premiums by reducing the amount of participants within a plan. On the other side, participants in need of cash can benefit from a lump-sum payout.

Before implementing a lump-sum window sponsors must first consider the various administrative aspects related to such an offering. The DB digest article “Lump-sum windows: Administrative tips to consider” by Nicholas Pieper highlights these nine administrative tips that can help plan sponsors with the process.

• Identify the eligible population
• Clean up the data
• Seek legal counsel assistance
• Determine the duration of your window
• Set a manageable deadline
• Deliver an announcement mailing
• Anticipate participant inquiries
• Create the ultimate lump-sum window packet
• Prepare for special circumstances

To learn more about lump-sum windows, click here.

A “Sign O’ the Times” for 401(k) plans?

Laursen DarleneTimes have changed since 401(k) plans were started back in the ’80s, just like hair styles and rock bands. Where most 401(k) plans only offered a lump-sum distribution option, the new trend in retirement plans may have you facing a decision. Could additional options, such as installments and ad hoc distributions, be the new featured value to plan participants? Could a lack of more distribution options be affecting participants’ distribution behaviors? Let’s look at the options and effects for the participants.

A 401(k) retirement plan that offers only a lump-sum distribution option requires participants to move the full account balance before they can even access one dollar from their accounts. While this may seem like no big deal, let’s turn this soup can around and read more about this lump sum on the label. It may provide greater insight into the lump-sum option.

If the need for cash at retirement is immediate, a participant may be forced to distribute the full account balance when the investment market is down. Participants would be locking in the investment loss on their entire account. This effect of the lump-sum distribution option affects participants whether rolling over their account or taking a distribution in cash.

These same lump-sum distributions can also adversely affect the plan as a whole. You may be scratching your head at this point and asking what do you mean? How can only having the lump-sum distribution option adversely affect the plan? Consider the scenario of a large population of plan participants retiring or terminating within a similar time period and possibly carrying away the larger balances in the plan. A tsunami of lump-sum distributions may trigger a significant drop in the total plan assets. This drop in assets may adversely affect the asset pricing structure for the remaining population of participants in the plan, creating a higher asset expense. Not to be a downer on lump-sum distributions, as they certainly have their place in retirement plans, but it may be time to consider offering additional options.

Installment payments can be a second option for a retirement plan. I like to call them the “Pac-Man” of the payment structures. This stream of same bite-size payments works like the Pac-Man arcade game. Pac-Man just kept munching his way around the board, eating until every bite was gone. The upside to installment payments is that participants can have a steady stream of income from the retirement plan and still remain invested. The participant continues to glean the benefit of lower investment pricing by remaining a participant in the plan. What participants should be considering, however, is the effect of these steady Pac-Man installment payments, which continue to happen in a downward investment market. Those installment payments can result in a larger reduction or faster depletion of a participant’s account than planned. For plan sponsors who offer the installment payment option, it is one way of potentially slowing down abrupt changes to the assets in the plan.

The third option, ad hoc distributions, may be considered the most flexible option in retirement plans. Let’s unpack how the ad hoc option can provide an ongoing investment benefit as well as distribution flexibility through retirement. Participants can leave their retirement accounts in the plan and remain invested in the plan’s institutional fund options. The ability to request a distribution when needed, or at the peak of a market upswing, can provide the ability to manage retirement drawdown. For participants who can afford to retire on other sources of income but may incur an unexpected medical cost during retirement, the ad hoc option provides a financial source to tap into only when needed.

Each distribution option has something to offer plan participants. Is it time to offer all three?

Communicating lump-sum windows

Lump-sum windows are common ways for defined benefit (DB) plan sponsors to shed pension liabilities. According to Milliman consultant David Benbow, effective communication is essential when employers consider offering of a lump-sum window. He offers his perspective in a recent Money Management Intelligence article.

Here is an excerpt:

Three things are necessary to make a lump-sum window successful: communication, communication, communication. In addition to the required legal notices informing participants of their rights, you should do your best to create a package that is eye-catching (not many people read their mail after it goes in the trash) and easy to read (if it reads like stereo instructions, people will jump to the election forms and make up their own rules). The communication should spell out the pros and cons of taking a lump sum so that the participant can make an informed decision. The last thing anyone wants is for a well-intended offer to turn into a class action because participants were misled.

It takes time to create a good communication package, and usually there will be several people who wants to take a whack at the piñata, including legal counsel. Just know that clear communication up front will reduce the number of questions and follow-up on the back end.

For more Milliman perspective on lump-sum distributions, click here.

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.

Is 2016 the year of lump-sum sweeps?

Hastings-SteveIn her February Retirement Town Hall post, Stephanie Sent asked if 2015 would be the year of lump-sum sweeps. The answer appears to be “yes” for a number of defined benefit plan sponsors, as the de-risking of plans and the savings on per-head administrative costs and Pension Benefit Guaranty Corporation (PBGC) premiums are compelling. Many lump-sum sweeps are already in progress. This year, we’ve seen plan sponsors take several approaches to lump-sum offerings, whether the option is limited or unlimited, permanent or a one-time window.

Further, for plan sponsors still considering a lump-sum sweep, 2016 just became more viable. A factor in the push for 2015 lump-sum projects was uncertainty as to how the Internal Revenue Service (IRS) would update the applicable mortality tables for 2016. Plan sponsors feared that lump-sum payments would increase significantly if the IRS adopted a new base mortality table and/or improvement methodology because of evidence of increased longevity. That uncertainty ended recently when the IRS published Notice 2015-53, which confirmed that the current base mortality table and methodology would remain in place for 2016 calculations.

As we’ve reached the end of August, the rush is now on to complete the necessary administrative tasks, as described in Lynn Yu’s post “Administration preparation for lump-sum cashout windows,” to ensure payments by the end of the calendar year. It may be too late to implement new lump-sum projects before the end of 2015, but recent developments have made 2016 another attractive year for projects. It is expected that 2016 will be the “last hurrah” for lump-sum payments using the current base mortality tables. And although interest rates have been volatile, the applicable interest rates of the past few months imply 2016 lump-sum calculations might be based on slightly higher rates than those used for 2015. Higher rates will reduce the lump-sum payment amounts rather than lock in liabilities during a period of historically low rates.

Of course, there are many pros and cons and administrative steps to consider before offering lump-sum payments. Please contact your Milliman consultant for additional information about whether such a project is a good fit for your company.

Administration preparation for lump-sum cashout windows

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.