As defined benefit pension plan sponsors seek to transfer pension risk, offering lump-sum pension cashouts for terminated vested participants has been an attractive option to consider. Many plan sponsors embarked on such cashout projects beginning in 2012 and this trend is expect to intensify throughout 2014, according to an analysis by HR consultancy Mercer.
“Among the attractions [of lump-sum cashouts] to the plan sponsor are reduced pension liability, leading to lower plan financial risk and volatility,” said Matt McDaniel, a senior consultant at Mercer, in a media release. “Other advantages include eliminating [Pension Benefit Guaranty Corp.] premiums, investment and administrative costs, and making payments before updated mortality tables come into effect. However, the business case for pension cashouts is driven by the unique circumstances of the plan sponsor and a cashout will not make sense in every situation.”
These programs also tend to be popular with eligible participants, McDaniel added. “Take-up rates for an effectively executed lump-sum exercise can be upwards of 50 percent.”
Some sponsors for whom a cashout might be appealing are waiting on the sidelines, Mercer’s analysis notes, hesitant because of concerns that include the following:
“Interest rates are too low right now.” Waiting for a rise in interest rates to take action is a bet on the direction of interest rates. If a plan sponsor is looking to profit from the expectation of a rise in interest rates, Mercer believes there are more efficient ways to achieve that than carrying terminated vested liabilities.
“Paying lump sums will trigger a profit and loss settlement charge and impact our share price.” Sponsors who wish to avoid settlement accounting can structure the lump-sum program to do so. “Even if settlement accounting were triggered, the market has become more savvy about adjusting earnings for pension expense and is less likely to penalize an organization for taking prudent steps to manage risk within its pension plan,” according to the analysis.
“I don’t want my employees to squander their pensions.” Mercer’s experience has been that over 80 percent of lump sums over $50,000 are rolled over into an individual retirement account or other tax-qualified vehicle. While participants may lose the longevity protection of an annuity benefit, a lump-sum payment provides participants with the flexibility to make individualized decisions based on their financial goals and preferences. Also, a lump-sum program is voluntary and participants who prefer the security of a lifetime annuity can keep it.
Stephen Miller, CEBS, is an online editor/manager for SHRM. Follow him on Twitter @SHRMsmiller.
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