On October 7, General Electric (GE) announced a series of decisions around their salaried pension plan:
- For participants continuing to accrue benefits, further accruals will be stopped at the end of 2020. (New employees hired after 2011 were not eligible for the pension plan.)
- A lump sum buy-out proposal to 100,000 terminated but not yet retired participants will be offered.
- Benefits in a supplemental plan for certain executives will also freeze.
Inevitably, whenever one of the largest pension plans in the country makes an announcement like this, it can cause executives at other companies to question if a similar decision makes sense for their plan. The action item here most germane to other plan sponsors, and the focus of the remainder of this article, will be to focus on the middle bullet point. Offering lump sums to non-retired, terminated participants has become a popular strategy among pension plan sponsors the last couple years as a way to reduce headcount without paying a premium to an insurance company to off-load the obligations.
Lump Sum Cashouts Defined
A Lump Sum Cashout program occurs when a defined benefit pension plan amends its plan to allow terminated vested participants to take a lump sum payment of their benefit and be cashed out of the plan entirely. The program is typically offered as a one-time window. Plans generally may offer this type of program only if their IRS funded percentage is at least 80% both before and after the program is implemented.
Many pension plans have offered, or at least considered, Lump Sum Cashout programs over the last several years to minimize their financial risk. Plan sponsors that have implemented these programs have been rewarded with significant cash savings as well as risk reduction.
Advantages of Implementing Lump Sum Cashout Today
1. Improved Funded Status
An advantage of the current interest rate environment is that lump sums will be less than most other liability measurements related to the plan. Employers will be paying benefits to participants using a value less than the balance sheet entries being carried for those benefits in most cases. These lower lump sum payments will then help employers improve the funded status of the plan in addition to de-risking or reducing the future risk.
2. PBGC Premium Savings
The most significant benefit of offering a Lump Sum Cashout Program is the Pension Benefit Guaranty Corporation (PBGC) premium savings. The PBGC continues to increase the annual premiums that pension plans are required to pay to protect the benefits of their participants in the pension plan. The per participant portion of the premium (flat-rate) is now up to an $80 payment per participant in 2019. This is more than a 200% increase since 2012. The variable rate portion of the premium is up to $43 per $1,000 underfunded which is an increase of almost 500% since 2012.
These rates are expected to continue to grow with inflation each year. Therefore it is ideal for pension plan sponsors to reduce their participant count sooner rather than later so they can save on these future premiums. In total, some pension plan sponsors could see annual PBGC premium savings of over $600 for each participant who takes a lump sum distribution.
Other Considerations When Planning for a Lump Sum Cashout
There are some concerns that pension plan sponsors will also want to consider such as:
- Potential increases to contribution requirements;
- One-time accounting charges that could be triggered;
- Potential increase to annuity purchase pricing upon pension plan termination. Note that a permanent lump sum feature may increase pension plan termination annuity pricing and cause some insurers to decline to bid.
The pension plan’s actuary should be consulted so they can properly evaluate the impact of offering such a program.
Some pension plan sponsors use lump sum cashouts as part of their pension plan termination preparation strategy. This Findley article provides tips to map your route to pension plan termination readiness. Already have a frozen plan and been considering a termination in the near future? For a complete A-Z walkthrough, check out our guide below.
Published on October 8, 2019
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