One of the most popular pension derisking strategies for the last few years—which shows no sign of slowing down in 2015—has been offering lump-sum windows (LSWs) to terminated vested participants. (As discussed in an earlier blog post, after the issuance of IRS Notice 2015-49, lump-sum offers to retirees in pay status are no longer permissible, but the vast majority of LSWs have not been extended to retirees in any event.) LSWs offer plan sponsors the opportunity to reduce their pension plan liabilities and headcount, and the associated Pension Benefit Guaranty Corporation (PBGC) premiums and administrative expenses without the premium required to settle liabilities through an annuity purchase (and, in some cases, at a discount to the related balance-sheet liabilities). The knowledge that new updated mortality tables will be required in determining lump-sum amounts (and will increase those amounts by 5–8%) as early as 2016 (although, more likely, in 2017) has added some wind to the lump-sum sails this year.
But, as LSWs have proliferated, so have concerns among the various federal agencies that regulate pension plans. As noted, the IRS has served notice that lump-sum offers can no longer be made to retirees in pay status. The US Department of Labor’s ERISA Advisory Council held hearings in 2013 on derisking, including LSWs, and issued a report that raises a number of concerns, including whether participants understood the risks that they were assuming by taking a lump-sum distribution and whether current disclosure requirements were sufficient. Additionally, the PBGC has recently begun requiring pension plans sponsors to provide reporting to PBGC regarding derisking activities, including LSWs.
Earlier this year, a fourth federal agency weighed in: the Government Accountability Office (GAO) issued a report on February 26 that summarizes its study of 11 LSWs offered by plan sponsors in 2012 and identifies a number of concerns. Its primary concern was that the communications materials provided to potential LSW participants were deficient. The GAO identified a number of major points that it said those communications should cover (see the list below), and it found that most of the communications were missing at least one of those points. In our experience, typical LSW communications do cover all those points, with one possible exception: making clear to participants that their pension is guaranteed both by trust funding and by PBGC insurance, so that they do not take a lump-sum distribution out of concern for their employer’s financial viability. It’s not clear whether that is a significant motivating factor for many participants in the decision to take a lump sum; nevertheless, the GAO’s report serves as a good checklist for LSW communications, and, in an abundance of caution, employers that offer LSWs may want to confirm that their materials cover all these points:
- What benefit options are available
- How the lump sum was calculated
- Relative value of the lump sum compared with a monthly annuity
- Potential ramifications, both positive and negative, for accepting the lump sum
- Tax implications of taking the lump sum
- The PBGC’s role and the level of protection that the agency provides
- Instructions for accepting or rejecting the lump-sum offer
- The point of contact for more information or help
Despite all this agency activity, for the time being, LSWs remain a viable option for plan sponsors and one that many sponsors that have not already done so may wish to explore before the end of 2015. However, sponsors need to be mindful of this developing set of regulatory concerns, and, in particular, be mindful of the concerns that the GAO raised in designing their communications plan for any LSW that they implement.