Six guidelines for pension cashout success


From the perspective of retirement plan sponsors, the most profound news of 2012 may well have been the summer's headline-making announcements from General Motors Co. and Ford Motors Co., as both auto manufacturing giants sought to reduce their defined benefit pension risk via cashout programs on a scale unprecedented in the U.S. The news led to a flurry of speculation that the DB cashout option would gain momentum as a risk-management strategy for many more companies.

Indeed, by taking advantage of rules that allow lump-sum benefit calculations to be based on corporate bond interest rates instead of Treasury bond rates, many plan sponsors have an opportunity to effectively reduce risk by offering a pension cashout program to eligible inactive employees. These programs are most commonly offered to vested/terminated participants who have yet to commence benefits, but as seen with GM and Ford, these programs could potentially also be extended to retirees who have already begun receiving pension payments, although this would generally require an IRS private letter ruling.

As 2013 dawns, many plan sponsors might follow the lead of the Detroit automakers, but words of caution are warranted. As attractive as it might be to remove pension risk from their books through a cashout strategy, plan sponsors face challenges in executing a successful cashout program. They must consider the numerous implications for participants in explaining and addressing whether a cashout is the right decision for that individual.

From our experience in helping DB plan sponsors develop, administer and communicate their plans, we have developed six key guidelines for DB cashout success. As sponsors weigh their options and develop plans, we advise them to put the needs and concerns of their participant population at the forefront by heeding these considerations:

1. Position the lump-sum cashout option as an enhancement to their options. With the addition of a lump-sum option, terminated/vested participants will have another choice when considering how they want to receive their pension. In addition, a lump-sum payment offers individuals the opportunity to take more control over their retirement assets. Individuals taking a lump-sum payment could consolidate this money with other retirement accounts, such as individual retirement accounts, to create a more complete picture of their total retirement assets.

2. Provide effective communication to participants. The choice of a lump sum vs. annuity is not always straightforward, and might be confusing to participants. As you communicate with your participants, help guide them through the many factors that should be part of their decision-making process, and encourage them to seek guidance from a financial and/or tax adviser. These factors include comparing the value of a lump-sum payment vs. an annuity; understanding the impact of deferring or not deferring payment; evaluating personal and family situations for immediate and long-term financial needs; engaging a qualified and trusted financial planner; examining the benefits of consolidating finances; and considering their health and life expectancy.

3. Take steps to ensure correct and complete data. The success of a DB cashout project is contingent upon having complete and accurate data. Take the time upfront to analyze the quality of your data and perform cleanup where needed. Without the proper advance diagnostics, the cashout strategy could be compromised or limited. Consider these questions: Do you have a complete list of impacted participants? Do you have certified benefit calculations for the impacted population? How confident are you that addresses are accurate and meet published post office standards?

4. Be prepared to explain the business rationale to a variety of stakeholders. It is not just the targeted participants who have a vested interest in your cashout project. All important stakeholders — including current employees, investors, clients and customers, industry constituencies, and the press — might want to know why you are taking this step. Without effective communication, these groups might draw their own conclusions, so having the business rationale carefully thought out and ready to communicate is essential. Be prepared to tell your story, retell it and then tell it again.

5. Understand the plan sponsor role as a fiduciary. To fulfill your responsibility to act solely in the best interest of the plan and participants, you should perform a feasibility study, consult legal counsel and make sure your participant communications are accurate and educational. It is also important to establish appropriate goals and objectives to guide your decision-making.

6. Work with a provider who is up to the challenge. Carefully choosing the right provider to help you execute your cashout program is a critical part of this initiative. Be sure the company you select is up to the challenge of this complex task by confirming its ability to perform key consultative, administrative and participant communications functions. It must be able to collect and prepare accurate data for the targeted population; create and deliver specialized participant communications; staff a quickly scalable contact center with knowledgeable, fully trained service representatives; and receive and process a large volume of distribution requests within the desired time frame.

These guidelines only reinforce the fact that the DB cashout approach is not to be taken lightly, and must note the concerns and perceptions of numerous stakeholders, including clients, customers, industry peers, and even the press. Once the DB cashout decision is made, plan sponsors must go beyond their strict fiduciary status and embrace the role of skilled communicator.

Andrew Yerre is a partner in Mercer's U.S. outsourcing business.

Jonathan Barry is a partner and U.S. risk leader for Mercer's retirement, risk and finance business.