(updated with correction)
The Internal Revenue Service's unexpected decision July 9 to ban lump-sum payments to retirees has plan sponsors keeping one eye open for further regulation but still considering those payouts for other plan participants.
While the policy change is not expected to have a major impact on plan sponsor behavior, it does have a symbolic one, and it is viewed as a broader effort by Washington regulators to encourage lifetime income. “This type of activity was getting attention from regulators. I think there certainly will be more attention,” said Matt McDaniel, a Philadelphia-based Mercer partner who leads the defined benefit risk business in the U.S.
“All that's happened here is retirees lost that option. The real story is probably what this says on the part of the regulators,” said Bob Collie, Seattle-based chief research strategist, Americas institutional, at Russell Investments. “They are trying to get ways to get people to turn lump sums into annuities, and to close leakage within defined contribution plans. It makes the retirement system much less effective than if the money stays in the system. You do see things building up.”
Until now, the IRS had allowed the offer of lump sums to defined benefit plan retirees on a case-by-case basis, through private letter rulings. That had some advocates like AARP and the Pension Rights Center on alert.
“The purpose of defined benefit is to provide income. Offering lump sums to people in retirement is so out of sync with pension regulation. Really, the only people who should be taking them is if they are on their deathbed,” said Drexel University law professor Norm Stein, a senior policy adviser to the Pensions Rights Center. “This was the right thing to do.”
It “was the group that they were most concerned about,” agreed Rick Jones, senior partner in Aon Hewitt's national retirement practices group, whose latest plan sponsor survey found a “small but very interested” percentage of plan sponsors likely to offer lump sums to DB plan retirees.
Companies that have made lump-sum offers to retirees in recent years include Alcatel-Lucent, Murray Hill, N.J.; NCR Corp., Duluth, Ga.; Ford Motor Co., Dearborn, Mich.; General Motors Co., Detroit; and Archer Daniels Midland Co., Decatur, Ill.
Annette Guarisco Fildes, CEO of the ERISA Industry Committee in Washington, said her corporate plan members were disappointed to lose that option without hearing from the IRS first.
“We are taking a hard look at the notice and conferring with legal counsel and companies on how broad the restrictions are. We are hopeful that we are going to be able to retain that flexibility” for other groups of employees. The IRS notice does not address terminated plans, employees on the verge of retiring or younger retirees who have not reached the age where minimum distributions are required.
The policy shift also does not affect the most common lump-sum practices.
“Lump sums for retirees were one of the options in the toolbox for plan sponsors, but not one of the biggest. Deferred vested (former employees) are at the top of the list,” said Mr. McDaniel of Mercer. Former employees vested in a defined benefit plan “are a fairly big target for lump-sum payments for many companies. It's been fairly popular since 2012,” said James Gannon, director of asset allocation and risk management at Russell Investments.
There are other, more pressing considerations in plan sponsor derisking decisions.
“The key drivers are No. 1, the desire to reduce financial volatility in their balance sheets and the cash requirements. Closely following that is a desire to mitigate costs,” Mr. McDaniel said.
Plan sponsors are braced for more costs in two areas. New mortality tables that the IRS is expected to use for calculating payouts as early as next year will make such risk transfers more expensive, and premium hikes at the Pension Benefit Guaranty Corp. start kicking in next year. PBGC officials, who have to worry about losing premium-paying participants and were concerned that premium increases would encourage more risk transfer activity, started collecting plan sponsor information on lump-sum offers and annuity purchases for former employees this year. The first results are due in October.
“PBGC premiums are always a consideration,” said Mr. Jones of Aon Hewitt, particularly for underfunded plans that have an additional premium penalty. “We are actively talking with clients. It may lend even more fuel to the fire for annuity buyouts,” he said.
Interest rates for calculating the cost of lump sums or annuities present another variable. “There are a lot of short-term things that could drive the popularity up or down,” said Mr. Collie.
When rates do start rising, “the crossover point of when it is profitable for an employer to derisk is going to get more and more attractive,” said Dallas Salisbury, president and CEO of the Employee Benefit Research Institute in Washington.
“We're helping our clients evaluate the costs of doing it now vs. doing it later,” said Mr. McDaniel. “I think we'll see the activity in the annuity buyout space pick up. (Recent buyout activity) dwarfed the prior two decades. We expect to see that continue and expand.”
Pension advocates say they will continue to scrutinize lump-sum practices. Allowing them for retirees “was terrible public policy,” said David Certner, AARP legislative counsel and legislative policy director for government affairs. “This issue is still at play for a lot of other people. You're still encouraging people to make bad decisions.”
The Government Accountability Office drew attention to lump-sum practices in a February report calling for better information to participants, after studying what was presented to former vested participants and some retirees about the calculations and comparisons to a lifetime benefit. Rep. Sander Levin, D-Mich., the ranking member of the House Ways and Means Committee who ordered the GAO study, said he will continue to work to ensure participants are making informed decisions.
“It's conceivable (that) PBGC collecting the information leads to proposals for legislation or modifications to discourage certain behaviors,” said EBRI's Mr. Salisbury. “It depends on what they find and the long-term implications for the PBGC. The logical extension” of the IRS notice would be guidance from the Department of Labor that sponsors “should be doing more annuities in their DB plan,” said Mr. Salisbury. “It's nibbling as far as they are allowed to nibble.” n