U.S. corporations are free once again to offer lump-sum windows to retirees and beneficiaries following a reversal by the IRS, but the inherent challenges are making a dramatic flurry of offers unlikely, industry experts say.
Both the IRS and the U.S. Treasury Department said earlier this month that they no longer plan to amend the minimum required distribution regulations under 401(a)(9) of the Internal Revenue Code to formally ban those types of lump sums.
The announcement reverses a 2015 notice in which the IRS said it intended to amend the code to disallow lump-sum offers to participants already receiving benefits.
Matt McDaniel, Philadelphia-based partner and leader of Mercer's U.S. financial strategy group, said in a telephone interview that the decision to allow these types of lump sums will be beneficial for plan sponsors.
"Any type of regulatory structure that gives plan sponsors more flexibility ... is a good thing," Mr. McDaniel said.
Interestingly, the IRS had always informally said it was against the concept of retiree lump sums, Mr. McDaniel noted. So in the past, corporations generally did not attempt to obtain private letter rulings to receive the go-ahead — but blockbuster pension risk transfer transactions changed all that.
Ford and GM
Two automotive behemoths, Ford Motor Co., Dearborn, Mich., and General Motors Co., Detroit, received those private-letter rulings from the IRS in 2012 to offer lump sums to retirees and beneficiaries. Ford was the first, announcing that April it would make an offer to about 90,000 combined U.S. salaried retirees and former employees. GM followed in June, offering a lump sum to 42,000 retirees in its U.S. salaried pension plan.
Other companies followed suit, although not nearly as prevalent as U.S. corporate pension plans offering lump sums to former employees who had yet to retire, which have not required private-letter rulings. When, in the summer of 2015, the IRS announced it would no longer offer private-letter rulings to corporations, companies ceased all attempts to pursue them.
J.C. Penney Co., Plano, Texas, was the last corporation of a few dozen to announce publicly its plans, making the offer to about 31,000 retirees and beneficiaries. That offer closed in September 2015.
Despite the new freedom to explore the option of offering lump sums to retirees and their beneficiaries without private-letter rulings, the challenges will remain the same as they did before the IRS' 2015 notice and will likely prevent a landslide of offers, said Ari Jacobs, Aon PLC's Chicago-based senior partner and global retirement solutions leader.
"No. 1 was the issue (that) these are older folks," Mr. Jacobs said, "many of whom are on a fixed income, many of whom have no other sources of income other than this. To be offered a single check, there's the question as to whether or not those individuals would be making the right decisions dealing with longevity risk."
Also, Mr. Jacobs added, there was a concern as to whether family members, financial advisers and others could be influencing retirees' decisions in an inappropriate way. Another challenge, more of an economic one, is the concept of "anti-selection."
"The people that would make this lump-sum selection would generally include those who were more infirm than others," Mr. Jacobs said.
Mercer's Mr. McDaniel agreed, saying the calculated lump sums are based on IRS mortality tables.
"If you go to a 40-year-old terminated vested participant and offer them a lump sum based on the standard mortality table, it's roughly a fair trade," he said. Retirees, however, are much more knowledgeable about their mortality.
"You have all of the unhealthy retirees take lump sums, all of the healthy retirees keep their annuities," Mr. McDaniel said.
The "take rate," as Mr. McDaniel puts it, is far more asymmetrical than the rate at which younger participants will likely take the lump sum and thus more difficult to calculate, and potentially more expensive for the plan sponsor.
Overcoming those challenges requires some creativity on the part of the sponsor.
"There could be some approaches that some are thinking about (including) issuing partial lump sums, paying out on a partial basis," said Beth Ashmore, St. Louis-based senior consultant in Willis Towers Watson PLC's retirement risk management group. "It's just a tricky thing relative to retirees. You have to look at your underlying plan and underlying characteristics."
Mr. McDaniel also mentioned perhaps offering lump sums only to younger retirees or retirees who receive very small monthly benefits. Those modifications may address the anti-selection risk.
Overall, Mr. Jacobs said, it's a positive that corporations have this tool to address their liabilities.
"I've always believed that companies should be given the option to offer this or not and make their own decisions on whether it was appropriate for their retirees to offer it," said Mr. Jacobs.
"And remember, this includes choice," Mr. Jacobs added. "These are all choice. We're not forcing lump sums on anybody. It's a positive to plan sponsors to give them more choices to give them the opportunity to offer more choices to their participants."
David Levine, a principal at Groom Law Group in Washington, said in an interview that theoretically plans could begin to offer windows to retirees by the end of summer, but were more likely to do so in the fourth quarter.