In the past few years, a growing number of defined benefit pension plans have been opting to transfer risk from the balance sheet through lump sum cashout windows and annuity purchases from insurers. While a number of very high-profile retiree annuity purchase transactions were made in 2012-2015, the most common form of risk transfer to date continues to be lump sum cashout windows for vested terminated participants.
The advantages to the plan sponsor of a lump sum cashout can be numerous, and the economics of such an exercise are often very compelling. Furthermore, looming mortality changes in 2017 may make 2016 an opportune time to execute. Benefits to the plan sponsor of offering a vested terminated cashout window include:
- Reduced pension liability, leading to lower plan financial risk and volatility.
- Eliminated PBGC premiums for participants electing a lump sum (PBGC per-participant premiums are scheduled to increase from $35 per participant in 2012 to $80 by 2019 and continue to increase thereafter).
- Eliminated ongoing administrative costs for participants electing a lump sum.
- Reduced investment management costs for the funds used to cashout.
- Ability to make lump sum payments before updated statutory mortality tables increase costs (the IRS is expected to release new mortality tables that could increase lump sum costs by 5%–10% or more).
- Potential interest rate arbitrage in 2016, depending on the relationship between lump sum rates and market-based rates.
At the same time, these programs tend to be popular[i] with participants. Many participants use the opportunity to consolidate their retirement assets into a 401(k), individual retirement account (IRA), or other tax-advantaged vehicle, allowing them to take more control over their retirement planning.
The trend for plan sponsors to execute cashout projects began in 2012 and has continued to intensify each year since. Keep in mind, however, that the business case for a project of this nature is driven by the unique circumstances of the plan sponsor, and a cashout will not make sense in every situation. That said, some sponsors for whom a cashout might be appealing are waiting on the sidelines, hesitant because of perceived concerns about offering a window. In this Mercer Point of View we identify some common concerns and discuss how they might be addressed to allow for a successful risk transfer project
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