Is your business’s pension plan costing you more than it’s worth?
Single-employer pension plans are getting more costly and risky to maintain while partial/full termination is cheaper than ever. Is it time to consider a lump-sum window, retiree lift-out, or even a pension plan termination? Consider these options.
Editor’s note: Pension interest rates increased dramatically for most of 2022. This reduced pension liabilities, especially lump-sum payments and termination costs. In addition, the quick decline in the same rates since October and November 2022 has given most pension plans a temporary opportunity to realize even lower plan termination costs/liabilities. This is referred to as interest rate arbitrage and often results in additional savings in the millions for plan sponsors. The specific interest rate arbitrage depends on several plan provisions and how these interact with participant demographics and benefits. To best estimate these arbitrage savings and lowered plan termination costs, contact Ben Johnson at Plante Moran.
Traditional single-employer pension plans are becoming increasingly rare and costly for businesses to manage. At the same time, the process of settling some or all of those plans is easier and cheaper than ever. As a result, many businesses are learning about the benefits of partial pension settlements, such as pension risk transfers, or even full plan terminations. The end result of each of these transactions is to leave your employees and retirees with the same benefits they would’ve had under the original plan, but reduce the administrative and financial burden of administering the plan.
Many businesses are learning about the benefits of partial pension settlements, such as pension risk transfers, or even full plan terminations.
Lump-sum window pension settlement
A lump-sum window can be either the first step toward a full plan termination or it can stand alone as the only step your business takes at this time to “clean up” some of the pension obligations. In short, it’s a lump-sum offer to former employees who are terminated-vested but not yet collecting benefits. Retirees and older active participants could be included, but plan sponsors need to make sure doing so is the correct fit. A lump-sum window is fully payable out of the plan assets. The costs are typically recovered by the plan in 1-2 years, and it reduces the cost (specifically PBGC premiums) and risks of the ongoing plan.
Former employees who receive the offer have the option to accept or decline. Those who accept the offer can roll the lump-sum payment into their 401(k)s/IRAs and work with their retirement advisors to manage the assets going forward, or take the lump sum as cash to be available immediately. This method will undoubtedly clean up some of the plan obligations hanging over your business, but the fact that the former employees can choose to take the lump sum or continue under the plan makes the final impact somewhat uncertain.
Retiree lift-out pension risk transfer
A retiree lift-out specifically addresses former employees who are retired and receiving monthly benefits. Pension plans often have a high percentage of retirees who receive relatively small monthly benefits often with a disproportionate amount on administrative burden and fees going to service these retirees with smaller benefits. In a retiree lift-out, the employer transfers the liability and administration of future payments to an outside insurance company.
In this instance, there is no change to the retirees’ benefit amount or timing. Affected retirees are simply informed of the transaction rather than given the ability to opt in or out, as noted above in the lump-sum window. The selected insurance company simply steps into the shoes of the employer for purposes of plan administration and the benefits continue to flow as they did before. The costs are fully paid out of the retirement plan, and participating employers often recover more than the cost of the transaction within 1-2 years via savings on administrative compliance and operating expenses.
Pension plan termination
Each of the two options discussed above can stand on their own as valuable modifications to streamline pension obligations and reduce the costs associated with a single-employer plan. In both of those cases, the employer will continue to sponsor the plan afterward. It will be managing a plan with fewer participants, thereby reducing the administrative burdens, time commitments, and costs. Further, by shrinking the overall size of the plan, risks associated with the plan, such as investment and interest rate risks, are significantly decreased.
In some cases, pension settlements and risk transfers may be the first steps to take in a process that eventually leads to a complete plan termination. If you find yourself simply maintaining your pension plan, not adding value to your business or employees, it’s likely that you could save hundreds of thousands if not several millions of dollars in future administration fees via a full plan termination. This process involves a combination of some of the steps noted above. All participants not yet collecting benefits (including active employees) are offered lump-sum payments. All those who don’t take the lump sum are then grouped with the in-pay participants (retirees) and transferred to an insurance company.
This option requires that the plan be fully funded at the time of the transfer, so depending on current funding status, significant additional contributions may be required. These additional contributions would be required over the upcoming years to fully fund the plan in either case, but the requirement to make the contributions is accelerated by the plan termination. However, once the transaction is completed, your business could be saving millions in future administrative costs and internal time/resources. Often, a full pension plan termination comes about as part of a process that involves planning and commitment of any possible financial resources.
Perhaps the most important thing to remember about planning to streamline or terminate a single-employer pension plan is that any solution will be highly dependent on the individual facts and circumstances of the plan and your business. The right answer for your business will depend on several variables, such as:
- Plan design and benefits included
- Funded status of plan
- Cash availability in your business
- Borrowing capability of your business
We often talk about developing a “journey plan” for managing your company’s pension plan. We start with the question, “Does your pension plan help you manage your workforce and do they appreciate it?” Based on your answer, we figure out what the best options are for your business to provide the retirement resources it has promised to its employees while minimizing the costs and regulatory burdens that have come to weigh so heavily on the pension-maintenance function.
We often talk about developing a “journey plan” for managing your company’s pension plan.
To learn more about the best options for your business, please contact Plante Moran.