Curtailing Lump Sum Pension Payouts?
In a sudden move, the Treasury Department said it will stop allowing employers to offer certain workers the option to take out their pensions in a lump sum. Notice 2015-49, Use of Lump Sum Payments to Replace Lifetime Income Being Received By Retirees Under Defined Benefit Pension Plans, applies as of July 9, 2015.Jerry Geisel of Business Insurance also reports, Pension advocate backs IRS rule banning annuity conversions to lump sums:
“The drums were beating, but no one thought this would be manifested by the IRS issuing this deadline-driven edict,” says Nancy Gerrie, an employee benefits lawyer with McDermott Will & Emery.
The idea of a defined benefit pension plan is that you (and your spouse) get guaranteed payouts for life. As the plans have become a drag on corporate balance sheets, companies have been shedding pension liabilities by offering participants the option of taking a lump sum buyout (cash) or transferring their pension to an insurer who would continue the lifetime payments. While the lump sum may seem like a windfall, it often short changes the retiree.
The new rules will change the lump sum game of pension derisking going forward. The new rules close one door, prohibiting lump sum offers for people already in pay status—those receiving a stream of pension payments. If a plan has been around a long time, there will be a lot of people in pay status. There are some outs for employers already in the process of offering lump sums: if the board has met and made an irrevocable decision to do this, or if the employer has already sent communications to participants about an upcoming offer. But otherwise, if an employer hasn’t started the process, forget about it for those in pay status.
Employers will still continue derisking and offering lump sum payouts to participants who haven’t started receiving payments. Employees offered lump sums should consider 8 Questions To Ask Before Taking A Lump Sum Offer.
The first big companies to offer lump sum pension payouts to both participants with deferred benefits and those in pay status were Ford and General Motors, who got private letter rulings from the IRS okaying the move in 2012 (the rulings were on a technical issue, whether the move ran afoul of required minimum distribution rules). When that was cleared up, that prompted interest among other big employers, and the IRS issued four more private letter rulings okaying the move in 2014. “Now all of a sudden, boom! It’s not okay,” Gerrie says.
The Pension Rights Center, an employee advocacy group, welcomes the fact that the IRS told off employers. Many workers just don’t get it, but lump-sum buyouts can easily be outlived, and often result in a loss of retirement wealth. Surviving spouses and older participants in payout status are at particular high risk.
“Offering a lump-sum can be a form of corporate elder abuse,” says Norman Stein, senior policy advisor to the Pension Rights Center and a law professor at Drexel University in a policy paper here. Stein elaborates on the lower economic value of a lump sum for most employees, outlines retirement management, spousal protection and tax problems, and discusses election and consent issues for employees facing cognitive decline.
Is the new IRS rule a harbinger of tougher rules to come on lump-sum buyouts? “Some would love to say, ‘You can’t offer lump-sum cash-outs anymore,’ but I don’t think [regulators] would go that far,” Gerrie says.
A new IRS and Treasury Department ban on employers offering pension plan participants currently receiving monthly annuity benefits the option to convert their benefit to a cash lump sum was needed to protect retirees, a consumer advocacy group says.Finally, Mekanie Waddell of ThinkAdvisor reports, IRS, Treasury Halt Lump-Sum Buyouts for Retirees Getting a Pension:
Federal regulators said last week that employers will not be “permitted to replace any joint and survivor, single life, or other annuity currently being paid with a lump sum payment or other accelerated form of distribution.” The ban generally went into effect July 9, though in certain situations, such as when an employer notified participants of the offer prior to July 9, the conversions still can place.
The Washington-based Pension Rights Center said it was “gratified” that regulators are ending the practice.
“The offer of a lump sum can create considerable confusion and anxiety for older Americans, who are often not in a position to appreciate the risks they face and the losses they might suffer,” Norman Stein a senior policy advisor at the Pension Rights Center and a professor at Drexel University School of Law in Philadelphia said Monday in a statement.
“Retirees who choose a lump sum have to invest the money at the same time they are drawing it down, which is even harder than investing money before retirement. They will have to pay new fees, which will reduce their account balance, and fluctuations in the markets can destroy their investment portfolio with no time to make up the losses,” he added.
Experts say to date, only a small percentage — less than 5% of employers, including Archer Daniels Midland Co., Ford Motor Co. and NCR Corp. — have given plan participants currently receiving benefits the option to convert their monthly annuity to a cash lump sum. Typically, such offers have been made to former employees who have earned an annuity but are too young to start receiving the benefit.
The key reason that such offers have not been extended to retirees collecting benefits is the fear of adverse selection in which retirees in poor health would be more likely you accept than those in good health, experts said.
The Treasury Department and Internal Revenue Service amended Treasury regulations last week to stop companies from offering lump-sum buyouts to retirees who already receive a monthly pension.I applaud the IRS and Treasury for clamping down on lump-sum pension payouts. America's pensions are in peril and the last thing it needs is more lump sum payouts which will exacerbate pension poverty.
The agencies’ new guidance will apply to plans going forward and not to employers that have amended their plans to make lump-sum buyout offers to retirees prior to July 9, 2015.
Norman Stein, senior policy advisor to the Pension Rights Center and a law professor at Drexel University, said that the Center is “gratified that Treasury has moved to stop these lump-sum buyouts, which are truly among the most cynical and dangerous pension abuses we’ve seen.”
The Pension Rights Center has criticized these so-called “de-risking" transactions, which it says “erase the federal private pension protections of [the Employee Retirement Income Security Act], turn guaranteed lifetime retirement income into a onetime chunk of money that can easily be outlived, and often result in a significant loss of retirement wealth for elderly Americans.”
Earlier this year Stein authored a policy paper on lump-sum buyouts and annuity transfers — another form of so-called “de-risking” activities. The paper asks whether pension plan de-risking is bad, whether it's legal, and whether it can be stopped, slowed or moderated.
Stein notes that the offer of a lump sum can create considerable confusion and anxiety for older Americans, “who are often not in a position to appreciate the risks they face and the losses they might suffer.”
Retirees who choose a lump sum “have to invest the money at the same time they are drawing it down, which is even harder than investing money before retirement,” he said. “They will have to pay new fees, which will reduce their account balance, and fluctuations in the markets can destroy their investment portfolio with no time to make up the losses.”
Some retirees may also be exploited by unethical financial advisors who gain to profit from a lump sum’s resulting fees.
By taking a lump sum, retirees also lose any guaranteed benefit for their spouses, should they die first. In fact, “offering a lump sum can be a form of corporate elder abuse,” Stein said.
While lump sum payouts sound attractive, the truth is they place enormous pressure on individuals to invest the money wisely and even if they do, they still run the risk they or their loved ones will outlive these savings. In other words, lump-sum pension payouts are no substitute for defined-benefit pensions which provide steady and secure payouts for life.
And while most companies have not offered lump sum pension payouts to their employees, the trend to de-risk pensions is clear, and it's important that regulators nip this trend in the bud as soon as possible.
More importantly, it's high time U.S. policymakers enhance Social Security for all Americans adopting the same approach and governance that has allowed the Canada Pension Plan Investment Board to prosper and successfully manage the pensions of millions of Canadians. Enhancing Social Security in the U.S. and enhancing the CPP in Canada is smart pension and economic policy.
Below, Mike Bernier, CFP, explains whether you should take the lump sum payout from your pension plan when you're retired. Bernier raises many good points but I disagree with him when he says if you have poor health you may want to opt for a lump sum payment. That is pure rubbish as far as I am concerned. Stick to DB pension payments and enjoy the peace of mind that comes with them.
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