On March 6, 2019, the IRS issued Notice 2019-18, which reverses the IRS’s previously stated intention to prohibit defined benefit plans from offering lump sum buyouts to retirees currently receiving benefits. Prior to the IRS’s announcement in 2015 of its opposition to such arrangements, lump sum buyouts had become increasingly popular as a way for sponsors of defined benefit plans to “de-risk” those plans by reducing uncertainty regarding future obligations. Typically, plans offered a buyout “window”, a specified period during which retirees receiving benefits could elect to forgo future annuity payments in exchange for a one-time lump sum payment.
The renewed availability of this de-risking option offers another option for sponsors of defined benefit plans to consider as they manage the obligations associated with such plans. However, there are a few items plan sponsors may wish to consider prior to implementing a course of action:
- As compared to lump sum buyouts of terminated vested participants not yet receiving benefits, which have been and continue to be allowed by the IRS, lump sum buyouts for retirees may suffer from an “antiselection” effect. As retirees are generally more advanced in age, they may be able to be better assess their expected future life span. This could result in those expecting to live shorter than average lives electing to take the lump sum, while those expecting to live longer may not. Thus, the expected cost savings of the buyouts may be cancelled out by remaining participants living longer than expected.
- There will be administrative costs associated with designing and executing a lump sum buyout window, including legal fees, costs of calculations of lump sum amounts, mailings and other publicity efforts, and so on. It will be important for Plan Sponsors to assess the number of retirees expected to take advantage of lump sum buyouts, and the associated savings on future benefit payments, prior to incurring these costs. It’s worth noting, that while buyout windows for terminated vested employees typically see acceptance rates of 50% – 70%, retirees who are already receiving annuity payments may be less likely to give up those annuity payments.
- Lump sum buyouts are not without controversy, as many in the pension plan industry have expressed concerns regarding the shifting of risk from Plan Sponsors back to retirees, who, in some cases, may now be responsible to manage their retirement income for the first time and may not have the sophistication to do so. Plan fiduciaries should consider the risk that lump sum buyouts may open the possibility of plan participants being exploited, or of ineffectively managing their assets and running out of their money prior to the end of their lives (such concerns, in fact, contributed to the IRS’s initial 2015 decision to prohibit these buyouts).
This article is an excerpt from Dopkins Employee Benefits Newsletter. To read the complete content, please click here.
For more information, please contact Brendan Brady at firstname.lastname@example.org.
About the Author
Brendan P. Brady CPA
Brendan, a Assurance Services Senior Manager, is responsible for managing client engagements, team scheduling, training and development. He leads general and specialized audits as well as internal control projects, and is one of the leaders of the Firm’s employee benefit plan audit practice. He uses his experience to offer management advice and suggestions for improving operational efficiency by obtaining a thorough understanding of a business, not just from the controller’s standpoint, but from management’s and the operational side.