IRS recently released Notice 2019-18, stating that it no longer intends to amend current required minimum distribution (RMD) regulations to prohibit the payment, as part of a “lump-sum window program,” of a lump-sum to a retiree currently receiving an annuity. The new Notice appears to authorize offering a lump-sum option to retirees in de-risking transactions – something that had been effectively prohibited since 2015 (under Notice 2015-49). (We discuss IRS’s Notice in our article IRS no longer intends to issue regulation prohibiting payment of lump-sums to retiree-annuitants.)
IRS noted, however, that retiree lump sums may present other issues.
Since IRS published this Notice, there has been significant press coverage of (fairly intense) criticism of IRS’s decision, by, e.g., the Pension Rights Center. And the issue of retiree lump sums has for some time been controversial.
In that context we thought it would be useful to review some of the issues presented by a retiree lump sum program that sponsors may want to consider.
1. The savings – vs. buying an annuity – isn’t as great as non-retiree lump sums.
Buying an annuity to settle a DB liability generally costs more than simply paying out the lump value. Annuity carriers have regulatory (and business) overhead, profit margin, and generally use more conservative valuation and risk assumptions than an ongoing plan would. Very roughly, all of these requirements can add between 15%-35% (or more) for non-retirees; because of (among other things) the shorter time period for payments, they only add (roughly) 5%-10% for current retirees.
2. There’s a hidden adverse selection cost.
Settling benefits by providing an annuity with a lump sum option is considerably more expensive than only providing an annuity. That is because individuals who believe they are likely to die before reaching the group’s average life expectancy will take lump sums, and the remaining group’s average life expectancy – and annuity payout period – will go up. In a lump sum window program, the sponsor will have to finance the obligation with respect to this now more longer-lived group that does not take the lump sum, and the cost of settling liabilities with respect to that group will go up, by perhaps as much as 5%-10%. That additional cost may be more than the savings from those participants who take lump sums.
3. Unisex tables exacerbate the adverse selection problem.
Because plans must use unisex life expectancy tables, which in effect overstate life expectancy for males and understate it for females, lump sums will be a (relatively) “good” deal for males and a “bad” deal for females. The latter point has been noted in press coverage of this issue.
4. Offering lump sums to some older annuitants may present consent/fiduciary issues.
Whether an older annuitant’s cognition is compromised, whether the individual is able to adequately consider a lump sum option, may (perhaps with some frequency) be disputed – perhaps years after the lump sum election and after all the money has been spent.
5. Given press coverage, retiree lump sums may become an enforcement target.
Experience has taught us that, with enough publicity and controversy, rules that were considered non-problematic can become problematic.
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As we discuss in our article De-risking in 2019, the savings from settling plan liabilities come from reduced administrative costs and the elimination of Pension Benefit Guaranty Corporation premiums. In light of the foregoing discussion, sponsors will want to consider both the potential savings and the potential cost of any retiree lump sum program.