Administration March 21, 2017

Vanguard Outlines ‘Last Best Chance’ for DB Plan Lump Sums

New mortality tables mandated by the IRS will go into effect in 2018, and PBGC premiums will only go up from here. 

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A recent analysis published by Vanguard suggests 2017 might be the “last best chance” for defined benefit (DB) plan sponsors to pursue a lump sum strategy on favorable terms.

The pressure to move on lump sums today is largely due to changes driven by the Internal Revenue Service (IRS) and, “to a lesser but still meaningful extent,” by the Pension Benefit Guaranty Corporation (PBGC). Recent interest rate movements are also impacting the appeal of pursuing a lump sum, according to Vanguard.  

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“It’s likely that most DB pension plan sponsors’ major objectives are to reduce the cost of maintaining their plan, increase its funded status, and mitigate its effect on the organization’s financial statements,” the firm explains. “Sponsors may be able to make progress toward these objectives in 2017 by offering a lump-sum window to terminated vested participants.”

The Vanguard analysis includes insight from Brett Dutton, Institutional Advisory Services, and Paul Bosse and Kim Stockton, of the Investment Strategy Group.

The trio explains that the IRS “indicated in September 2016 that it was postponing until 2018 the implementation of updated Society of Actuaries (SOA) mortality tables used to calculate lump-sum values, minimum funding requirements, and PBGC premiums.” Simply put, moving on lump sums now before the new SOA tables take effect may result in more favorable calculations from the plan sponsor’s perspective.

Vanguard warns that “sponsors should know that the IRS prohibits DB plans from paying lump sums to in-pay retirees and beneficiaries,” but many terminated vested participants will view lump sums as attractive. In the end it can be a win-win—the participants gain more control over their wealth while sponsors gain better control of their DB plan longevity exposure. 

NEXT: Getting ahead of PBGC premium hikes 

Concerning the PBGC, Vanguard suggest “premiums are going nowhere but up.”

“In addition, by reducing their plan's participant count by the number of terminated vested participants who accept a lump-sum window, a plan sponsor is reducing the amount it would pay in total PBGC premiums going forward after 2017,” Vanguard explains. “These savings can be substantial … In all cases, it would reduce the flat-rate premium paid on a per-participant basis; in some cases, the variable-rate premium might additionally decline due to a reduction in the cap, which is also calculated on a per-participant basis.”

The analysis steps through a variety of mitigating factors that can make offering a lump sum less attractive for plan sponsors, and these should be considered carefully, the experts warn. But on its face the consideration is fairly straightforward: “The two main factors that determine the value of lump sums paid to participants are mortality assumptions and interest rates … This is a good thing because the higher the long-term interest rate, the lower a plan's liabilities, the better its funding ratio, the lower its lump-sum values, and the lower the cost impact of the plan on the organization's financials. However, this lift might not help some plan sponsors thinking about a lump-sum window in 2017. The PPA [Pension Protection Act] requires a sponsor to define a look-back period of one to five months, generally before a plan year, as a measurement date for the interest rate used to determine lump sums. Thus, a plan might be required to pay 2017 lump sums based on interest rates that don't reflect the post-election boost.”

The experts urge plans to “carefully consider whether the impact of increasing longevity will be offset, or more than offset, by the impact of rising interest rates on lump-sum costs in future years … While the crystal ball to help plan sponsors know where interest rates will be in the future doesn't exist, it's worth noting that Vanguard doesn't expect rates to move much further in 2017.”

Data and Research March 21, 2017

Medical Expenses and Debt Among Retirement Concerns

In addition, few workers are confident Social Security and Medicare will provide the same level of benefits to them in retirement as they do for today’s retirees.
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Two in three workers (65%) report feeling very or somewhat confident about being able to afford basic expenses in retirement, including 26% who feel very confident, according to the Employee Benefit Research Institute’s 2017 Retirement Confidence Survey (RCS).

Workers’ confidence in their ability to afford basic expenses is higher than the confidence they report regarding their ability to pay for medical expenses in retirement. Forty-five percent of workers are not too or not at all confident they will have enough money for medical expenses in retirement. An even greater share is not too or not at all are confident in their ability to pay for long-term care expenses: nearly six in 10 (57%) do not feel confident about having enough money for long-term care in retirement.

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“Workers with a retirement plan are more likely to have confidence in paying for expenses in retirement. This is because they save more,” Stephen Blakely, editor and communications director for EBRI, said in a media call.

Retirees, who are already in that life stage, express higher levels of confidence than workers in each of these financial aspects of retirement. More than four out of five retirees (85%) feel at least somewhat confident in their ability to afford basic expenses throughout their retirement years. Three in four (77%) are very or somewhat confident about having enough money to cover medical expenses, and 55% feel very or somewhat confident in their ability to pay for long-term care.

In addition, workers are more likely to say that debt is a problem for them than retirees. Nearly three in five workers (59%) say debt is a problem for them, while 40% say debt is not a problem. In contrast, just 36% of retirees say that debt is a problem for them. Workers are twice as likely to say that debt is a major problem as retirees (18% versus 9%).

The RCS has consistently found a relationship between debt levels and retirement confidence. In 2017, just 4% of those with a major debt problem say they are very confident about having enough money to live comfortably in retirement, compared with 31% of workers who indicate debt is not a problem. On the other hand, 36% of workers with a major debt problem are not at all confident about having enough money for a financially secure retirement, compared with 8% of workers without a debt problem.

NEXT: Will Social Security and Medicare be there?

The RCS found that just 37% of workers say they are very or somewhat confident that the Social Security system will continue to provide benefits of at least equal value to the benefits received by retirees today, including just 6% who are very confident. One in five workers (20%) are not at all confident.

Confidence that Social Security will continue to provide benefits that are at least equal to today’s value is higher among workers ages 55 or older than among younger workers, and retirees are more likely than workers overall of any age to be confident about the future value of Social Security benefits. Half of retirees (51%) say they are confident about the future value of Social Security benefits, including 13% who are very confident.

Today’s workers are almost half as likely to expect Social Security to be a major source of income in retirement (35%) as today’s retirees are to report that Social Security is currently a major source of income (61%). However, roughly nine in 10 workers and retirees both expect/report that Social Security will be/is a source of income in retirement, whether as a major source or minor source of income.

Worker confidence in maintaining Medicare’s current level of benefits in the future is also low. Just 38% of workers say they are very or somewhat confident that the Medicare system will continue to provide benefits of at least equal value to the benefits received by retirees today, and only 5% are very confident. One in six (17%) are not at all confident in future Medicare benefits.

Like views of Social Security, worker confidence about the future value of Medicare benefits is higher among those ages 55 and older, and retirees are more likely than workers overall of any age group to be confident. Even so, just 8% of retirees say they are very confident in the value of the future benefits paid by Medicare, but 44% are somewhat confident.

The survey was conducted from January 6, 2017, to January 13, 2017, through online interviews with 1,671 individuals (1,082 workers and 589 retirees) ages 25 and older in the United States. RCS results and fact sheets may be found at https://www.ebri.org/surveys/rcs/2017/.

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