Data and Research October 23, 2020

COVID-19’s Effect on Retirement Savings Could Be Long-Lasting

Actions detrimental to employees’ long-term financial security have increased 50% since April, and illustrations show the effect of some of those actions on account balances at retirement.

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More than one-quarter of respondents (26%) to the Edelman Financial Engines “2020 Financial Insights Study” have withdrawn money from their retirement or savings accounts during the COVID-19 pandemic.

Of those, more than one-third (39%) gave money to help a family member or friend in need, and more than half (51%) paid their own bills. On average, those who withdrew money say it will take almost six years to replenish their savings.

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Separate research by Edelman Financial Engines shows actions detrimental to employees’ long-term financial security have increased 50% since April. Nearly half of those actions (45%) directly harmed retirement accounts (e.g., changing portfolio allocations, reducing savings rates and borrowing from the plan), while 30% increased outstanding debt and 21% reduced or depleted emergency savings.

The second survey of 1,902 U.S.-based retirement plan participants in August and September found a high prevalence of early retirement account access, with 28% reporting having previously accessed funds from their retirement plan. Of those, 43% have done so multiple times. COVID-19 is accelerating this trend, with 16% of participants currently considering early access and nearly half (46%) saying the primary reason is related to the pandemic.

Of those who withdrew or borrowed money from their retirement plans, 55% say they now regret it, according to the research. The regret may be well-founded.

The research report includes an illustration of the effects of a defined contribution (DC) plan loan. Edelman Financial Engines created hypothetical scenarios for a borrower named John who is 45 years old and has a $100,000 balance from which he can take a loan. John contributes 6% annually to his plan and his employer provides a 3% matching contribution. The scenarios assume a 5% loan interest rate, a 7% average annual investment return, that contributions to the plan are prohibited until the loan is repaid and a that a default could occur after two years, but the taxes and penalties incurred are removed from the default scenario.

In the best case scenario, John never borrows from his account and, by the time he is 70, his account is worth nearly $1.2 million. If he takes a $50,000 loan and repays it, his account is worth $992,519 when he’s 70. If he defaults on the loan, his account is only worth $590,247 by the time he’s 70.

To show the effect of a hardship withdrawal, Edelman Financial Engines performed a similar calculation for PLANSPONSOR. The calculation assumes a hardship withdrawal of $72,780, which, after paying taxes, yields $50,000 in after-tax funds, to be equivalent to taking out a $50,000 loan (22% federal tax, 9.3% California state tax). In this case, John’s balance at age 70 would be $774,833.

Edelman Financial Engines says this shows that taking a hardship withdrawal is even more detrimental to retirement savings than taking out a loan that is repaid.

Data and Research October 23, 2020

PBGC Reports Effect of Pension Risk Transfers on Its Premium Income

The agency could see a premium income loss of $196 million for the 2019 premium payment year, but certain trade-offs make it hard to tell if the PBGC’s future net financial position will be strengthened or weakened.

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Eight percent of plans covered by the Pension Benefit Guaranty Corporation (PBGC) performed a risk transfer activity (RTA) during the 2015 to 2018 period.

Risk transfers are one of the methods used by defined benefit (DB) plan sponsors to reduce the financial risks associated with sponsoring their plans. Risk transfer transactions reduce some or all the pension plan’s liability and risk by offering lump-sum distributions to participants or by purchasing annuities from insurance companies to provide participants’ promised benefits. The PBGC revised premium filing procedures in 2015 to require after-the-fact reporting of RTA.

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Data collected from PBGC premium filings shows 44.8% of large single-employer plans (those with more than 1,000 participants) performed an RTA during the 2015 to 2018 period. Nearly all (92.6%) plans that performed an RTA during the period provided a lump-sum distribution window, compared with only 18.8% of plans that opted to purchase annuities.

The PBGC notes in its recent report of the data that 2.4 million participants received either a lump-sum distribution or an annuity as part of a risk transfer transaction, and, thus, are no longer participating in their DB plan or, in the case of a risk transfer, are not covered by PBGC insurance. These participants represent 7.9% of the 30.9 million reported to be participating in DB plans in 2014. Sixty-three percent of all participants affected by an RTA during the 2014 to 2018 period received a distribution from their plan through the election of a lump-sum distribution.

Effect on PBGC Income

Single-employer DB plans pay a flat-rate premium for each participant in the plan. For 2019, the flat-rate premium was $80 per participant. For illustrative purposes, the PBGC assumed the participants leaving the single-employer program through RTAs would not have left the system by some other cause during the 2015 through 2018 period. In that case, the 2,444,460 participants removed through RTAs from 2015 through 2018 represent a flat-rate premium income loss to PBGC of $196 million for the 2019 premium payment year. This represents 8.7% of the $2.236 billion flat-rate premium income PBGC’s single-employer program is estimated to receive from plans for the 2019 premium payment year.

However, the agency notes that there are other factors to consider when projecting flat-rate premium income loss from RTAs. Participants removed from the system through RTAs would have eventually left the system for some other reason, it says, so the flat-rate premium income lost due to a participant’s removal is not an annual loss in perpetuity. Participant counts in single-employer plans are reduced for other non-RTA reasons, such as mortality, election of a lump sum or an annuity purchase not associated with an RTA, and plan termination.

In addition to the flat rate premium, underfunded single-employer pension plans pay a variable-rate premium (VRP) based on the amount of the plan’s underfunding, up to a cap based on the plan’s participant count. For the 2019 premium filing year, the VRP rate was $43 per $1,000 of unfunded vested benefits, with a cap of $541 per participant.

“Reducing the VRP may be a factor in a sponsor’s decision to perform an RTA, particularly if the plan is paying VRPs at or near the per-participant cap,” the report says. The data shows that plans paying VRPs at the per-participant cap performed RTAs at a rate more than three times greater than all other plans (8.79% vs 2.74% from 2015 through 2018). It also shows VRPs appear to be more impactful on a small plan’s likelihood of performing an RTA than a large plan.

The impact of RTAs on PBGC’s VRP income is not easily determined, since a plan’s underfunding (and subsequent VRPs) are determined by factors not directly related to the RTA. However, the agency used the participant reduction in plans paying the per-participant VRP cap as a source for a rough estimation. Using the simplified assumption that plans paying the VRP cap in the year in which they performed an RTA will continue to pay the cap in the subsequent year (and would have continued to pay the cap had they not performed an RTA), the VRP income lost from those plans will roughly equal the VRP cap multiplied by the number of participants removed through an RTA, PBGC explains.

According to 2018 premium filings, 168 plans that were paying the VRP cap performed an RTA, removing a total of 117,050 participants. User the PBGC’s assumption, those 117,050 participants represent a “loss” of premium collections of $63 million, based on the $541 per-participant VRP cap applicable to the 2019 premium filing year. This represents only 1.3% of the $4.77 billion VRP income the agency’s single-employer program is estimated to receive from plans for the 2019 premium payment year.

However, the PBGC notes that not all plans performing RTAs are currently at the VRP cap. “It is possible that the removal of participants through RTAs could cause a plan not at the VRP cap to hit the cap, resulting in additional lost income for PBGC. Thus, the $63 million income loss from the simplified calculations of plans currently at the VRP cap may represent only a portion of total VRP loss due to RTAs,” the report says.

While RTAs represent a loss of future premium income to PBGC’s single-employer program, they also reduce the participant population and the benefits that PBGC is responsible for insuring. “This raises the question of whether, on balance, PBGC’s future net financial position is strengthened or weakened by RTA activity,” the report states.

The agency looked at whether a plan performing an RTA is more or less likely to present a claim to the PBGC after the RTA is completed, and how the RTA affects the PBGC’s exposure (i.e., the plan’s unfunded guaranteed benefits). One thing it found is that the RTA rate among large plans sponsored by financially weak companies does not significantly differ from the RTA rate among other large plans (47% vs. 44.2%). Additionally, the proportion of total participants removed through RTAs during the study period was similar between plans sponsored by financially weak companies and other plans.

“As for whether RTAs impact the size of a potential future claim to PBGC, we do not currently have enough data to determine trends in claim size following an RTA,” the agency concluded.

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