Should Plan Sponsors Purchase Annuities for Their Pension Plan?

At times, the recommendations of trusted advisers can seem to be at odds. This may be true concerning whether to use an annuity purchase to de-risk a company pension plan. How does the plan sponsor get to the best answer? Consider this scenario:

 

Recent reports show that pension plans have experienced a growth in their funding percentages. Company XYZ’s pension plan’s funded status has improved over the last year and a half. The sponsor has also read articles concerning lump-sum buyouts, plan terminations and annuity purchases.

 

The phone rings. On the line is an annuity broker. He explains that there are advantages to purchasing annuities for some of XYZ’s pension plan participants. This transaction would transfer the liabilities and associated assets to an insurance company. The broker goes on to explain the advantages of an annuity purchase:

 

• It lowers a plan’s participant count, resulting in a lower Pension Benefit Guaranty Corporation (PBGC) premium;
• It lessens volatility in financial measurements, as the pension liability would be lower;
• It transfers risk;
• It lowers recordkeeping and administrative costs; and
• It removes the requirement for a plan audit, if the plan’s participant count drops below 100.

 

The broker also notes that annuities can be purchased with plan assets.

 

An annuity purchase sounds like it might be a good idea to explore. So the sponsor calls the plan’s actuary to discuss the prospect.
The actuary agrees with the advantages the annuity broker named but also brings up some potential negatives:

 

• The minimum required contribution may increase. If the purchase price for the annuities is significantly greater than the liability released, the minimum required contribution could go up.
• The purchase could trigger settlement accounting; the net periodic cost could increase for the year of purchase.
• If any of the participants are formerly Highly Compensated Employees (HCE), some restrictions will kick in. The plan will need to be funded at 110% to purchase annuities for HCEs.
• PBGC premiums could actually increase in some circumstances.

OK. Now what?

 

There are ways to plan an annuity purchase and control the negatives by looking at the plan’s specific circumstances. Here are some strategies to consider:

Forecast future funding

The plan’s actuary should be able to perform a forecast to determine expected future funding. The forecast could look at the lower asset value and smaller population possible after the transfer. It might be worth the increase in funding to lower PBGC premiums and realize other benefits.

Avoid an accounting settlement charge

The sponsor could limit the purchase to the sum of its service cost plus interest cost. It will also need to consider the regular benefit payments of the plan in that analysis.

PBGC premium strategy

Purchase annuities for participants who have a small benefit and/or for older participants who have a small liability. An analysis of current and forecasted expense savings for various benefit levels can help with the right annuity purchase.

 

The PBGC premiums for 2019 are the per participant fee of $80 and the variable rate fee of 4.30% with a cap of $541 per participant. If the plan is at the cap, it will pay $621 per participant per year. There are also other administrative expenses such as bank fees, plus 1099 and annual notifications.

 

The following chart shows administrative expenses as a percentage of the benefit increases as the monthly benefit amount decreases.

An annuity purchase should be a strategic tool to manage the risk of a pension plan. Before considering such a purchase, plan sponsors should take a closer look at all of the advantages and disadvantages specific to their plan and coordinate with their trusted advisers.

 

For more information, contact David Davala at 216-875-1923 or David.Davala@findley.com.

 

David Davala is a senior consultant at Findley. He is an enrolled actuary (EA), a member of the American Academy of Actuaries (MAAA) and a member of the Society of Pension Actuaries (MSPA). 

 

 

This feature is to provide general information only, does not constitute legal or tax advice, and cannot be used or substituted for legal or tax advice. Any opinions of the author do not necessarily reflect the stance of Strategic Insight or its affiliates.