Administration October 8, 2019

Could GE Have Continued Its DB Benefits?

GE is freezing pension plans and offering a lump-sum window to certain former employees, but John Lowell, with October Three, questions whether a design-based solution would have helped the company continue to offer DB benefits to employees.

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GE announced it is taking three actions related to its U.S. retirement benefits as part of its strategic priority to improve its financial position.

The company is freezing the U.S. GE Pension Plan for approximately 20,000 employees with salaried benefits, and U.S. Supplementary Pension benefits for approximately 700 employees who became executives before 2011, effective January 1, 2021. It is also pre-funding approximately $4 billion to $5 billion of estimated minimum Employee Retirement Income Security Act (ERISA) funding requirements for 2021 and 2022.

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GE is also offering a limited time lump-sum payment option to approximately 100,000 eligible former employees who have not started their monthly U.S. GE Pension Plan payments.

In total, the actions announced are expected to reduce GE’s pension deficit by approximately $5 billion to $8 billion and industrial net debt by approximately $4 billion to $6 billion. At year-end 2018, the plan’s funded ratio was 80%, under generally accepted accounting principles (GAAP). After distribution of the lump sum amounts, the company expects to record a non-cash pension settlement charge in the fourth quarter of 2019, which will be determined based on the rate of acceptance.

Kevin Cox, chief human resources officer at GE, said, “Returning GE to a position of strength has required us to make several difficult decisions, and today’s decision to freeze the pension is no exception.  We carefully weighed market trends and our strategic priority to improve our financial position with the impact to our employees. We are committed to helping our employees through this transition.”

John Lowell, Atlanta-based partner and actuary for October Three, notes that GE has taken steps that a number of other large organizations have taken. He concedes that without knowing what other options GE may have considered or were presented to the company, it’s not possible to decide if this was the optimal solution for it. However, he says, “In our discussions with defined benefit sponsors in similar situations, we’ve often apprised them of options that don’t result in an exit from the defined benefit system, but do serve the purpose of limiting volatility in liability growth and in cash and accounting costs. Such design-based solutions may become a wave of the future once employers see that perhaps better results can be achieved by staying in the DB system.”

According to Lowell, traditional risk transfer solutions smooth out the financial effects of a defined benefit, but they do so at a substantial psychological cost to those employees who are depending on lifetime income. “If a company has been in the defined benefit arena for as long as GE, then what they have essentially done is made a commitment to providing lifetime income solutions at a fair price to their employees. What has driven many companies away from this is not the lifetime income concept, but the volatility and unpredictability of the costs of defined benefit.”

One suggestion for a design-based solution is a market-based cash balance plan, according to Lowell. “It gives employees the opportunity to get to choose between lump sums or fairly priced lifetime income (within the plan) and they do so with cost predictability and stability for the employer. In my opinion, it’s the design that forward-thinking employers will be looking at for the next generation. The key about market-based cash balance is that it eliminates most of the unwanted volatility.”
Ask the Experts October 8, 2019

(b)lines Ask the Experts – Difference Between Plan Distribution Withholding and Actual Taxes Paid

Experts from Groom Law Group and Cammack Retirement Group answer questions concerning 403(b) plans and regulations.
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“What is the difference between the 20% withholding for most retirement plan distributions (i.e., eligible rollover distributions) and the actual taxes paid? My 403(b) plan participants (current and former) who take distributions seem to be thoroughly confused on this issue, so any assistance the Experts can provide would be greatly appreciated!”

Stacey Bradford, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

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Indeed we can provide assistance! In order to best explain the difference between withholding and actual taxes paid, the Experts often use the analogy to how a participant gets paid by his/her employer. When an employee is paid each pay period, a certain amount is withheld from each check for payment of federal, state and local taxes. However, this is NOT the actual amount of taxes an employee owes; that amount of taxes is NOT figured out until an employee files his/her personal income tax return. If the amounts that have been withheld are GREATER than the amount of taxes an employee actually owes on his or her income, then the employee receives a tax refund. If the amounts that have been withheld are LESS than the taxes the employee owes on his or her income, then the employee owes the IRS additional taxes at the time of filing.

Plan distributions work in a similar fashion; at the time of distribution, a portion of the distribution is generally withheld for the payment of taxes. For eligible rollover distributions (e.g., lump sums), it is a mandatory 20% withholding, and a participant cannot opt out of this 20% withholding. There are exceptions to this mandatory withholding in the case of non-eligible rollover distributions, for example, when a participant withdraws elective deferrals in the event of financial hardship, or to the extent the distribution is a required minimum distribution. In those cases, a participant may generally elect a withholding amount; many recordkeepers will withhold 10% unless a participant elects otherwise.  Separately, for annuity payments, wage withholding applies.

The plan distribution is then added to an employee’s income for tax purposes. If 20% was withheld from the distribution, and the employee actually owes, say, 40% tax on that distribution, he/she would owe an additional 20% of that distribution at tax time to pay outstanding taxes on that distribution. Of course, if the employee only owes 10% on the distribution, he/she would be entitled to an additional refund (or credit against taxes otherwise owed) equal to 10% of the distribution. However, many employees, particularly ones who are younger than 59 1/2 when they take a distribution, end up owing additional taxes on distributions at filing time. The reasons for this are a) there is a 10% tax penalty on distributions if the employee is younger than 59 1/2, and b) the income from the distribution can push the employee into a higher income tax bracket, which means that a higher tax rate would apply to the distribution (this can be a particular problem with large distributions).

Of course, a cash distribution can be rolled over by the distributee within 60 days as well, subject to certain rules. In that event, the 20% withheld will still generally be taxable unless the distributee makes it up by finding other cash to rollover within the required period—that is why a direct rollover to the new plan or IRA is often preferable for the distributee.

Therefore, in order to address any employee confusion, you should explain to them that withdrawals are similar to receiving the taxable income that they receive in a paycheck (only with an additional 10% penalty tax if they are younger than 59 1/2). Thus, any plan distributions should be considered when tax planning for the year to avoid having to pay additional taxes at the end of the year. In high tax states, this could be as high as 50% of the distribution amount, which is why distributions prior to retirement can be quite disadvantageous from a tax perspective.

 

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

Do YOU have a question for the Experts? If so, we would love to hear from you! Simply forward your question to Rebecca.Moore@strategic-i.com with Subject: Ask the Experts, and the Experts will do their best to answer your question in a future Ask the Experts column.

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