Among the various techniques implemented by plan sponsors in recent years for de-risking of single employer pension plans is the cash-out window: an offer to terminated, vested participants of a limited period of time to voluntarily elect a lump sum cash distribution or immediate annuity, rather than having to wait until early or normal retirement age to obtain a lifetime or joint and survivor annuity distribution from the plan. In Notice 2015-49, the IRS also alerted plan sponsors that they cannot offer retirees in pay status the option to take a lump-sum payment in lieu of ongoing annuity payments, and therefore, any current windows are limited to terminated, vested participants who are not in pay status. These “cash-out windows” or “risk transfers” have been part of a trend in de-risking techniques, as opposed to a full pension plan termination or freeze, as plan sponsors strive to find ways to reduce plan liabilities and/or overall costs associated with managing a pension plan program. With anticipated changes coming to the IRS’ mortality tables in 2017, as well as changes to the interest rate environment, it remains to be seen whether the lump sum cash-out windows will remain an attractive de-risking technique in prospective years. Nevertheless, for any plan sponsor currently contemplating this approach, or in the midst of rolling out this approach in 2016, it is important to be mindful that while the decision to amend a plan to provide for such a window or risk transfer mechanism is a business or settlor decision, the implementation of that decision is a fiduciary responsibility, and prudent participant communications regarding any window opportunity are critical.
De-risking approaches were studied in 2013 by the Advisory Council on Employee Welfare and Pension Benefits Plans (the “Council”) (which was established under Section 512 of ERISA to advise the Secretary of Labor) and part of their charge was to identify areas of concern that warranted further guidance for these windows. One of the areas identified by the Council as requiring more guidance included participant disclosures. The Council recommended that disclosures be provided to participants at least 90 days prior to the date an election for a distribution had to be made. This disclosure which includes relevant information to enable a participant to make an informed election including equivalent comparisons of a lump sum distribution to the normal form of benefit under the plan, tax information, and explanation regarding any early retirement subsidies included in the calculation of a lump sum distribution.
In 2015, the Government Accountability Office (“GAO”) also released a report entitled “Private Pensions: Participants Need Better Information When Offered Lump Sums that Replace Their Lifetime Benefits”. After reviewing data from 22 plan sponsors that offered lump sum windows in 2012, as well as 11 informational packets provided by plan sponsors, the GAO concluded that the information consistently lacked key information needed to make an informed decision or was otherwise unclear. The issues identified by the GAO as requiring further explanation include the calculation of the lump sum and its relative value versus the monthly annuity, positive and negative ramifications of opting for the lump sum, tax implications, the roll of the PBGC with regard to the pension benefits, and assistance and general instructions for accepting the lump sum during the window. In 2015, the Council also continued to focus on advocating for the provision of unbiased information that participants need to make informed decisions when faced with lump sum risk and insurance annuity risk transfer, and sought to provide the Department of Labor with draft model notices and disclosures that could be used by plan sponsors for this purpose.
While a model form of notice or mandate has not been issued by the Department of Labor to date, plan fiduciaries should consider the issues that were raised in these various reports when designing plan communications regarding any lump sum cash out window or risk transfer (which would be in addition to other required plan distribution notices). Suggested topics to address in communications include:
• Description of the plan benefit options and explanation of the lump sum calculation
• Explanation of the pros and cons of the window options in an objective, unbiased tone
• The relative value of a lump sum compared to the normal form of benefit under the plan
• Tax implications of a lump sum and rollover rights
• Investment and longevity considerations of outliving the lump sum distribution
• Considerations related to purchasing a retail annuity with a lump sum
• Explanation of the role of the PBGC and the level of protection it offers to the benefits under the plan
• Clear instructions regarding how to elect the lump sum distribution during the window period, any consents required, and where to go for assistance or questions
• Voluntary nature of the window and right to defer benefit commencement
• If the window includes an annuity risk transfer option, explain the difference between a plan annuity and an annuity contract outside the plan, and the change from a PBGC protected benefit to an annuity subject to State Insurance Guarantees; also the fiduciaries must prudently select the annuity provider and should consider the guidance under DOL Interpretive Bulletin 95-1.
Any plan sponsor contemplating a de-risking strategy that involves plan distributions such as these should take the time to ensure that the participant communications and disclosures are prudently designed and that a window election period provides participants with sufficient time to review the information package provided and make their elections (e.g., 90 days). This will guide participants in their understanding of their benefits and their choices under the window. Plan fiduciaries will also be able to demonstrate that they are acting solely in the interest of plan participants and beneficiaries with the exclusive purpose of providing benefits to them.