With the impending change in corporate tax policy, it is important to consider how funding up the pension plan now, under the current tax structure, may be financially advantageous to your organization. Additional funding may then put you in a good position to take action with one or more of the “de-risking” options outlined below.
MINIMIZING RISK IN PENSION PLANS
Pension plan “de-risking” has become a prudent consideration for pension plan sponsors, especially for those plans that have frozen or partially frozen benefits or otherwise curbed the longevity of the plan, but also for ongoing plans that want to minimize risk wherever possible. De-risking actions employ strategies to lessen a plan’s sensitivity to factors such as market swings, life expectancy improvements, PBGC premiums, pension legislative changes, changes in tax code, and other uncontrollables. Some of these factors affect legally required minimum funding, some affect the real cost of the plan (the real cost of paying all benefits due and administrative expenses over the life of the plan), and most affect both.
APPROACHES TO DE-RISKING
In very general terms, there are four approaches to de-risking:
- Allow lump sum payments from the pension plan when individuals terminate employment
This strategy removes risk of future mortality improvements and interest rate fluctuation with regard to the future benefit streams that are instead paid as a lump sum. There are varying degrees of offering lump sums: to all terminated employees, at retirement age only, up to a stated threshold, or as a “window” opportunity for terminated employees. This approach has the additional benefit of reducing per-participant PBGC premiums and alleviating the administrative cost of tracking participants who are no longer employees.
- Use a Liability Driven Investment (LDI) asset management approach
This strategy involves investing pension assets in vehicles that match the future pension plan cash flow needs. As a plan matures and has greater cash outflows and a shorter time horizon, a larger portion of investments under this approach will be directed to fixed income vehicles to preserve capital and reduce the impact of market swings.
- Transfer longevity risk via use of insurance company products
Purchasing annuities for retirees in pay status provides a secure vehicle outside the pension plan to continue the retirees’ lifelong benefit payments. Although this approach may be expensive to complete, there are creative options that can be employed when teaming up with experienced pension risk transfer professionals to hedge costs, such as buying into a group annuity contract rather than purchasing individual annuities. This approach will reduce per-participant PBGC premiums and alleviate administrative cost of tracking retirees. Your retirees will experience easy transition with no disruption to their monthly benefit payments.
- Plan termination
The ultimate de-risking action is to terminate the pension plan and pay out all benefits to participants via annuity purchases and/or lump sum payments. If your plan is frozen, plan termination is probably your goal as soon as feasible. Sponsors may want to consider financing the cost of plan termination if the interest cost would be less than the expected future administrative costs. Plan termination is a lengthy and costly process, but if it will be done eventually, the decision is mostly about timing.
THE NEXT STEP
Each approach to decreasing risk requires careful consideration of the benefits and trade-offs such as cost, tax advantages, philosophical positions, administration, time horizon, etc. with regard to the particular pension plan and its company sponsor. Watkins Ross has the expertise and resources to assist you and your advisors in exploring how these opportunities would best suit your specific circumstances.
Contact Cheryl Gabriel, CPC at email@example.com to begin the discussion.