Reducing Risk in Your Pension Plan: Lump Sum Payments to Former Employees

Have you considered offering lump sums to former employee participants as a step toward reducing pension risk and expense? Below are some things to consider:

• The first priority of the plan fiduciaries is to act solely in the interest of plan participants (which includes former employee participants), providing them with the full benefit they’ve earned and communicating their options with regard to the distribution of their benefit.
• Is the plan’s funded percentage (AFTAP) over 80%, or has the plan been completely frozen since before September 1, 2005? If the answer to either of these is “yes”, you have jumped a hurdle that would limit your ability to pay the lump sums. Still, because this percentage changes annually, you should discuss this possible limitation with an actuary.
• In general (but depending on your plan’s provisions), lump sums under $1,000 may be paid without participant consent; lump sums over $1,000 require the participant’s affirmative election to take a lump sum, and lump sums over $5,000 require that you also offer a monthly benefit as an alternative to the lump sum in order for the participant to make a valid election. These factors affect the administrative work involved with the lump sum process.
• Highly Compensated former employees may possibly not be permitted to receive a lump sum distribution. There are many parameters on this “restriction” so it should be discussed with an actuary.
• Get an estimate of the value of these lump sums. Lump sums are typically higher than the liabilities calculated for minimum funding purposes that you see in your annual actuarial valuation report. Paying lump sums could result in higher minimum contributions, decreased funded status, and/or other effects that may be of significance. An actuary can assist in the analysis of this when providing an estimate of the lump sum values.
• Lump sum distributions from the plan could trigger a “settlement” recognition on your company’s financial statement pursuant to pension accounting rules. You may want to get an estimate of the impact so that this isn’t a big surprise after the lump sums have been paid.

These are some of the main considerations in determining whether paying lump sums to former employees makes sense for your plan. To learn more about all options available to reduce the risk in your pension plan, read Reducing Pension Plan Risk.

If you would like assistance in determining whether paying lump sums is an effective and viable option for your plan, contact our actuarial team.