Helping employers overcome pension cash out misconceptions

While cashing out pensions for terminated vested employees may be a beneficial move for employers, many are hesitant to do so because of concerns that can easily be addressed by benefit advisers and brokers.

Seeking to transfer pension risk, many defined benefit pension plan sponsors have opted to offer lump sum cash out windows for terminated vested participants, and the consulting firm Mercer expects this trend to intensify in 2014 due to increases in interest rate levels and improvements in funded status during 2013. Still, while the advantages for employers may be plentiful, many still hesitate to go forward with such a move due to worries about interest rates, liability, cost and more.

“Some employers for whom a cash out might be appealing are waiting on the sidelines,” a recent Mercer report says; benefit advisers and agents could be working with employers to create a “successful risk transfer project.”

What’s the worry?

Most commonly, employers hold back from cash outs thinking that “interest rates are too low right now,” Mercer says in the newly published paper called Terminated Vested Cash Outs, Overcoming Common Misconceptions. A lower interest rate leads to a higher lump sum value, causing some employers to worry they are paying out lump sums at the “top of the market.” But, Mercer writes, interest rates have increased about 75 basis points from their 2012 lows and says that if employers were looking to profit from the expectation of rising rates, “there are generally more efficient ways to do so than carrying terminated vested liabilities,” including selling bonds.

Employers are also concerned that paying lump sums will trigger a profit and loss, or P&L, settlement charge and impact the company’s share price, but advisers can work with employers to structure the lump sum program to avoid settlement accounting, Mercer says.

Other common misconceptions Mercer found that advisers can be addressing include employers believing their participant data is not clean enough, worrying their contributions will go up or thinking the cost of administering the cash outs will be too expensive.

Employers may also be unaware of all the benefits reaped by offering cash outs to terminated vested employees, which advisers can highlight.

The good

Attractions to employers are “reduced pension liability, leading to lower plan financial risk and volatility,” says Matt McDaniel, a senior Mercer consultant. “Other advantages include eliminating PBGC premiums, investment and administrative costs and making payments before updated mortality tables come into effect.”

“Companies are offering these buyouts as a way to shrink the size of their pension plans, which ultimately reduces the impact of that pension plan on the company’s financials,” John Beck, senior vice president for benefits consulting at Fidelity Investments says in a blog post on Fidelity’s website. “From an employee’s perspective, the decision comes down to a trade-off between an income stream and a pile of money that’s made available to them today.”

McDaniel says the cash out programs tend to be popular with eligible former employees, however, because “take-up rates for an effectively executed lump sum exercise can be upwards of 50%.”

He cautions that “the business case for pension cash outs is driven by the unique circumstances of the plan sponsor, and a cash out will not make sense in every situation.”