It’s an idea, it seems, whose time has gone. The traditional defined benefit pension plans that were once a bulwark of middle class financial security are drying up, beset on three sides by demographic, economic and monetary Pension challenges:
First, retirees are living longer into retirement – in some cases with their retirement years as pension claimants outnumbering the years they spent working.
Second, increased globalization is forcing American companies to operate on narrower operating margins. It is more difficult now for American companies to direct operating earnings into pension plans and still compete with foreign manufacturers who aren’t laboring under the burden of supporting a generation or two of former workers.
Third, A prolonged period of low interest rates is holding down returns on pension funds, which in turn hampers the eventual benefit levels these funds can support.
As a result, employers nationwide are increasingly cancelling their defined benefit plans – at least for new workers – and seeking to stop the hemorrhaging by buying out their pension obligations.
In the past two years, corporations have bought back more than $49 billion worth of pension obligations from workers – and experts say that trend is going to continue for a while.
The ones that aren’t discontinuing and dismantling their plans for cash payments are busily transferring their risk to third-party financial institutions. A 2014 white paper from Prudential indicated that almost half of financial executives expected to engage a pension insurer to lower pension plan risk exposure.
The Prudential report also found that pension buyouts were increasing among small and medium-sized employers.
Types of Buyouts
Broadly speaking, there are three types of pension buyouts:
Full buyout: The pension plan is shut down entirely. Companies buy annuities for all plan beneficiaries/participants.
Partial buyout with lift-out: The company buys an annuity for existing retirees (or some other specific group of participants
Partial buyout with spin-off and termination: As the name implies, the plan is eventually terminated.
Is a buy-out in store for your business?
For some financially solid businesses with low labor inputs, solid margins and/or limited competition from overseas, continuing with a defined benefit pension plan is not a problem. For others, it may just be a matter of time before the company has no choice but to restructure or terminate the pension plan. If you’re in this boat, or think you might be, here are the steps to execution:
Assemble a team of executives, including your CFO, HR chief and any outside advisors.
Get your data together.
Identify your specific objectives. Can you accomplish them with a partial buyout?
Consider the pricing and transaction structure. For example, will there be an in-kind asset transfer? Cash? How does the mix between cash and other assets affect your pricing?
Consider the rate of return: Are the annuities, if any, competitive? Do they accomplish the risk transfer goals of the organization?
Do the annuities adequately protect plan participants? Are they drawn on a company with sufficent strength and financial stability to keep its obligations to plan participants?
Execute the transfer or termination, and distribute cash or annuities as appropriate.
Reconcile your data.
“Following a structured process and working with an experienced insurer are keys to shortening the timeline for executing a transaction and accomplishing a smooth pension risk transfer,” advised Scott Gaul, one of the authors of the Prudential report and a senior vice president in charge of the Pension Risk Transfer desk at Prudential.
BusinessPlans, Inc. does not intend to provide legal or tax advice and information contained in this article should not be interpreted as such. Regulations governing pretax plans are often open to interpretation and should be reviewed with your legal or tax advisor before making any decisions regarding your plan.