As the end of the year approaches, defined benefit and defined contribution plan sponsors need to be aware of their obligations, say experts.
For defined benefit plan sponsors, now is the time to look at changes in the IRS mortality tables, a rise in Pension Benefit Guaranty Corporation premiums and potential tax reform to determine how those three things will impact their retirement plans.
For defined contribution plan sponsors, the end of the year is the time when plan sponsors should reexamine why they offer employees a retirement plan, says Gregg Levinson, an attorney in Willis Towers Watson’s compliance group. You should “measure the trends in your own population about how effective these plans are and how plans ae being utilized and how good the design is.”
Experts recommend focusing on the following areas:
Defined benefit plans
Matt Sicking, a national retirement business leader for Willis Towers Watson, says that there are a number of things impacting defined benefit plans in 2018, including new mortality tables, tax reform, lower discount rates and higher equity returns.
The IRS’ updated mortality tables for 2018 increase the amount of money plan sponsors must allocate to their pension plan budgets and reduce a plan’s funded status in the short-term, according to the Society of Actuaries.
IRS life expectancy projections have gone down slightly since 2014 when a 65-year-old was expected to live 23.1 more years. In 2017, the IRS reduced that number to 21.7 years.
PBGC premiums, the amount defined benefit pension plan sponsors must pay per participant to the Pension Benefit Guaranty Corporation rose from a flat rate of $64 per participant in 2016 to $69 per person in 2017. That number is expected to increase to $74 per participant in 2018 and $80 per participant in 2019.
Companies pay premiums to the Pension Benefit Guaranty Corporation as insurance against a time when the plan can no longer pay benefits to participants and the PBGC must take over paying benefits for the plan.
Veteran consultants say that with all of these changes, defined benefit pension plan sponsors must decide if they want to keep their plans or de-risk them in the coming year by either buying annuities or offering lump sum payments to participants as a way to eventually shut down their plans and shift those plan liabilities off their balance sheets.
Beth Ashmore, senior consultant, retirement risk management for Willis Towers Watson in St. Louis, says that there is “a lot of emphasis on how plan sponsors are thinking about financing the debt they currently have.”
On the funding side, more organizations are accelerating their cash contributions to their plans. Much of that activity stems from the rising PBGC premiums.
“Many clients who have been taking funding holidays are going to start seeing cash funding requirements so they are trying to get ahead of that,” Ashmore says.
Conversations around tax reform, specifically corporate tax rates going down in the future, have spurred plan sponsors to make additional contributions because there is a fairly good return for getting cash into their pension plans now, she adds.
There has been a lot of talk about liability settlements, but in the past year, only 10% of obligations have been transferred via annuity or lump sum distributions.
“A lot of sponsors have done that, but in fairly small transactions,” Ashmore says.
There have been a “significant amount of lump sums for terminated vested participants,” she says but adds that that activity is going to level off.
Ashmore believes that lump sum distributions are still an economically attractive option for lowering risk in pension plans in 2018.
The annuity marketplace is growing. Many plan sponsors are exploring this as an option for their plans. In 2012, $36 billion was transferred to the annuity market in the second quarter, driven by General Motors’ and Verizon’s decisions to close their pension plans. In the second quarter of 2017, $6.5 billion was transferred to the annuity market.
“There has been a steady increase in terms of deal flow, the amount of dollars and the number of sponsors entering the marketplace,” Ashmore says.
Instead of transferring their entire pension plan liability, most plan sponsors are doling out partial retiree settlements, particularly on retirees with smaller benefits, she says. Those benefits have the same administrative load as someone with larger benefits so it makes sense to maximize the head count to reduce operational costs.
“If you’re thinking of an annuity purchase, the way you approach the marketplace will depend on the size of the transaction you are doing,” Ashmore says. “You can’t do that unless you know what strategy you are trying to obtain. There is no one size fits all.”
Defined Contribution Plans
Defined contribution plan sponsors also must keep an eye on tax reform as Congress dabbles with the idea of drastically reducing pre-tax contribution limits to help pay for business tax cuts, say experts.
Levinson says that Willis Towers Watson tries to measure other things besides plan participation because a plan could have 95% participation and still be an underperforming 401(k) plan.
“What you want to look at is deferral rates up to and beyond the match, the lineup in the investment lineup and how well participants are using the tools at their disposal,” he says.
Plans that use modeling tools have better participation rates, higher deferrals and better investment returns, Levinson says. The bad news is that a plan can have a 96% participation rate in their plan but only 14% of those participants use the modeling tools.
Including financial wellness programs as a benefit can help increase the financial outcomes of DC plan participants, he adds.
Levinson recommends that defined contribution plan sponsors implement ideas for better plan outcomes, including offering plan features like automatic enrollment, automatic escalation and a qualified default investment alternative like target-date funds. As well, he counsels companies to meet people where they are, not just taking a one size fits all approach to different demographics of employees and to consider holistic financial wellness because most people’s financial problems don’t begin with how much they are saving for retirement.
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