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Education Can Make Lump Sum Windows Work for Employers, Employees

In recent years a major focus for employers has been pension risk management. For those companies that sponsor a traditional pension plan, one of the most common strategies is offering a “lump sum window” to terminated employees who are entitled to a pension later, but have not yet reached retirement age. This strategy removes these plan participants from the plan, and correspondingly eliminates any future financial risk to the employer.

With new improvements in mortality likely to be factored into lump sum calculations in future years, some favorable movement in interest rates, and rising PBGC (Pension Benefit Guaranty Corporation) premium payments, the implementation of lump sum windows should continue to be popular in 2016.

This one-time lump sum payment is in lieu of receiving a monthly lifetime pension. This transfers the investment and longevity risk entirely to the employee. This decision to receive a lump sum payment and take on the associated risk is a difficult one for the individual. Preparation by the employer, including well-designed communication pieces for their former employees, is key to a successful lump sum window.

One of the hurdles to overcome is the fact that these employees no longer work for the organization. Making a meaningful connection with an employee who may have left the company years ago may not be easy. The primary form of communication is through the mail. There should be a postcard mailing in advance, letting everyone know there is an upcoming opportunity, and they will receive a follow-up mailing with their individualized benefit package shortly. This advance notice increases the employee response rate, which for the average plan is about 60 percent. The individualized mailing should focus on the choices available, and the pros and cons of each. Specific requirements, including deadlines, should be made clear and repeated several times.

A dedicated call center and email address should be established to handle questions. This reassures the employee that help is available and adds a level of comfort while making a difficult decision. The call center is a vital part of the process because no matter how detailed the written communications are, many people will have additional questions and feel better talking to someone live.

Finally, a reminder postcard sent mid-way through the window to all those that have not made an election is a great way to increase the response rate. It’s human nature to procrastinate. A reminder always helps.

One concern that many employers have is that employees will take the lump sum directly, as a taxable distribution, rather than electing a tax-deferred rollover to an IRA or to their current employer’s retirement plan. When offering a lump sum, a choice must be given to take the money directly as a taxable distribution, in addition to the rollover option. If the money is not rolled over, not only will it be taxed at ordinary income rates, an additional 10 percent penalty will apply for those under age 59 ½. The immediate cash-in-hand option is still tempting for many, even with the penalty tax. The last thing an employer wants is employees spending their retirement income too early. After all, this was the pension plan’s original intent—to help to fund a comfortable retirement. However, a well-structured educational piece can go a long way to encouraging an employee to roll over the distribution. Numerical examples, pointing out the risks of early distribution as well as the benefits of investing tax-deferred over time, can be very effective. 

This generation of workers will have to manage their retirement savings with a smaller percentage of guaranteed monthly income compared to prior generations. Thorough and easy-to-understand communications can help an employee decide if an immediate lump sum is the right choice, or if waiting for the guaranteed monthly pension at retirement is better. Making an informed decision benefits both the employer and the employee.

Employers have the dual responsibility of managing the corporation’s financial risks and educating employees about retirement planning. A properly structured lump sum window with a focus on excellent employee education can achieve both goals.


John W. Jeffrey, FSA, is a consulting actuary and chair of the Conrad Siegel Actuaries business development committee. He is a specialist in retirement plan consulting and post-employment health care benefits, focusing on consulting and administrative services for 401(k) plans, actuarial services for corporate pension plans, and actuarial services for school districts to comply with GASB 45. 

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