Private Pensions: Participants Need Better Information When Offered Lump Sums That Replace Their Lifetime Benefits
Published: 2015-01-27T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Since 2012, a number of large pension plan sponsors have given selected participants a limited-time option of receiving their retirement benefits in the form of a lump sum. Although sponsors' decisions to make certain lump sum “window” offers may be permissible by law, questions have been raised about participants' understanding of the financial tradeoffs associated with their choice. GAO was asked to review critical issues associated with these types of offers.
This report focuses on 1) the prevalence of lump sum offers and sponsors' incentives to use them, 2) the implications for participants, and 3) the extent to which selected lump sum materials provided to participants include key information. To conduct this work, GAO identified sponsors offering lump sum windows and used social media to identify participants given offers. GAO reviewed 11 informational packets acquired through interviews with selected plan sponsors and participants. GAO also analyzed lump sum calculations and interviewed federal officials and pension experts.
section_title: What GAO Found
paragraphs: Little public data are available to assess the extent to which sponsors of defined benefit plans are offering participants immediate lump sums to replace their lifetime annuities, but certain laws and regulations provide incentives for use of this practice. Although the U.S. Department of Labor (DOL) has primary responsibility for overseeing pension sponsors' reporting requirements, it does not require sponsors to report such lump sum offers, making oversight difficult. Pension experts generally agree that there has been a recent increase in these types of offers. By reviewing the limited public information that is available, GAO identified 22 plan sponsors who had offered lump sum windows in 2012, involving approximately 498,000 participants and resulting in lump sum payouts totaling more than $9.25 billion. Most of these payouts went to participants who had separated from employment and were not yet retired, but some went to retirees already receiving pension benefits. Sponsors are currently afforded enhanced financial incentives to make these offers by certain laws and regulations issued by the U.S. Department of the Treasury (specifically the Internal Revenue Service) governing the interest rates and mortality tables used to calculate lump sums.
Participants potentially face a reduction in their retirement assets when they accept a lump sum offer. The amount of the lump sum payment may be less than what it would cost in the retail market to replace the plan's benefit because the mortality and interest rates used by retail market insurers are different from the rates used by sponsors, particularly when calculating lump sums for younger participants and women. Participants who assume management of their lump sum payment gain control of their assets but also face potential investment challenges. In addition, some participants may not continue to save their lump sum payment for retirement but instead may spend some or all of it.
GAO reviewed 11 packets of informational materials provided by sponsors offering lump sums to as many as 248,000 participants and found that the packets consistently lacked key information needed to make an informed decision or were otherwise unclear. Using various sources, including financial advisors, federal agency publications, laws, and regulations, GAO identified eight key types of information that participants need to have a sound understanding of a lump sum offer. While GAO did not review the packets for compliance or legal adequacy, most packets provided a substantial amount of this key information. However, all of the packets GAO reviewed lacked at least some key information. For example, the relative value notices were often unclear about how the value of the lump sum compared to the value of the lifetime monthly benefit provided by the plan. Similarly, many packets did not clearly indicate the interest rate or mortality assumptions used, limiting participants' ability to assess how the lump sum payment was calculated. Further, few of the packets informed participants about the benefit protections they would keep by staying in their employer's plan—full or partial protections provided by the Pension Benefit Guaranty Corporation, the agency that insures defined benefit pensions when a sponsor defaults. This omission is notable because many participants GAO interviewed cited fear of sponsor default as an important factor in choosing the lump sum.
section_title: What GAO Recommends
paragraphs: GAO recommends that DOL improve oversight by requiring plan sponsors to notify the agency when they implement lump sum windows, and coordinate with Treasury to clarify guidance on the information sponsors provide to participants. Further, Treasury should reassess regulations governing relative value statements, as well as the interest rates and mortality tables used in calculating lump sums. Agencies generally agreed with GAO's recommendations.

section_title: Letter
paragraphs: Approximately 32 million U.S. workers and retirees participate in private  sector single-employer defined benefit plans—the type of pension plan  that generally provides a lifetime monthly benefit based on a formula  specified in the plan. Under this type of plan, employer-sponsors typically  bear the risks associated with investing the plan’s assets and ensuring  that sufficient funds are available to pay the benefits to plan participants  as they come due. However, during 2012, a number of large private  sector sponsors of defined benefit plans acted to reduce their pension  liabilities by essentially transferring the liabilities to other parties. Through  one particular type of risk transfer action, sponsors offered to pay some  participants—including participants already retired and receiving a  monthly pension—the estimated present value of their lifetime benefit in  one immediate lump sum payment. This action, commonly referred to as  a “lump sum window,” presents certain participants with a choice of  keeping their lifetime retirement annuity or taking the lump sum amount.  Participants who accept the lump sum assume all the risks of managing  the funds themselves. Further, their retirement benefits are no longer  governed by the Employee Retirement Income Security Act of 1974  (ERISA), as amended, including the guarantees provided by the Pension  Benefit Guaranty Corporation (PBGC), which insures benefits from  private sector defined benefit plans up to certain statutory limits. In light of  these and other consequences for those accepting lump sums, you and  Representative George Miller requested that GAO study what is spurring  sponsors to make such offers and the potential effect these offers have  on participants’ retirement security.
This review addresses (1) the extent to which sponsors of defined benefit  plans are transferring risk through the use of lump sum windows, and the  incentives for sponsors to take such actions, (2) the implications for  participants who accept a lump sum payment, and (3) the extent to which  sponsors’ lump sum window information materials enable participants to  make an informed decision.
To identify the extent that sponsors are using lump sums windows, we  collected and analyzed available information about lump sum offers  implemented by plan sponsors during 2012. We obtained documents  from the Securities and Exchange Commission (SEC), PBGC, the  Pension Rights Center, consulting firms, and sponsors. To explore  sponsors’ incentives for making lump sum offers, we interviewed  managers from three plan sponsors who took such actions, as well as  other stakeholders, such as consultants, insurance company  representatives, independent fiduciaries, and subject matter experts. To  explore the implications for participants, we consulted retirement security  experts and reviewed associated literature. We also used social media to  identify and interview pension plan participants whose sponsor had  offered them a lump sum payment. Specifically, we contacted alumni  groups associated with sponsors whom we had identified as having  carried out lump sum windows. We solicited input from plan participants  who had been offered lump sums and administered a questionnaire to 37  participants who had contacted us. These individuals were associated  with 11 plan sponsors. Of the group, we interviewed 33 to gather  additional information. We also collected information materials provided to  participants by all 11 of the sponsors. While not generalizable,  participants’ responses helped inform our discussion about the factors  participants weighed when making benefit choices. In addition, we  developed a lump sum calculator to generate lump sum amounts based  on participant information obtained during our interviews. Using the  calculator, we mimicked sponsor lump sum calculations to gain a better  understanding of how certain provisions in federal law and regulations  affect lump sum amounts, and we evaluated whether the rules advantage  either sponsors or participants in how the amounts are calculated. Lastly,  to determine the adequacy of the lump sum offer materials sponsors  provide to participants, we identified key types of information participants  need to make an informed decision based on a review of publications by  federal agencies, financial advisors, and various other sources. We then  evaluated the contents of 11 packets of information materials, each from  a different sponsor’s lump sum window offer, to determine whether the  packets included this information. We also asked the participants we  interviewed about the completeness and understandability of the  information materials they had been given.
We conducted this performance audit from March 2013 to January 2015  in accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Background
subsections: section_title: Pension De-risking and Risk Transfers
paragraphs: Sponsors of defined benefit pension plans are responsible for managing  the financial risks associated with their plans’ general administration.  Such risks can include fluctuations in the value of plan assets and in  interest rates, either of which can cause volatility in the plan’s funded  status and plan contributions. This type of volatility has been  exacerbated by recent fluctuations in the national economy, while a 2006  accounting standard change caused pension funding status to take a  more prominent role on private sector plan sponsors’ balance sheets,  making such volatility more visible.sponsors have chosen to lessen their exposure to such financial risks by  shifting away from defined benefit plans and choosing to offer or  emphasize defined contribution plans, such as 401(k) plans, whereby the   Over the past several decades, many  various risks are borne by the participants whose sustainable retirement  income will depend on factors such as the participants’ contribution  decisions, the investment returns on their personal accounts, their spend- down decisions in retirement, and their longevity. Likewise, sponsors  who have chosen to retain their defined benefit plans have taken steps to  reduce their plans’ financial risks by other means. In some cases, these  steps have also resulted in the transfer of risk to participants.
The steps sponsors can take to limit the financial risks they see posed by  their plans are commonly referred to as pension “de-risking.” Broadly  speaking, de-risking actions can be divided into two groups, internal and  external methods. Internal methods of de-risking—although beyond the  scope of our study—allow the plan sponsor to reduce risk without directly  removing liabilities, or participants, from the plan. These methods may  include restricting plan participation or modifying the benefit formula to  reduce future benefit accruals. They may also include adjustments to the  allocation of plan assets, such as by liability-driven investing. This may  involve shifting away from equities and toward fixed income securities  that match the duration of plan liabilities in order to shield the plan from  risks associated with market fluctuations in both stock market values and  interest rates. Although these internal methods allow sponsors to mitigate  some of the risks associated with their plans, the existing liabilities remain  in the plans and, as a result, continue to expose sponsors to certain  remaining risks. For example, plan sponsors continue to be subject to the  longevity risk of plan participants living longer than anticipated.
External approaches, on the other hand, involve permanently removing a  portion of pension liabilities from the plan, discharging the obligation to  pay a lifetime annuity to plan participants. Two of these approaches can  be appropriately termed “risk transfers” because the risks of providing  pension income or managing pension assets are essentially transferred to  another party outside the plan. One form of risk transfer—also beyond the  scope of our study—is the purchase of a “buy-out” group annuity,  whereby plan assets are transferred to an insurance company that then  assumes the responsibility for making pension benefit payments to  participants removed from the plan. When a sponsor implements an  annuity buyout, the risks associated with providing promised pension  benefits are shifted from the plan sponsor to the insurer. In 2012, two  large plan sponsors, General Motors and Verizon, purchased group  annuities from Prudential Insurance Company involving the transfer of a  reported $32.6 billion in plan liabilities.
A second form of risk transfer is a “lump sum window” offer—the form of  risk transfer that is the focus of our study. Any lump sum window offer  must satisfy applicable requirements under the Internal Revenue Code.  In a lump sum window offer, the participant is offered a choice between  three optional forms of his or her benefits accrued to date. Generally, the  participants who are given the offer will be separated participants— participants no longer employed by the sponsor—waiting for their pension  annuity to begin in the future, or retirees already receiving their pension  annuity payments.
The three options are as follows:  1.  Annuity at normal retirement age (or current annuity) – In the case of  a separated participant not yet in pay status, this is their lifetime  annuity promised under the plan that would begin at a future date,  often age 65. In the case of a retiree in pay status, it is the lifetime  annuity they are currently receiving.  2.  Immediate annuity (or alternate annuity) – In the case of a separated  participant not yet in pay status, this is their lifetime annuity promised  under the plan, with payments beginning at the time of the lump sum  offer rather than at their normal retirement age. The payments are  reduced by a specified factor to account for the earlier  commencement of benefits. In the case of a retiree in pay status, it is  the lifetime annuity they are currently receiving, but they may have the  option of changing to another form of benefit offered under the plan.  3.  Lump sum – In the case of both a separated participant not yet in pay  status or a retiree in pay status, this is the actuarial equivalent of the  remaining expected payments of their lifetime annuity, given to them  in a single immediate payment.
The participant then has a limited amount of time, or window, to choose  between the three options. When participants elect to receive their benefit  as a lump sum, the risks involved in providing retirement income are thus  transferred from the sponsor to the participants.
section_title: ERISA and Federal Oversight
paragraphs: ERISA establishes protections for plan participants and their  beneficiaries, and sets minimum funding standards for pension plans that  are sponsored by private employers, among other provisions. One broad  protection offered by ERISA is the requirement that sponsors be subject  to fiduciary standards in their management and administration of the plan.  As fiduciaries under ERISA, sponsors are required to administer the plan  solely in the interest of participants and beneficiaries and for the exclusive  purpose of providing benefits and defraying plan expenses. However,  some functions, such as those related to establishing a plan and choosing  its design features, are considered settlor functions that are not subject to  ERISA’s fiduciary standards. For example, a sponsor’s decision to take  risk transfer actions, such as offering a lump sum window, is a matter of  plan design, generally making it a settlor function rather than a fiduciary  function. However, once the sponsor embarks on implementation of the  strategy, such action would fall within the realm of its fiduciary role,  requiring the sponsor to operate in the best interest of participants and  beneficiaries.
The administration of ERISA is divided among three federal agencies: the  Department of Labor (DOL), the Department of the Treasury (specifically  the Internal Revenue Service ), and the Pension Benefit Guaranty  Corporation (PBGC). DOL takes primary responsibility for ERISA  reporting and disclosure requirements. In addition, DOL promulgates  regulations and produces guidance related to reporting and disclosure.  Within DOL, the mission of the Employee Benefits Security Administration  (EBSA) includes efforts to ensure the security of Americans’ retirement  benefits by assisting and educating plan participants, plan sponsors,  service providers, and fiduciaries. To that end, EBSA develops  regulations and enforces the law, including ERISA’s fiduciary standards.  As GAO has reported previously, certain disclosures are specifically  required to be written in a manner calculated to be understood by the  average participant, and for disclosures that do not include such a  requirement, DOL officials have noted that ERISA’s basic fiduciary  standards require that fiduciaries consider how understandable the  disclosures are.
ERISA also created the ERISA Advisory Council to advise the Secretary  of Labor.  The council has carried out its role by studying testimony and  deliberating on various topics and submitting recommendations regarding  the Secretary’s functions under ERISA. Due to the recent heightened  interest in risk transfers and their perceived increase in popularity, the  council held hearings in 2013 exclusively focused on such actions and the  effects they may have on plan participants.summarizing the hearings, the council observed that there had been an  increased level of activity by sponsors to reduce or eliminate the risks  associated with their pension plan liabilities and concluded with several  recommendations to DOL. For example, the council recommended that  disclosures associated with lump sum windows include information which   In its final report  enables a participant to make an informed decision. In addition, the  council recommended DOL consider collecting relevant information at the  time sponsors take risk transfer actions.
For its part, the IRS determines whether private sector pension plans  qualify for preferential tax treatment under the Internal Revenue Code.  Qualified pension plans receive favorable tax treatment, generally  including the deferral of taxes on contributions and investment earnings  until benefits are received. To be qualified, a plan must meet a number of  requirements. Plan sponsors can request a determination letter that  addresses the qualified status of the plan. In addition, a plan sponsor can  request that the IRS address a unique issue requiring immediate  guidance that is not likely to be provided through the determination letter  process. If the IRS determines that it is in the interest of good tax  administration to respond to this request, its response, known as a private  letter ruling, will interpret and apply tax laws to the sponsor’s represented  set of facts. By law, this specific ruling may not be used or cited as  precedent by other taxpayers or by IRS personnel.
Also, to protect the value of each participant’s pension benefit, the  Internal Revenue Code prescribes the interest rate and mortality table  that the sponsor must use to calculate the minimum amount of any lump  sum option.  A plan may pay a larger lump sum, but it may not pay less  than this prescribed minimum. Further, sponsors are required to provide  several specific pieces of information to the participant as part of the  offer. For example, sponsors, when distributing pension benefits in any  form, are required to provide notices to participants detailing tax  implications, rollover options, and a description of the financial effect of  electing an optional form of benefit. As part of this description, the  participant must receive a statement comparing the relative value of the  new form of benefit to their original benefit. For instance, when an  optional lump sum would replace a monthly annuity, participants must be  shown how the lump sum compares to the value of that annuity. Also, in  order to receive the benefit in a form other than an annuity, such as a  lump sum, the participant (and if married, the spouse) must receive and  sign a waiver consenting to this alternative form of payment.
The PBGC, also established by ERISA, acts as an insurer of private- sector defined benefit pension plans by guaranteeing participants’  benefits up to certain statutory limits. In the case of covered single- employer plans, PBGC protects participants if the plan terminates with  insufficient assets to pay all benefits, such as in the bankruptcy of a plan  sponsor with an underfunded plan. Under ERISA, plan sponsors pay  premiums to PBGC to help fund its guarantees. The law currently  requires sponsors to pay both a per-participant flat rate premium and a  variable rate premium based on the plan’s level of underfunding. PBGC  also collects a termination premium from sponsors who terminate their  plans under certain criteria.
In both the case of a sponsor’s buyout through a group annuity purchase  and the case of a participant’s acceptance of a lump sum payment, the  participant loses the protections of ERISA and the guarantees offered by  PBGC. Group annuities provided by an insurance company are  guaranteed by state benefit guaranty associations up to certain levels  established by the state. Lump sum payments carry no guarantees with  respect to the amount and duration of future retirement income they may  ultimately provide.
section_title: Little Is Known about the Extent of Lump Sum Windows, though Cost-Saving Incentives May Be Encouraging Sponsor Use
paragraphs: Data are lacking about the prevalence of lump sum windows, as there are  no requirements that sponsors report when they use this practice.  However, experts in the field of retirement pensions, including DOL’s  ERISA Advisory Council, generally maintain that since 2012 an increasing  number of sponsors have used lump sum window offers to shed plan  liabilities. The offers we identified included offers made to separated  vested participants not yet receiving benefits, as well as offers targeted to  retirees who were already receiving benefit payments. While lump sum  windows have the effect of reducing the size of sponsors’ pension plans,  thereby reducing sponsors’ financial risk, the recent reported increase in  use may reflect enhanced financial cost-saving incentives for such  actions. These include changing federal laws and regulations governing  the interest rates and mortality tables used to calculate lump sums, and  those affecting PBGC premium rates. Likewise, other longstanding rules  may also serve as incentives to act. Sponsors must also take into account  their unique business circumstances and certain disincentives associated  with lump sum windows.
subsections: section_title: Full Extent of Lump Sum Offers Is Unknown
paragraphs: Comprehensive data on the details and the number of lump sum window  offers are not publicly available. Although DOL takes primary  responsibility for ERISA reporting requirements, neither it nor the other  two agencies that oversee ERISA provisions, IRS and PBGC, are  required to track or compile comprehensive data on such offers. As a  result, the information currently required to be reported by sponsors when  they implement lump sum windows is insufficient to provide a complete  picture of the extent of the practice. For example, whenever lump sums  are paid out from a pension fund, the sponsor is required to report the  payout to IRS.associated with a lump sum window from other types of payouts from  pension funds, such as monthly annuity payments. In addition, some   However, such reporting does not distinguish payouts  sponsors may choose to disclose limited information about lump sum  window offers within their annual corporate reports and some may do so  as part of periodic filings to the SEC. However, absent more specific  requirements to report on lump sum window offers, meaningful data on  the extent of their use do not exist.
Nevertheless, pension experts generally agree that sponsors’ use of lump  sum windows has become more frequent in recent years. In summarizing  its 2013 hearings on pension de-risking, the ERISA Advisory Council  concluded that the testimony they had heard served to confirm that risk  transfer actions, such as lump sum windows, are on the rise. Studies  cited by leading pension consulting firms, albeit without full disclosure of  their data and study methods, have furthered this perception. Citing  proprietary data, one firm has estimated that nearly 200 sponsors  implemented lump sum windows during 2012. That firm reported that its  survey of 180 plan sponsors found that 26 percent had implemented a  lump sum window in 2012, and another 41 percent were in the process  of, or considering, taking such action between 2013 and 2015. Another  firm reported that its study indicated that of 223 sponsors surveyed, 12  percent had recently implemented a lump sum window. Of the remaining  sponsors, 43 percent were reported to have said they were very or  somewhat likely to do so in 2014.
We based our analysis on publically available information from a variety of sources,  including information collected from PBGC, a participant advocacy group, SEC filings,  corporate reports, and media reports. We verified this information to the extent possible. In  October 2014, PBGC informed us, based on limited sources of information, that they were  aware of at least 17 additional lump sum windows announced by sponsors during 2013  and 2014. However, we were not able to verify this information before the publication of  this report. time, these 22 cases alone involved offers to approximately 498,000  participants. Public data on the dollar amount of lump sums paid were  limited, but for the 16 sponsors providing this information, we found the  total payouts to be just over $9.25 billion in 2012. Based on its study of  lump sum windows completed during 2012, a pension consulting firm  reported acceptance rates ranging between 25 and 85 percent, with a  majority being between 45 and 65 percent. Most (19 of 22) of the lump  sum windows we identified only targeted participants who were not yet  receiving their retirement annuity. However, three of the actions involved  lump sums being offered to retired participants who had already begun  receiving annuity payments.
According to many pension experts, the lump sum windows implemented  by Ford Motor Company and General Motors Company in 2012 could be  viewed as a new approach to the practice, as they were reported to be  the first known instances of lump sum offers to retirees in payment status  rather than to separated vested participants not yet retired. Prior to  implementation, it was also widely reported that both sponsors had  requested and obtained IRS private letter rulings stating that their actions  would “not fail to satisfy” certain provisions of the Internal Revenue  Code. According to the letters, one important question was whether  such lump sums would violate existing rules governing the amount and  benefit payment period.
In both private letter rulings, IRS concluded that  such actions were permissible because the lump sum option was being  offered pursuant to a plan amendment and only during a limited window  period.
section_title: Cost Savings Provide Incentive for Sponsors to Offer Lump Sum Windows
paragraphs: Substantial financial advantages exist for plan sponsors considering  implementing lump sum windows. In general, sponsors’ use of lump sum  windows reduces the size of their pension plans, which can result in  reduced financial volatility for the sponsor’s cash flow, income statement,  and balance sheet, as well as reduced administrative burden and costs.  However, changing federal laws and regulations concerning interest  rates, mortality tables, and PBGC premiums may be providing additional  cost-saving incentives for more plan sponsors to offer lump sums to their  plans’ participants in recent years. Moreover, certain longstanding rules  can also afford savings to sponsors by allowing them to offer lower lump  sums by choosing an advantageous interest rate and excluding certain  additional plan benefits, such as early retirement subsidies, when  calculating lump sums. Lump sum windows also offer sponsors an  opportunity to reduce oversized plan liabilities, such as in cases where  the pension plan is large relative to the size of the plan sponsor’s  business. They also offer sponsors an opportunity to target specific  groups of individuals, such as vested terminated participants who may  have had no prior relationship to the plan sponsor because they were in a  plan that had been taken over as part of a merger or acquisition deal. At  the same time, implementation of lump sum windows also involves costs.  Sponsors have to weigh both the incentives and disincentives before  taking such actions in order to determine if implementing a lump sum  window addresses their unique business goals in a cost-effective manner.
subsections: section_title: Recent and Impending Rule Changes That Provide Incentives for Lump Sum Windows
paragraphs: The federal laws and regulations regarding how lump sums are calculated  have been changing in recent years. From the sponsor’s perspective,  these changes make it more advantageous to implement a lump sum  window at this time. Rules concerning interest rates have become more  favorable, making it more advantageous to implement a lump sum  window now and in the future than it was in the past. Impending changes  to mortality tables provide an incentive to implement a lump sum window  now to realize a potential financial cost-savings, an opportunity that will  likely disappear when new mortality tables are adopted. Rising PBGC  premiums also provide an ongoing and rising incentive for some plan  sponsors to remove liabilities from the plan via a lump sum window or  some other means.
Switch to More Favorable Interest Rates  Recent changes to the rules regarding how lump sums are calculated  allow the use of interest rates that can result in lower lump sums for  participants, which would be advantageous to plan sponsors trying to  minimize the cost of implementing a lump sum window offer. Prior to  enactment of the Pension Protection Act of 2006 (PPA), sponsors were  required to calculate lump sums using interest rates on 30-year Treasury  bonds. Since PPA, sponsors have been allowed to use generally higher  corporate bond interest rates, which can serve to lower the amount of  the lump sums offered to many participants. A consulting firm  estimated that, because of the general reduction in lump sum amounts  resulting from this rule change, one of their client sponsors paying out  $40 million in lump sums could potentially save about $10 million due to  the switch to the higher rates. The PPA switch from Treasury bond rates  to corporate bond rates became fully effective in 2012, and some experts  believe that this timing may partly explain the reported recent increase in  risk transfers since 2012.
Illustration of How PPA Rules on Interest Rates Can Affect Lump Sums Bob is 45, has a lifetime deferred retirement pension of $10,000 a year starting at age  65, and was offered a lump sum in October 2012.
Prior to PPA, Bob’s immediate lump sum would have been $62,643, calculated based  on a 30-year Treasury interest rate of 3.65 percent.
After PPA, Bob’s immediate lump sum is $32,453, calculated based on a corporate bond  interest rate of 6.02 percent, or 48 percent less than it would have been under rules prior  to PPA.
In addition, the Moving Ahead for Progress in the 21st Century Act (MAP- 21) allowed more sponsors to take advantage of this rule change by  temporarily raising the interest rates that can be used to value plan  liabilities, significantly improving many plans’ reported funded status,  which in turn allowed more plan sponsors to consider offering lump-sum  payouts.
The mortality tables which sponsors must use in determining minimum  lump sum amounts provide another incentive to conduct a lump sum  window at this time. This is because the tables currently required for this  purpose under IRS regulations do not reflect the accelerated rate of  longevity improvements that have occurred in recent years. These  longevity improvements have been reflected in updated mortality tables  recently released by the Society of Actuaries (SOA) and they are  expected to be adopted by IRS for lump sum calculations, but possibly  not until 2016. The new SOA tables reflect a longer life expectancy for  individuals, and when used to calculate lump sums will yield  correspondingly larger lump sum amounts. Thus, sponsors making lump  sum offers prior to IRS’s anticipated adoption of the new tables can  realize substantial financial savings since their lump sum calculations will  still be based on older tables. According to SOA, the new mortality tables  reflect a 10.4 to 11.3 percent longer life expectancy for individuals age 65  in 2014—increases that could translate into lump sums that are  markedly greater than those based on the current tables used for 2014  lump sum calculations. Therefore, sponsors with lump sum payouts  exceeding, for example, $100 million could potentially save millions of  dollars by taking action before the adoption of new mortality tables, all  other factors remaining the same.
Prior to SOA’s release of the new tables, in August 2013, IRS announced  that the currently required tables will continue to be used for the  calculation of minimum lump sum payments in 2014 and 2015, and IRS  officials we interviewed said there is currently no timetable for when it will  adopt new tables. They said nothing precludes IRS from adopting new  tables prior to 2016, but they said it will not occur until the agency  completes its issuance process. Several pension experts are of the  opinion that the switch is not likely to occur until at least 2016. Until then,  sponsors can continue to use the current mortality tables and generate  relatively lower lump sums, providing a window of opportunity to  implement a lump sum window at lower cost than in the future.
Illustration of How Use of Current versus New Mortality Tables Can Affect Lump  Sums Jane is 45, has a lifetime deferred retirement pension of $10,000 a year starting at age  65, and was offered a lump sum in October 2012.
Jane’s immediate lump sum would be $35,944, calculated based on new mortality  tables reflecting more up-to-date longevity estimates.
Jane’s immediate lump sum is $32,453, calculated based on current mortality tables, or  10 percent less than it would be using the new tables.
Recent federal legislation that has increased PBGC premium rates, as  well as scheduled additional future increases, creates another potential  cost-saving incentive for sponsors to conduct a lump sum window offer.  PBGC premiums are based, in part, on the number of participants in a  plan, so reducing the number of participants via a lump sum window  directly reduces the total amount of the annual premium for that sponsor.  The flat rate portion of the single-employer premium rose 63 percent— from $35 to $57 per participant—between 2012 and 2015. Further, this  rate is scheduled to increase another 12 percent, to $64 per participant, in  2016, for an overall rate increase of 83 percent from 2012 to 2016.  Thus, for each participant that had been removed from a plan prior to  2015, the sponsor reduced its 2015 PBGC single-employer, flat rate  premium costs by $57. Likewise, removal of participants in 2016 will  result in similar savings.
Terminated vested participants can be a particularly attractive group  through which to achieve PBGC premium savings through a lump sum  offer since they often represent a large portion of a population but a small  portion of the participant liabilities. According to a leading consultant’s  analysis of selected plans, terminated vested participants can represent  less than one-sixth of the total amount of liabilities in single-employer  pension plans but nearly a third of the total plan participant counts. As a  result, terminated vested participants can account for a significant portion  of a plan’s ongoing administrative expense, such as PBGC premiums. A  sponsor can generate significant administrative cost savings, especially  for large plans, if they can remove participants and their associated  premium costs from the plan. Experts differ in their opinion of the extent  to which rising PBGC premium rates act as an incentive for sponsors to  implement a lump sum window. Notably, two of the sponsors we spoke to  said the rate increases did not factor into their decision to any great  extent. However, one said they were a concern and that the impending  premium increases could prompt them to take further action in the future.
section_title: Longstanding Rules That Provide Incentives for Lump Sum Windows
paragraphs: In addition to recent and impending changes in federal rules, certain  longstanding federal rules can also act as financial incentives to sponsors  considering implementing a lump sum window by potentially reducing the  size of lump sum amounts or by allowing the sponsor to avoid potential  plan costs.
Ability to Choose a “Lookback” Rate  One longstanding IRS rule that can sometimes provide a significant  financial incentive for offering a lump sum window is the provision that  permits plan sponsors to select the interest rate used for lump sum  calculations from up to 17 months prior to the month of the lump sum  offer. This interest rate is commonly known as a “lookback” rate. IRS  officials we interviewed pointed out that when used for the calculation of  lump sums that are part of a plan’s ongoing design (not a lump sum  window situation), this rule can work to the advantage of either the plan  sponsor or the plan participant at different points in time, depending on  whether interest rates have decreased or increased since the “lookback”  month. However, when used in association with a one-time lump sum  window with a fixed payment date, the “lookback” rate can be selectively  used to financial advantage by plan sponsors when interest rates have  decreased. This is because it allows sponsors to choose favorable  interest rates that are higher than prevailing rates, resulting in smaller  lump sum payouts. In 2012, as interest rates were declining, this rule  allowed plans to look back to higher rates from as early as August 2011.  Of the 11 sponsors whose information packets we examined, all sponsors  who disclosed the interest rates used for the lump sum calculations had  used sponsor-favorable “lookback” interest rates from between 11 and 16  months prior to the lump sum payment date.
Illustration of How the “Lookback” Rules on Interest Rates Can Affect Lump Sums Dan is 45, has a lifetime deferred retirement pension of $10,000 a year starting at age 65,  and was offered a lump sum in October 2012.
Dan’s immediate lump sum would have been $46,967, calculated based on prevailing  interest rates as of September 2012, the month prior to the lump sum offer.
Dan’s immediate lump sum is $32,453, calculated based on “lookback” rates as of August  2011, or 31 percent less than it would have been using a rate as of the month prior to the  offer.
Ability to Exclude Certain Additional Plan Benefits  Another longstanding rule that provides an incentive for offering a lump  sum window is the rule that allows sponsors to exclude certain additional  plan benefits when calculating the amount of the lump sum. These  additional plan benefits that are sometimes provided by pension plans  include subsidized early retirement benefits, subsidized joint-and-survivor  benefits, and supplemental early retirement benefits. Although a  separated participant, in the absence of a lump sum window, might have  gone on to be eligible for and collect such additional benefits in the future,  or might already be eligible for such benefits, the lump sum may still be  calculated assuming the participant would have collected a normal  retirement benefit without any additional benefits.
Illustration of How the Exclusion of Early Retirement Subsidies Can Affect Lump  Sums Pam is 45, has a lifetime deferred retirement pension of $10,000 a year starting at age 65,  but also qualifies for a subsidized, unreduced early retirement benefit starting at age 60.  She was offered a lump sum in October 2012.
Pam’s immediate lump sum would have been $54,301, if the lump sum is calculated  assuming that Pam would have retired at age 60, i.e., if the early retirement subsidy had  been included in the lump sum calculation.
Pam’s immediate lump sum is $32,453, if the lump sum is calculated assuming that Pam  would have retired at age 65, i.e., if the early retirement subsidy was not included in the  lump sum calculation, or 40 percent less than it would have been if the subsidized,  unreduced early retirement benefit was included.
section_title: Other Considerations
paragraphs: In addition to these potential incentives, sponsors and experts say the  decision to implement a lump sum window is often driven by how large  the sponsor’s pension liabilities have become in comparison to the overall  size of the business. This consideration takes on particular importance  when a business downsizes or, conversely, acquires other companies.  Indeed, two of the three sponsors we spoke to said recent restructuring of  their companies had resulted in their plan’s liabilities becoming  unacceptably large relative to the overall size of the business. Both had  recently experienced significant downsizing of their core business, yet  both had retained large amounts of benefit obligations owed to  participants. This particular issue was also mentioned by one of the  sponsors who requested an IRS private letter ruling prior to offering lump  sums to retirees in pay status. The sponsor had stated that the pension  obligations reported on the company’s financial statements had become  “disproportionately large” and very sensitive to swings in interest rates.  They explained that such volatility increases the cost of financing, makes  cash flow management more difficult, and makes the company less  competitive in the marketplace. The sponsors we talked to said their  decision to reduce their pension liabilities was a means to shore up their  overall balance sheet.
The other sponsor we interviewed told us that, in their case, their  business had grown due to the acquisition of other companies. However,  with the mergers had come additional pension liabilities and costs  associated with the defined benefit plans of the acquired companies.  They said they were now burdened with pension costs associated with  separated vested participants who had never been directly associated  with their corporation. This sponsor told us they implemented a lump sum  window primarily on the advice of their pension consultant, who presented  the action as a cost-effective means of reducing administrative burden  and costs associated these types of separated participants.
section_title: Disincentives to Offering a Lump Sum Window
paragraphs: Implementing a lump sum window is not cost-free for plan sponsors.  Despite the potential incentives, many experts point out that the decision  to implement a lump sum window will be based on each sponsor’s unique  business considerations, and potential downsides must be considered.  Disincentives include the administrative costs involved, future costs  associated with adverse selection, the need to make sizeable immediate  payments, interest rate uncertainty, and foregone potential returns.
Administrative costs. Conducting a lump sum window requires  sponsors to collect and verify data on their participant population to  properly value their benefit obligations, which in some cases may  involve the reconciliation of thousands of participant data records. In  addition, participant communications, including information materials,  must be prepared, and call centers may need to be set up, requiring  staffing and training. If these administrative tasks are performed in- house, it will take time and resources; if outsourced to a third party,  the sponsor will likely incur service fees.
Adverse selection. When lump sums are offered, it is possible that  relatively unhealthy participants will be more likely to accept the lump  sum and, conversely, healthier participants will choose to keep their  existing deferred annuity. If so, the remaining plan participants may  outlive the mortality assumptions used to value liabilities, requiring  additional plan funding in the future to cover benefit payments.
Sizeable immediate payments. The payment of lump sums results in  an immediate depletion of plan assets. In such cases, it is possible  that the sponsor might have to sell assets at a poor time, when their  position in the market is low. In addition, lump sum payouts could  reduce the funded ratio of an underfunded plan, potentially increasing  minimum required contributions.  Interest rate uncertainty. Future interest rate increases can reduce  the lump sum amounts to be paid, so that the sponsor might have  achieved greater benefits if action had been postponed. However, the  potential effect of interest rate increases on the value of plan assets  would also be a consideration. For example, if a sponsor anticipates  that interest rates will rise in the future, they will need to determine  whether the cost savings associated with paying lower lump sum  amounts then is offset by the potential for investment losses on plan  assets before the lump sum window is executed.
Foregone potential returns. Lump sum payments can come at the  expense of future market earnings, if future rates of return on the  assets would have exceeded the interest rate used to calculate the  lump sums. Foregone potential returns is a flipside of risk reduction,  as reduced risk often means reduced potential rewards as well.
section_title: Lump Sum Payments Can Lose Value for Participants in Various Ways
paragraphs: When participants of defined benefit pension plans accept lump sums,  they are waiving their right to receive a lifetime income stream from their  pension plan and must manage the payment received on their own from  that point forward. Some may try to replicate an income stream by using  their lump sum to purchase an annuity on the retail market. Others may  roll over their lump sum into an Individual Retirement Account (IRA) and  then invest and withdraw funds at their discretion. Still others may choose  to use the lump sum to pay off debt or purchase consumer goods. While  the participant may manage or spend their lump sum in ways that are  beneficial to their circumstances, participants in all three of these  situations are at risk of losing value from their retirement savings in  various ways.
subsections: section_title: Annuitizing a Lump Sum Payment May Not Fully Replace the Value of the Plan’s Annuity
paragraphs: In cases where participants accept the lump sum and then wish to  replicate a lifetime income stream by purchasing an annuity on their own,  the amount of their monthly benefit could be significantly lower than what  would have been provided by their plans. It might seem counterintuitive  for an individual to use a lump sum to purchase a lifetime annuity, since  the individual could have just kept the lifetime annuity he or she already  had from the defined benefit plan. Most of the participants we interviewed  who accepted lump sum payments told us that they did not trust the  security of their plan benefit (discussed further in the next section), and  some said they were encouraged by others to purchase a retail annuity.
subsections: section_title: Differences between Retail and Plan Annuities
paragraphs: Using the lump sum to purchase a retail annuity could result in  significantly less annuity income than what would have been provided by  the plan because different factors are at play for sponsors converting  pension annuities to lump sums than for insurance companies selling   Insurers in the retail market use  lifetime annuities on the retail market.different interest rate assumptions and mortality tables than those used  by plan sponsors to calculate minimum required lump sums, and also  include other factors such as profit margins in their pricing. Additionally,  unlike plan sponsors, insurers can price annuities differently for men and  women when selling annuities outside the qualified retirement plan  environment.
These reductions in retirement income can also be thought of as the gap between the  amount of lump sum offered and the amount of lump sum that would be needed to  replicate the pension benefit. valuation of a plan lump sum payment can be pronounced for reasons  such as 1) discount rate (interest rate) differences and mortality  assumption differences, 2) gender differences, and 3) differences  between group and retail annuity pricing.
As illustrated in figure 1, on average, lump sum values were insufficient to  meet the group annuity purchase rates in order to replace the coverage in  the retail market. This is likely due in large part to differences in the  actuarial factors used to value minimum lump sums, as set by law and  regulation, versus those used by insurance companies to price annuities.  One such factor is the discount rates, or interest rates used to convert  future projected annuity payments into a lump sum amount or an annuity  price. The generally higher lump sum discount rates have the effect of  making the lump sum less than the amount needed to purchase a  corresponding annuity, with the gap increasing at younger ages. A  second factor is the mortality (or longevity) assumption. As noted earlier,  the mortality assumption for determining minimum lump sums has not  kept up with increases in longevity and, all else equal, has the effect of  making lump sums today lower than they would be with up-to-date tables.  In contrast, insurance companies will factor this increased longevity into  their pricing, so that this factor will also tend to make minimum lump sums  insufficient to purchase a corresponding annuity.
The reduction in retirement income, or the gap between the amount of the  lump sum offered and the amount needed, varies significantly by both the  age and gender of the participant. Regarding gender differences, for  example, figure 1 shows a 36 percent reduction in income for a 55 year- old male, compared to a 41 percent reduction for a 55-year-old female,  from accepting a lump sum and purchasing an annuity. This gender  differential occurs because federal law requires a sponsor calculating the  amount of the lump sum payment to assume both men and women have  the same life expectancy, while an insurer offering retail annuities  outside the qualified retirement plan environment generally can charge  different rates to men and women. On average, women live longer than  men and thus collect benefits over a longer period of time. The insurer will  thus require a woman to pay more than a man of the same age to  purchase an equivalent lifetime monthly benefit.
Most participants accepting the lump sum payment, but then wishing to  still have an annuity, will be subject to purchasing a more costly individual  retail annuity rather than a group annuity. One reason for this cost  difference is that the individual retail annuity market is also subject to  adverse selection, which means that when given a choice, relatively  healthier individuals will tend to purchase or select annuities, increasing  average costs because such individuals are expected to live longer.  According to the American Academy of Actuaries, adverse selection can  add about a 10 percent increase to the annuity price. Retail annuities can  also include additional distribution, administrative and sales charges that  can add further to their cost differential over group annuities. Moreover,  certain individuals, particularly older retirees, may find that regardless of  cost, they do not have the ability to purchase a lifetime annuity on their  own. For example, one retail annuity site we examined would not offer  lifetime annuities to individuals older than age 85. An expert also told us  that some insurers will not sell a retail annuity for less than a certain price.
section_title: Certain Participants Contacted about Purchasing Annuities
paragraphs: Although in many instances the acceptance of a lump sum payment with  the intention of purchasing a retail annuity essentially results in the  exchange of a cheaper plan annuity to purchase a more expensive retail  annuity, some participants have received contacts encouraging them to  do so. One financial planner we spoke with told us that he noticed that a  few participants who had been offered lump sums were approached by  financial service providers trying to sell retail annuity products.  Additionally, our interviews of participants found that a few (3) participants  had received unsolicited contacts about purchasing an annuity with the  lump sum. However, none of the participants that accepted a lump sum  actually purchased an annuity with most of their lump sum payment. The  financial planner, who advised participants affiliated with two prominent  lump sum window offers in 2012, said he counseled many of the  participants considering the purchase of a retail annuity to simply stay in  their plan and receive lifetime annuity income through the plan.
section_title: Rolling Over a Lump Sum into an IRA Brings Added Control, but also Management Risks and Challenges
paragraphs: Participants who elect lump sum payments and roll them over into IRAs  now have the ability to control and manage their own funds. But they  must also manage the risks and challenges associated with decisions  regarding the investment and withdrawal of the funds that were previously  the responsibility of their DB plan sponsor.earn a rate of return that allows them to accumulate and withdraw the  monies in amounts that replicate the benefit they gave up under the plan,  or to provide protection over their entire retirement period should they live  to an old age. As with any investment strategy, the participant will face a  tradeoff between maximizing return with riskier investments, such as  stocks, versus maintaining their assets with lower return, lower volatility  investments, such as bonds.
subsections: section_title: Risks and Challenges of Asset Management
paragraphs: Participants who roll over their lump sums into IRAs will face risks in  managing and investing the monies for later drawdown. Specifically, by  making this choice, participants must contend with 1) the potential of  outliving their assets; 2) complex decisions concerning the investment of  the lump sum and the drawdown of the assets; and 3) the difficulty of  finding trusted advice.
A major risk that participants face overall is that they may outlive their  lump sum assets. Figure 2 shows how long a hypothetical lump sum,  based on a $10,000 annual ($833 monthly) benefit, would last for a 45- year-old participant if the participant invested the lump sum and drew  down the monies beginning at age 65. The illustration shows that the age  at which the drawdown exhausts the monies is highly sensitive to the rate  of return. For example, at an annualized 2 percent rate of return, the  participant’s monies will exhaust after 5 years at age 70. However, at an  annualized 7 percent rate of return, the participant’s monies will last an  additional 30 years, exhausting after 35 years at age 100. While these  drawdown scenarios are not specific to a participant’s gender, they do  highlight that women may be particularly vulnerable to outliving their  assets as women tend to have longer life expectancies than men.
Managing Assets Prior to and through Retirement  Participants face challenges in managing the many complex decisions  involving their lump sum during both the accumulation phase prior to  retirement and the spend-down phase after they begin drawing down their  lump sum. These decisions are further complicated by the ups and downs  of financial markets, including fluctuating rates of return, effect of fees,  and deciding when and how much to withdraw, especially when spouses  or other beneficiaries need to be taken into consideration.
Fluctuating rates of return. Unlike the constant rates of return  reflected in the preceding spend-down scenario (see figure 2),  participants’ investments may fluctuate, and the sequence of  fluctuating rates of return can pose additional risks. For example, due  to net cash outflows from a retiree’s spend-down of his or her lump  sum, the lump sum account has a diminishing asset base that can be  particularly at risk if the retiree encounters periods of low returns or  losses, as the account will have less time to recover from such  downturns. Further, the continued draw-down of the account during  such periods means that assets might have to be sold at depressed  values, and less money will remain in the account to benefit from any  future market upturn.
Effect of fees. As prior GAO work on fees has shown, fees can  significantly decrease retirement assets. Even a small fee deducted  from one’s assets annually could represent a large amount of money  years later had these funds remained in the account to be reinvested.  This means that participants will have to carefully consider fees as  they review alternative investment options. Compared to participant  controlled investment in account-based pension plans, this can be  more difficult in the retail market.
Loss of budgeting signal. A monthly pension has the advantage of  providing a retiree a budgeting signal as to how much can reasonably  and safely be spent each month. During the spend-down phase, this  valuable information is lost when a participant converts a monthly  pension into a single lump sum. The retiree may spend more of the  lump sum each month than is sustainable. In addition, the retiree may  have to make large unforeseen expenditures at certain times without  realizing the likely negative impact on the exhaustion date of the lump  sum, whereas for a retiree receiving a monthly pension, a large  expenditure can be seen relative to the monthly pension amount and  may lead the retiree to take other remedial measures. Additionally,  in some cases the retiree may unnecessarily restrict his or her  standard of living by spending less each month than a steady pension  would have permitted.
Diminished capacity. Managing assets through retirement may be  particularly challenging for retirees who experience diminished  physical or mental capacity as they age. For example, a retiree with  dementia may find it more difficult to manage the many decisions  involved with investing and drawing down an IRA compared to the  relative simplicity of receiving a monthly pension check. As one  scholar has noted, if the retiree misuses a monthly pension check,  another check will arrive the following month. However, if the retiree  makes investments that result in significant losses for their IRA, there  may be no additional funds for future withdrawal.
Planning for spouses. Our previous illustration assumes the money  is drawn down for an individual’s lifetime. Acceptance of a lump sum  over $5,000 for married or formerly married individuals requires  spousal consent to waive the right to a future annuity based on the  combined lifetime of participant and spouse, known as a joint and  survivor annuity. However, this does not preclude the participant from  including a spouse or beneficiary in his retirement planning. If the  participant wishes to account for his spouse’s lifetime as well, he may  need to add more years of spend-down, either by lowering the amount  paid out per month or taking on additional investment risk in an  attempt to achieve greater returns.
Participants assuming responsibility for managing their funds may find  dealing with all these challenges difficult and may seek out professional  advice to assist them. According to a DOL official, many participants are  unlikely to understand the full complexity of accepting a lump sum and  may not be well-equipped to manage the lump sum assets on their own.  Ideally, a financial planner should be able to help people navigate the  myriad decisions required to accept and manage a lump sum payment.  However, participants could face additional challenges finding trusted  advice in managing their assets if they do not feel comfortable managing  investment and drawdown decisions on their own. Others might find it  challenging to afford a financial planner. In previous work, we have found  that participants can receive conflicted advice because the financial  interests of those giving advice may not be aligned with the best interests  of the participant.
Those offering investment advice to participants may be motivated by  financial gain through sales of preferred financial products, commissions,  or other fees for services. that their advisor might have benefited more financially had they elected  the lump sum, noting that the advisor was interested in managing a large  sum of money.
The specific investment products held in 401(k) plans and IRAs, as well as the various  financial professionals who service them, are subject to oversight from applicable  securities, banking, or insurance regulators, which can include both federal and state  regulators. For example, mutual funds, offered in both plans and IRAs, are generally  regulated by the Securities and Exchange Commission (SEC), which requires funds to  disclose fees and to inform investors of products’ potential risks. An investment adviser  provides a wide range of investment advisory services, including management of client  portfolios. Investment advisers manage the portfolios of individuals as well as the  portfolios of pension funds and mutual funds. Broker-dealers provide brokerage services  where they act as an agent for someone else; a dealer acts as a principal for its own  account. SEC has primary responsibility for oversight of investment advisers and broker- dealers, while those who sell insurance products are also subject to state insurance  regulation. Investment advisers, broker-dealers, and insurance agents are subject to  different standards of practice.
Results of our participant questionnaire reveal that participants given  lump sum offers often received unsolicited financial advice, for example,  from financial planners, investment advisors, or even other plan  participants. About a quarter (10 of 37) of the participants who completed  our questionnaire reported being contacted by individuals not formally  connected with the pension plan who offered unsolicited services directly  related to the lump sum payment. For example, participants reported  being contacted by individuals offering to provide tax advice, help create  a retirement or financial plan, or invest the funds. Some (9) participants  noted unsolicited mail and email invitations they received at the time of  the lump sum offer, and being contacted by individuals offering to help  them manage the money.
section_title: Reasons Participants May Choose Rollover IRAs
paragraphs: GAO-13-30. participants who accepted lump sums directly rolled over their distribution  into a 401(k) or an IRA.
section_title: Using Lump Sums for Immediate Expenditures May Have Benefits but also Consequences for Retirement
paragraphs: One of the most critical decisions that participants must make with their  lump sums is whether they will continue to manage their lump sum  payments as part of their retirement planning goals. When participants  choose to use the lump sums to pay off debts or spend the money on  consumer goods, rather than keep the funds in the tax-qualified  retirement system, this is often referred to as “leakage.”“leakage” may be appropriate for some participants. They may have other  uses for their payment that are beneficial to their circumstances, for  example, paying health care expenses, paying for additional education  that may lead to more secure employment, or bequeathing the money.
Besides potentially diminishing their retirement savings, participants who  do not directly roll over all of their lump sum payment into a tax-preferred  account may be subject to certain additional taxes or withholding. For  example, when a participant cashes out their lump sum payment, there is  an additional tax of 10 percent, in addition to ordinary income tax, if the  participant is younger than age 59½. In addition, the sponsor must  withhold 20 percent of the value of the lump sum to cover federal and, if  applicable, state taxes. The ultimate tax liability will depend on the  participant’s individual circumstances, but he or she is likely to witness  some erosion in the value of the initial lump sum.
Studies have found that younger workers, lower earners, and persons  with smaller distributions are most likely to take lump sums and not keep  them as retirement savings. On the other hand, individuals may have  important immediate spending needs that must be addressed prior to  retirement. Our interviews of participants presented with lump sum  window offers found that only 2 of the 15 participants who accepted the  lump sum cashed it out to pay for immediate expenditures. In both cases,  the participants had important immediate needs associated with their  expenditures. In one case the former participant used most of the lump  sum to pay for living expenses; in the other the former participant used  most of the monies to pay down mortgage debt.
section_title: Lump Sum Window Materials We Reviewed Often Lacked Key Information Participants Need to Make an Informed Decision
paragraphs: Participants need information in certain key areas to make an informed  decision about their options when provided a lump sum offer. While our  analysis of materials provided by plan sponsors showed that they  appeared to include certain required information, they often lacked other  key information. Most participants we interviewed cited fear that their  sponsor would not deliver on their pension promise as a primary reason  for accepting the lump sum offer, but many of these participants were not  aware of the protections afforded by PBGC.
subsections: section_title: Participants Need Information in Eight Key Areas to Make an Informed Decision
paragraphs: Based on a review of publications by federal agencies, the ERISA  Advisory Council, financial advisors, investment firms, financial services  firms, and participant advocacy groups, as well as relevant federal laws  and regulations, we identified eight key areas of information that  participants need to weigh their options and determine what is in their  best interest when faced with a lump sum window offer (see table 1).
Under existing federal law and regulations, plan sponsors who offer a  lump sum in place of a retirement annuity are required to provide certain  disclosures to participants related to some of the eight key areas we  identified. For example, the sponsors’ disclosures to participants are  required to include information on the need for spousal consent, the tax  implications of taking a lump sum, and the relative value of the lump sum  compared with the plan’s benefits. However, this information, even when  provided as required, may not be sufficient to enable participants to make  an informed decision. During the ERISA Advisory Council hearings in  2013, several experts testified about their concerns for participants being  offered lump sums. In their testimony, some experts noted that  participants may not fully understand their retirement benefits or the risks  involved in taking their benefits in the form of a lump sum payment. For  example, participants electing a lump sum assume responsibility for  investing their retirement assets and thus bear the risk of both market  losses and of outliving their retirement assets. The council recommended  that the disclosure materials include additional information to clarify,  among other things, the tax implications of a lump sum payment, the  treatment of early retirement subsidies in the lump sum calculation, and  how participants’ benefit options compare against each other.
section_title: Materials Provided by Sponsors Lacked Key Information That Could Have Helped Participants
paragraphs: In our review and analysis of 11 packets of information that sponsors— representing about 248,000 participant offers—provided to participants  regarding a lump sum window offer, we found that all of the packets  lacked important information that could have helped participants.  However, all packets appeared to include information that is required by   For  current federal law and regulations governing benefit distributions.example, all packets included a spousal waiver for electing a lump sum  and information about the tax implications associated with the  participant’s decision. In addition, all of the packets included the required  relative value statement. Further, one packet GAO reviewed was  commendable in that it provided 7 of the 8 key pieces of information GAO  identified, and provided several resources beyond this threshold  information. Most packets (8 of 11) provided at least 5 of the 8 key pieces  of information GAO identified as necessary to make an informed decision.  However, our review also revealed that all 11 packets lacked at least one  key piece of information a participant would need to make a more fully  informed decision about his or her benefit choices, as described below.  Our interviews with 33 plan participants revealed they may have lacked  key information, as many (13 of 33) told us that more information would  have helped them assess whether or not to accept the lump sum.
subsections: section_title: Key Factor #1: Benefit Options
paragraphs: We found that all the sponsors’ packets initially presented at least two  benefit options: the lump sum payment and the monthly benefit amount  for an immediate annuity. Most packets (9 of 11) also presented a  deferred annuity option: the estimated monthly benefit amount promised  under the plan once the participant reached the plan’s normal retirement  age. Only one packet provided the amount of the monthly annuity at the  plan’s early retirement age. In the cases involving the two packets that  did not provide information about a deferred annuity option at normal  retirement age, the participants were separated participants who had not  begun to receive monthly pension benefits. While some participants might  have on file the estimated monthly benefit amount at normal retirement   Without that information, it would be challenging  age, others may not.for participants to determine if deferring receipt of benefits until reaching  normal retirement age should be an option worth considering. One  participant we interviewed whose sponsor did not provide this information  said that she was glad she had retained records showing her estimated  pension amount because otherwise it would have been difficult to assess  her lump sum offer effectively.
Three participants we interviewed (affiliated with one plan sponsor) were  very concerned that their sponsor did not provide information on the  estimated monthly benefits that participants could receive once they  qualified for an early retirement. According to that plan’s provisions,  participants who had enough years of employment could receive  unreduced monthly benefits as early as age 60 rather than at the normal  retirement age of 65. If participants are not informed of this option, they  may not realize that they could be eligible to receive the same monthly  benefit 5 years sooner.
section_title: Key Factor #2: Lump Sum Calculation
paragraphs: With respect to the lump sum calculation, we found that the information in  only 2 of the 11 packets fully explained how the lump sum had been  generated, providing sufficient information to facilitate an understanding  of the interest rate, mortality table, and benefit used by the sponsor. The  remaining 9 packets lacked some key information used in calculating the  lump sum amount, such as the interest rates or mortality assumptions.  For example, 8 of the 11 packets did not disclose the interest rates used  for the calculation. about the specific mortality assumptions used in the calculation. Lastly, 4  packets did not explain whether certain additional plan benefits, such as  early retirement subsidies, were included in the calculation. Although not  all participants would necessarily use information about interest rates,  mortality assumptions, or treatment of additional plan benefits to help  them arrive at a decision, our discussions with participants informed us  that some (7) likely would.
Six packets provided the interest rates used to develop the relative value notice, but no  mention was made regarding whether these rates were also used in calculating the lump  sum. GAO did not consider the inclusion of these interest rates sufficient for participants’  purposes in assessing the lump sum offer. interest rates or mortality assumptions had been used so they could  assess whether the assumptions were fair. Some participants (7 of 15)  said they wanted the underlying assumptions and a clearer explanation  as to how the lump sum was calculated to confirm it had been calculated  correctly. A few of these participants (4 of 15) said they had been able  to obtain information on mortality assumptions or interest rates through a  call center, and all of these participants said they should not have had to  track down this information themselves. For example, one participant said  that she had to contact the call center several times before learning she  would have to write a formal request to receive the information. This  individual believed the information should have been provided clearly in  the information materials.
section_title: Key Factor #3: Relative Value of a Lump Sum Versus an Annuity
paragraphs: In all the packets we reviewed, we found the relative value notice required  by IRS to inform participants how the overall value of the lump sum  compares to that of the plan’s annuity. These statements typically took  the form of a table.  We found little additional explanation in any of the  packets to help participants understand what the numbers meant. Some  participants (7 of 33) said the relative value statements were not user  friendly or particularly helpful for them in assessing whether to accept the  lump sum.
26 C.F.R. § 1.417(a)(3)-1(c)(1)(iv) and (v). In its bulletin accompanying the issuance of  the final regulations on the Relative Value Notice (Internal Revenue Bulletin 2006-16), IRS  states that the regulations were developed to help plan participants compare different  forms of their pension benefits “without professional advice.” The regulation offers some  flexibility as to how sponsors should convey this information. Specifically, the sponsor can  1) state the lump sum amount as a percentage of the actuarial present value of the  monthly annuity, 2) state the amount of the annuity that is the actuarial equivalent of the  lump sum, or 3) state the actuarial present value of both the lump sum and the annuity. statement showed that the lump sum payment was less valuable than the  annuity. In two other cases, the relative value statement showed that the  lump sum payment was actually worth significantly more than the annuity  (114 and 120 percent). Plan participants may not understand the  importance and effect of assumptions used to calculate the relative  values, and the materials we reviewed did not explain why the lump sum  values may be more or less valuable than an annuity. In the absence of  any further explanation, it is unclear how participants could have  interpreted the results or to what extent the notice could help them reach  an informed decision.
In addition, in many (5 of 11) of the packets, the relative value statements  compared the lump sum payment amount to the value of an immediate  annuity starting at the same time as the lump sum payment would occur,  but not the value of the deferred annuity available when the participant  reached full retirement age, often at age 65. It also was not clear if any  of these packets included the value of a deferred annuity beginning at  early retirement age with any additional plan benefits. A number of the  packets did not disclose whether the participant would be eligible for any  additional plan benefits, such as early retirement subsidies, if they waited  to claim their annuity (4 of 11). IRS guidance allows sponsors to show a  relative value notice for an immediate annuity, which may exclude  consideration of certain additional plan benefits that have not yet been  earned. However, this may limit the usefulness of the relative value  statement for participants, who may be eligible for early retirement  benefits at some point in the future or who could qualify for other types of  additional plan benefits.
Further, none of the relative value statements included information about  how much it would cost on the open market to replicate the same stream  of payments from the plan’s lifetime annuity. While there is no obligation  for sponsors to do so, and it might not be reasonable to expect sponsors  to research the open market to provide such an estimate, many  participants trying to assess the relative value of a lump sum could benefit  from researching and considering this cost. Several participants (4 of 33)  said they had either researched or asked their financial advisor to  estimate how much it would cost to buy a market annuity equal to their  promised lifetime annuity. Two others had tried to determine the monthly  benefit they would be able to secure if they used their lump sum to  purchase a market annuity. After reviewing the figures provided, all 6  participants who analyzed the cost of a market annuity relative to either  their plan’s monthly annuity benefit or the lump sum amount rejected the  lump sum offer.
section_title: Key Factor #4: Positive and Negative Ramifications of Accepting a Lump Sum
paragraphs: To make an informed decision about accepting a lump sum, individuals  also need to understand potential positive and negative ramifications of  their decisions. All 11 of the packets we reviewed discussed at least one  of the potential negative ramifications of accepting a lump sum payment,  and about half (6) also discussed at least one of the positive ramifications  of accepting an offer (see table 2). A few participants (4 of 33) said that  more information related to the positive and negative ramifications would  have helped them decide whether or not to accept the lump sum. beneficiary other than a spouse when they die. For instance, one woman  wanted to ensure that her daughter would benefit from the pension funds,  and one man we interviewed lived in a state that did not recognize same- sex marriages at the time the lump sum offer was made and wanted to  ensure his partner would be able to access the funds.
Participants’ understanding of the positive and negative ramifications of  accepting a lump sum offer would be enhanced to the extent the  participants have adequate levels of financial literacy (combined with  adequate disclosure of information as discussed above). For example,  understanding the risk of outliving one’s assets could help participants  make a more informed decision. In addition, for participants who do elect  a lump sum, financial literacy could help with the challenges of managing  that lump sum. Participants’ elections are also influenced by factors other  than rational analysis of benefits and risks. combined with financial literacy, could potentially help counteract  behavioral tendencies that sometimes might not result in the best  outcomes for participants.
section_title: Key Factor #5: Tax Implications
paragraphs: As demonstrated by research from the field of behavioral finance and economics,  emotion and intuition can play a role in financial decision-making, as people are not  always rational as would be assumed under conventional financial and economic theory. provided to them about the tax implications of their decision was  understandable, and almost all the individuals who accepted a lump sum  rolled it into an IRA.
section_title: Key Factor #6: PBGC Protection
paragraphs: To make an informed decision regarding lump sums, individuals also  need to assess the risk that a plan might not have sufficient funds to fully  make promised payments, and understand the extent to which their  promised pension would be guaranteed by PBGC if that were to happen.  Indeed, most participants we interviewed (10 of 15) who accepted lump  sums said that one of the main reasons they chose to accept the lump  sum was because they were worried the sponsor would default on its  pension promise. explained the role of PBGC or provided information on the level of PBGC  protections to an individual’s lifetime annuity.
Technically, pension payments are paid out of the plan, not by the plan sponsor. The  sponsor’s obligation is to make required, actuarially determined contributions to the plan.  So a plan sponsor cannot “default on its promise to pay pension benefits,” but can default  on its required contributions to the plan. could lose some or all of their benefits. Many of these individuals (6 of 10)  were not aware of the protections offered by PBGC.
Pension Benefit Guaranty Corporation (PBGC) Protections  PBGC is a government corporation created by the Employee Retirement Income Security  Act of 1974 (ERISA) to protect pension benefits in private defined benefit plans. When  plans insured by PBGC end—known as a plan termination—without enough money to pay  all benefits, PBGC’s single-employer insurance program pays participants the benefit they  would have received from their pension plan up to certain limits set by law. PBGC’s  maximum benefit guarantee is set each year under ERISA. The maximum guarantee  applicable to a plan is generally fixed as of that plan’s termination date. For 2014, the  maximum guaranteed amount for singe-employer plans is about $59,320 per year for  workers who begin receiving payments from PBGC at age 65. The maximum guarantee is  lower for participants who begin receiving payments from PBGC before age 65, or if the  pension includes benefits for a surviving spouse or other beneficiary. The maximum  benefit is higher for participants who are over age 65 when they begin receiving benefits.  In addition, PBGC’s guaranteed benefit amounts are subject to the “phase-in” limit (related  to benefit increases made in the previous 5 years) and the “accrued-at-normal” limit  (which excludes supplemental benefits).
Participants can find out whether their pension plan is insured by PBGC by obtaining a  copy of the plan’s “Summary Plan Description,” or SPD, from the employer or plan  administrator. A table showing PBGC’s maximum guarantee at various ages can be found  at http://www.pbgc.gov/wr/benefits/guaranteed-benefits/maximum-guarantee.html.
The other participants (4 of 10) were aware of PBGC’s protections, but  said they were worried they would not receive their full benefit or any  benefit at all from PBGC if their pension plan defaulted. Specifically, a few  individuals we interviewed (3 of 15) told us that they had accepted the  lump sum—even though they believed it to be a bad deal—because they  were afraid they might ultimately be left with nothing if their plan sponsor  went out of business or mishandled the pension funds. For example, one  participant said he was afraid he would “walk away with nothing,” and  another said he was concerned he would “only get pennies on the dollar.”  Yet another participant said he had decided to “get out while the going is  good.”
section_title: Key Factors #7 and #8: Instructions and Assistance
paragraphs: Understanding how to complete the administrative process of making a  benefit election and who to contact for help are two other important  pieces of information plan participants need in order to make an informed  decision. All 11 of the election material packets we reviewed provided  clear administrative instructions on how to elect a lump sum, immediate  annuity, or deferred annuity. Similarly, all packets provided a contact,  such as a call center, for asking general questions about the lump sum  offer. In addition, almost all the plan sponsors provided contact  information for at least one source of federal assistance, typically the IRS.
Participants responding to our questionnaire generally did not raise  concerns related to the administrative steps needed to elect a lump sum  or retain their annuity, or the length of time they had to make their  decision. Specifically, most said the data included in the election  materials (such as years of service and age) were accurate (29 of 37) and  that they found the process of completing the paperwork fairly  straightforward (23 of 37). Few (2 of 37) reported experiencing significant  administrative burdens in gathering the required information  (identification, notarized consents, etc).
section_title: Fear of Plan Default and of Outliving Assets Were Cited as Main Reasons for Accepting or Rejecting a Lump Sum Offer
paragraphs: A few themes emerged regarding the primary reasons participants who  completed our questionnaire either accepted or rejected their lump sum  offer, and how they went about making their decisions (see figure 3).  Specifically, most participants accepting the lump sum offer were  motivated by fear that retaining their annuity would hurt their prospects for  a secure retirement (10 of 15), either because the pension plan would  default on its promise (10 of 15) or because the plan sponsor would not   In contrast, many  manage the pension benefits responsibly (6 of 15).participants who chose to reject the lump sum offer indicated that their  retirement might be more secure if they retained their annuity.  Specifically, most of these participants (17 of 22) did not think the lump  sum amount would last as long as they expected to live and a majority  (14 of 22) believed that the calculation was unfair or not to their benefit.
Most participants (27 of 37) reported taking at least three steps to assess  whether or not to accept the lump sum. Specifically, most participants  reported conducting research using the Internet and reading articles  about lump sum offers. Many participants (20) also reported trying to  estimate the lump sum’s value based on anticipated life expectancy and  using various interest rates. About a third of participants (11 of 37)  reported receiving a tool from their sponsor—such as a spreadsheet or  calculator—they could use to assess the lump sum offer and of those,  many (7 of 11) said it was very helpful. Two participants who did not  receive such a tool from their sponsor said they wished they had. Most  (30 of 37) participants also consulted with professionals, such as financial  advisors or tax professionals, to help them assess the lump sum offer.  About a quarter of participants (9 of 37) reported receiving unsolicited  contacts by individuals not formally connected with the pension plan while  trying to decide whether to accept the lump sum.
section_title: Conclusions
paragraphs: While plan sponsors may be permitted by law to choose to offer their  participants lump sum windows to reduce the financial risks associated  with their defined benefit plans, the full extent of their use is unknown. It is  apparent that lump sum windows affect a significant number of plan  participants and can involve very large amounts of lump sum payments.  Some of the recent lump sum window offers may have been driven by  federal rules that may serve as cost-saving incentives for sponsors to  take such actions. Through lump sum payments, sponsors transfer the  risks and responsibility of retirement security away from themselves—and  the defined benefit system more generally—and onto participants. As the  proportion of the U.S. population over age 65 increases, the importance  of retirement security for our country’s well-being increases as well. Yet  the federal agencies charged with pension oversight have not been able  to fully examine how these risk transfers impact workers and retirees— and thus cannot take steps to ensure any potential adverse effects on  participants are minimized.
Given the likelihood that plan sponsors will continue to use lump sum  window offers as a means of reducing current pension liabilities, we share  a number of the 2013 ERISA Advisory Council’s concerns about these  risk transfers. For example, the pension oversight agencies lack data  about when and where these actions occur, who is affected, and how  these actions impact participants. This means that the agencies may not  have sufficient information to determine whether additional participant  protections are needed when sponsors implement lump sum windows.
For participants being asked to choose between a lifetime benefit option  and a lump sum, it is important that they understand how the two  compare. As our analyses show, once a participant cashes out a lifetime  annuity by taking a lump sum, the participant’s retirement savings can be  diminished in a number of ways or used on other expenses. Participants  may not be aware of the effect that certain allowable assumptions used to  determine their lump sum—such as outdated mortality tables and  favorable “lookback” interest rates—may have on their ultimate payment  amount. In most cases, the lump sum payment received is unlikely to  purchase an equivalent annuity on the retail annuity market. Furthermore,  the lump sum is exposed to potential erosion over the years, as the  participant assumes all the risks inherent in managing both the  investment and drawdown of their lump sum amount. Regrettably, such  challenges may become more acute as the participant ages and the effort  required for sound financial management becomes more burdensome.  Ultimately, the greatest risk associated with accepting a lump sum is the  risk of outliving it, which may occur despite the most savvy management.
Participants presented with a lump sum offer may not have a full  appreciation of the range of risks involved in forfeiting their lifetime  annuity under their sponsor’s plan. While we found that some sponsors  did a commendable job in their efforts to inform participants about their  benefit choices, it is notable that such efforts often fell short of fully  preparing the participant to make an informed decision based on many of  the eight key factors we identified. The relative value statements were  often confusing, explanations of how the lump sum was calculated were  often lacking, and many participants did not understand the PBGC  protections they would be giving up by taking a lump sum.
section_title: Recommendations for Executive Action
paragraphs: To ensure that federal regulators have better information about lump sum  windows and to better ensure that participants have ready access to key  information they need to make a decision when presented with a lump  sum offer, the Department of Labor should:  1.  Require plan sponsors to notify DOL at the time they implement a  lump sum window offer, including the number and category of  participants being extended the offer (e.g., separated vested; retiree)  as well as examples of the materials provided to them.  2.  Coordinate with IRS and PBGC to clarify the guidance regarding the  information sponsors should provide to participants when extending  lump sum window offers and place the guidance on the agency’s  website. Guidance should include clear and understandable  presentations of information, such as the relative value of the lump  sum, the role and level of protections provided by PBGC, and the  positive and negative ramifications of accepting the lump sum. Such  guidance could also include promising practices for information  materials from plan sponsors which are particularly effective in  facilitating informed participant decision-making.
In addition, to provide participants with useful information and to provide  for lump sums that are based on up-to-date assumptions, Treasury  should:  1.  Review its regulations governing the information contained in relative  value statements to ensure these statements provide a meaningful  comparison of all benefit options, especially in instances where the  loss of certain additional plan benefits may not be disclosed.  2.  Review the applicability and appropriateness of allowing sponsors to  select a “lookback” interest rate for use in calculating lump sums  associated with a lump sum window that can serve to advantage the  interests of the sponsor.  3.  Establish a process and a timeline for periodically updating the  mortality tables used to determine minimum required lump sums— including a means for monitoring when experts’ views may indicate  that mortality tables may have become outdated, and for taking  expedited action if warranted.
section_title: Agency Comments
paragraphs: We provided a draft of this report to DOL, Treasury (including IRS), and  PBGC for their review and comment. Treasury and PBGC did not provide  written comments. DOL provided written comments, which are  reproduced in appendix III. DOL, Treasury (on behalf of IRS) and PBGC  provided technical comments, which we incorporated where appropriate.  In oral comments, Treasury officials generally agreed with our  recommendations.
In its written comments, DOL generally agreed with the findings and  conclusions of the report. They noted the challenges participants may  face when they take on the risks of pension management themselves.  Specifically, DOL noted that EBSA is especially committed to increasing  awareness of lifetime income options because participants are  increasingly taking on many retirement management responsibilities.  GAO agrees that increasing awareness of lifetime income options in  retirement is a worthy goal. Additionally, understanding the scope of lump  sum window offers and the informational needs participants have under  such offers could help focus efforts to educate participants on the  importance of lifetime income options at the point of decision.
DOL generally agreed with the recommendations of the report.  Specifically, they agreed that the type of information that would be  collected pursuant to our first recommendation would be helpful in  determining the extent to which lump sum window offers are made and  the types of disclosures participants receive. However, DOL noted that  ERISA does not clearly grant the department the authority to impose such  a requirement on plan sponsors and said that it will be necessary for  EBSA to determine whether DOL has such authority. We agree that DOL  should determine whether there is any action it could take within the  scope of its existing authority to implement this recommendation. Should  DOL conclude as a result of its analysis that the department lacks  authority to require plan sponsors to notify the department at the time  they implement a lump sum window, we would encourage DOL to pursue  appropriate legislative changes.
DOL agreed with the second recommendation on coordinating with  Treasury (including IRS) and PBGC to clarify guidance regarding  information sponsors should provide to participants when extending a  lump sum window offer. They noted the manner of publishing such  guidance would depend on the coordination process with IRS and PBGC.
As agreed with your office, unless you publicly announce the contents of  this report earlier, we plan no further distribution of this report until 30  days from the report date. We are sending copies of this report to the  Secretary of Labor, the Secretary of the Treasury, Commissioner of  Internal Revenue, the Acting Director of PBGC, and other interested  parties. This report is also available at no charge on the GAO website at  http://www.gao.gov.
If you or your staff have any questions regarding this report, please  contact me at (202) 512-7215 or jeszeckc@gao.gov Contact points for  our Offices of Congressional Relations and Public Affairs can be found on  the last page of this report. Key contributors are listed in appendix IV.
section_title: Appendix I: Objectives, Scope, and Methodology
paragraphs: Our objectives were to examine 1) the extent to which sponsors of  defined benefit plans are transferring risk through the use of lump sum  windows, and the incentives for sponsors to take such actions, 2) the  implications for participants who accept a lump sum payment, and 3) the  extent to which sponsors’ lump sum window informational materials  enable participants to make an informed decision. To address these  objectives we collected and analyzed available information about pension  risk transfers. We also interviewed managers from three plan sponsors  and other stakeholders, such as consultants, insurance company  representatives, independent fiduciaries, and subject matter experts. In  addition, we administered a questionnaire to plan participants,  interviewed selected participants, and collected and analyzed disclosure  materials given to participants. We developed a lump sum calculator to  analyze lump sum calculations. Lastly, we reviewed literature, as well as  federal laws and regulations relevant to pension risk transfers. We  conducted this performance audit from March 2013 to January 2015 in  accordance with generally accepted government auditing standards.  Those standards require that we plan and perform the audit to obtain  sufficient, appropriate evidence to provide a reasonable basis for our  findings and conclusions based on our audit objectives. We believe that  the evidence obtained provides a reasonable basis for our findings and  conclusions based on our audit objectives.
subsections: section_title: Literature Review and Legal Analysis
paragraphs: We reviewed literature, laws, and regulations relevant to risk transfer  activities. Most literature was obtained from ERISA Advisory Council  testimonies, pension expert and consultant presentations, and other  materials obtained during pension-related conferences, as well as  publications and whitepapers issued by subject matter experts, pension- related organizations, business associations, consulting firms, and  insurance companies. Legal research primarily focused on the Employee  Retirement Income Security Act of 1974 (ERISA), Pension Protection Act  of 2006 (PPA), Moving Ahead for Progress in the 21st Century Act (MAP- 21), and the Internal Revenue Code, but also included additional research  on laws and regulations governing retirement income, benefit  distributions, and participant disclosures.
section_title: Data Collection for Pension Risk Transfer Actions
paragraphs: We used a variety of sources to collect information about recent pension  risk transfer actions that U.S. plan sponsors have taken. Prior to  identifying these actions, we asked relevant federal agency officials and  pension experts what sources of information were available and we were  told such sources were limited. To identify sponsors who had  implemented a lump sum window during 2012, we first used lists provided  to us by the Pension Benefit Guaranty Corporation (PBGC) officials and  the Pension Rights Center. We verified the lists to the extent possible,  primarily with information contained in sponsors’ SEC filings and  corporate reports. We removed sponsors from the lists if we could not find  sufficient evidence that they had performed a lump sum window during  2012.
We made efforts to contact managers associated with 18 risk transfer  actions in order to collect additional information and schedule interviews.  For all but three sponsors, we either were not able to establish contact  with the appropriate manager, the sponsor was unresponsive to our  efforts, or we were told that the sponsor did not wish to participate in our  study. During the interviews with the three sponsors who agreed to speak  with us, we asked questions regarding the lump sum window  implementation process they followed, the reasons behind their decision  to transfer pension risk, and to the extent possible, the outcomes of the  action. In some cases, we also collected informational materials that had  been provided to participants offered lump sums.
To supplement the sponsor interviews, we interviewed other  stakeholders, such as pension consultants, insurance company  representatives, an independent fiduciary, and subject matter experts. We  asked them about several aspects related to lump sum offers, such as  recent trends, what is driving the practice, and their potential effect on  plan participants. We also reviewed written reports, papers, and studies  conducted by consulting firms and other pension experts to gain a better  understanding about the prevalence of pension risk transfers, in general,  and why sponsors may be conducting or considering them.
section_title: Data Collection for Participant Disclosure Materials and Participant Experiences
paragraphs: To collect information to provide the participant perspective of lump sum  windows, we first used social media to identify corporate alumni groups  associated with the sponsors we had identified as having offered lump  sums during 2012. From those groups we solicited participants who had  been offered lump sums and received over 65 responses from  participants who were interested in participating in our study. From those,  we selected 37 participants across as many sponsors as possible. To  those individuals we administered a questionnaire that asked them to  provide information on their overall experience when offered a lump sum,  what they considered when making their decision, their opinion on the  understandability and usefulness of the information packet they had  received from the sponsor, and why they ultimately made the choice they  did. We also conducted phone interviews with 33 of the 37 participants in  order to gain additional insight into their questionnaire responses, and to  supplement the information captured by the instrument. We did not  independently verify information presented by participants in these  interviews. Consequently, no legal conclusions can be drawn from our  work as to whether plan sponsors complied with any applicable legal  requirements.
Our selection of participants to survey was also designed to yield a group  of participants that represented a relatively broad variety of attributes,  such as gender, age, and whether they had accepted the lump sum offer  or not. The selected participants represented 11 different sponsors. Most  of these individuals were ages 50 to 59, with the remaining individuals  fairly evenly split between the 40 to 49 and 60 to 69 year old age groups.  Almost all the participants had been salaried employees. Most individuals  in the survey group were currently working full time. Most, including those  who were working and those who were fully retired, had other sources of  retirement income in addition to the defined benefit plan for which they  were offered a lump sum, including Individual Retirement Accounts,  401(k) or 403(b) plans, and Social Security benefits. Of these 37  participants, 15 accepted the lump sum offer and 22 rejected the lump  sum offer. While not generalizable, we used the participants’ responses  from the questionnaires and phone interviews to inform our discussion  about the factors participants weighed when making their benefit choices.
In addition, we developed a lump sum calculator to generate lump sum  amounts based on participant information obtained during our interviews,  such as age, gender, and deferred annuity amount. Using the calculator,  we mimicked sponsor lump sum calculations to gain a better  understanding of how mandated assumptions affect lump sum amounts,  and how changes in those assumptions affected amounts for participants  across differing ages and gender. For details of those analyses, see  appendix II.
section_title: Factors for Analyzing Packets
paragraphs: During participant interviews we asked participants if they could provide  us the written materials that sponsors gave them when offering the lump  sum. We asked participants to redact any personally identifiable  information such as names or offer amounts, and asked for as many  materials as they could provide. Because these materials were  participant-provided, we cannot be certain whether the materials we  reviewed were accurate and complete representations of the materials  provided by each sponsor to its affected participants. Similarly,  participants provided us materials in hardcopy, so, for example, materials  that sponsors provided electronically might not have been transmitted to  GAO unless the participant had printed and retained this information.  Electronic information likely would have been password protected and not  available for GAO’s review. We collected at least one packet for each of  the 11 sponsors executing lump sum offers to the participants we  interviewed. These 11 sponsors represent, according to our review of  SEC filings, about 248,000 participant offers.
To analyze participant packets, we identified eight key areas of  information participants would need to understand in order to make an  informed decision about a lump sum offer. To identify these areas, we  gathered information from federal agencies, the ERISA Advisory Council,  financial advisors, investment firms, financial services firms, participant  advocacy groups, and federal laws and regulations. Since these key  factors were gathered from diverse sources, they were also vetted and  reviewed by GAO’s Chief Actuary and a research methodologist to  ensure they could be applied when we analyzed the materials for  informational content.
To apply the eight key factors to the informational materials, we identified  specific pieces of information, or sub-factors, that the packet would need  to contain in order to fully satisfy the main factor. GAO developed  decision rules for each main factor regarding how many of these sub- factors were needed in order to fully satisfy the main factor. Under these  decision rules, for seven of the eight key factors, all sub-factors needed to  be present to fully satisfy the main factor. However, for one of the eight  factors, our decision rule only required that one of the elements be  present. Specifically, for our factor on “What are the potential positive and  negative ramifications of accepting the lump sum?,” we identified many  potential positive or negative ramifications that could be highlighted in the  materials, but specified that a packet only need to list at least one  negative ramification of accepting the lump sum to satisfy this factor.  Table 3 has more detail on the extent to which the packets, in aggregate,  met our main factors and sub-factors.
As noted earlier, this review was an information review and did not  constitute a compliance or legal review. Our only purpose in conducting  this review was to determine whether the information packets provided to  participants in connection with lump sum offers contained sufficient  information to enable them to make informed decisions. Consequently, no  legal conclusions can be drawn from our work as to whether plan  sponsors complied with any applicable legal requirements. As with the  development of these factors for analyzing the information packets, the  process for implementing the factors was vetted and reviewed by GAO’s  Chief Actuary and a research methodologist. An analyst reviewed the  materials for informational content based on the implementation sub- factors and a second, independent analyst verified the process and  validated determinations of the review.
section_title: Appendix II: Lump Sum Calculations and Additional Figures
subsections: section_title: Basic Components of the Lump Sum Calculation
paragraphs: At the most basic level, determining a lump sum is converting a stream of  projected future monthly benefits into a present value. A present value is  the current worth of a future sum of money or stream of cash flows given  a specified rate of return, also known as an interest rate or discount rate.  The future cash flows are discounted at the discount rate, and the higher  the discount rate, the lower the present value. In the context of a monthly  benefit provided by a defined benefit pension plan, the stream of  payments generally commences at an age specified by the plan, known  as the normal retirement age, or at an optional early retirement age for  eligible participants, and ends when the participant dies (or when the later  of the participant and beneficiary dies, for a joint annuity). How long the  stream of benefits will last depends on how long the participant lives, and  lump sums take into account the probability that the participant will be  alive at each future date. A mortality table is a common actuarial  convention which shows, for each age, the probability that a person will  die before his or her next birthday.
For ease of reference, we refer to this simply as § 417(e)(3) throughout this appendix. segments of a corporate bond yield curve.term corporate bond interest rate applied to projected pension payments  payable within 5 years; the second segment is a medium-term corporate  bond interest rate applied to payments payable 5 years or more, but less  than 20 years, into the future; and the third segment is a long-term  corporate bond interest rate applied to payments payable in 20 years or  more.
section_title: Description of Our Lump Sum Calculations
paragraphs: We constructed a calculator of minimum lump sums to show some of the  effect certain methods and assumptions can have on the calculation. We  constructed a number of illustrative individuals to show how the minimum  lump sums may vary according to key participant characteristics, namely  age, gender, and retirement age, and key input calculation parameters,  namely interest rates, mortality tables, and the inclusion or exclusion of  certain additional plan benefits. While we performed lump sum  calculations across a number of illustrative individuals, throughout this  appendix we present the results for single individuals in 10-year age  increments, from age 35 to age 95. We assumed all individuals are full  integer ages—that is, the participant has his or her birthday on the  measurement date of the lump sum offer. For terminated vested  participants, we assumed a normal retirement age of 65. For retired  participants, the present value of their lump sum is calculated and  commences at their current age and is based on the remaining payments  that are expected to be due from that point forward. Technically, our  calculator projects an annual lump sum factor, which produced a lump  sum based on an annual benefit. We used a common actuarial  adjustment factor to account for monthly payments.
We verified our lump sum calculations in two ways. First, when we started  our study we asked Pension Benefit Guaranty Corporation (PBGC)  officials with actuarial expertise to furnish us with lump sum amounts  based on varying age and benefit commencement assumptions using  various mortality and interest rate assumptions consistent with  § 417(e)(3).to base our calculations on annual benefit amounts, and asked the  officials to perform the calculation using such a method. Additionally, to  determine if we could come reasonably close to actual offers, we  reviewed lump sum offers in two participant packets for which we had  enough information to calculate or approximate the lump sum in that  packet. Our calculations differed by 1.5 percent and nearly zero percent  for the two offers we reviewed. The 1.5 percent difference is very modest  and may be due to the fact that the birth date or the date of normal  retirement age of the participant we used differed from the date of the  offer by a few calendar months. Based on these small differences, and  since our purpose was to then estimate changes to lump sums based on  changes in certain assumptions, we deemed our calculator to be  adequate for such purposes.
section_title: Figures and Results
paragraphs: We discuss our lump sum results below and show how values can  change depending on certain key factors. Generally, we are comparing  alternative assumptions to our baseline assumptions. We found, of the  materials we reviewed, that many of the lump sum election windows  occurred between September and December 2012. Based on our review  of election materials, we found that many of these sponsors elected to  use August 2011 interest rates for the 2012 plan year. Thus, our  “baseline” assumption is an offer made in October 2012, using a  methodology under § 417(e)(3) for August 2011 interest rates for the  2012 plan year, along with the IRS published unisex mortality table for the  2012 plan year, and without including any additional plan benefits.  Comparisons and deviations from this baseline are noted with the figures.
Figure 4 compares, for our range of ages, the PPA interest rate basis (our  baseline) against the pre-PPA interest rate basis for minimum lump sums,  for a lump sum payment offer made in October 2012. As noted, our  baseline uses August 2011 corporate bond segment rates (for the 2012  plan year), which under PPA uses corporate bond rates published by IRS  as the interest rate used to determine minimum required lump sums. The  comparison uses the August 2011 30-year Treasury Securities Rate  (TSR), as the 30-year TSR was used to determine minimum required  lump sums prior to PPA. Figure 4 shows that lump sum payments are  most disparate for younger individuals. This occurs because these  individuals have their payments discounted at the second or third  segment rates, which are much higher than the 30-year TSR in this  instance, and because lump sum amounts for younger participants are  more sensitive to changes in interest rates because of the greater length  of the discounting period. As shown, minimum lump sums for 35-year-old  participants would have increased by 142 percent if an August 2011 30- year TSR was used instead of the baseline.
Figure 5 compares the effect of using the “lookback” interest rates that  sponsors are allowed to select (our August 2011 interest rates baseline  used for the 2012 plan year) against using interest rates as of the month  immediately preceding the month of the lump sum offer (September 2012  rates). As noted previously, sponsors may elect a stability period of one  year with a maximum lookback of 5 months. This means that the rates  used at the time of the offer may be nearly 17 months old compared to  rates that are current just before the offer. As shown, minimum lump  sums would have been higher at all ages, as much as 65 percent higher  for 35-year-olds, if more current interest rates were used instead of the  “lookback” rates.
Figure 6 compares the effect of using current prescribed mortality tables  (baseline) against using more up-to-date mortality tables on a  participant’s minimum lump sum amount at selected ages. Here we show  lump sums that are calculated using the new mortality tables and  projection scales devised by the Retirement Planning Experience  Committee of the Society of Actuaries and compare that to the current  mortality tables used for lump sum payments under § 417(e)(3). The  differences in lump sum values, which are also sensitive to the assumed  interest rate, vary significantly depending on the age of the participant. As  shown, the more up-to-date mortality method improves lump sums by as  little as 5 percent for 95-year-olds but as much as 13 percent for 35-year- olds.
Figure 7 compares baseline lump sums against an estimate of what they  would be if based on group annuity purchase rates. It shows how a lump  sum payment, calculated in 2012 using sponsor-elected August 2011  corporate bond interest rates (for the 2012 plan year) and the prescribed  mortality tables, would compare to lump sum payments calculated in the  month before the offer was made, or September 2012, using the interest  rate, mortality assumptions, and loading factors used by PBGC. This  method uses the survey that PBGC takes of recent prices of group  annuities to derive the interest factors that are used to calculate the  present value of future benefit-payment obligations under section 4044 of  the Employee Retirement Income Security Act of 1974 (ERISA). These  future benefits are obligations that PBGC must pay to participants in the  plans that they have taken over as trustee.
As observed earlier in the report, figure 7 shows that lump sum payments  under the minimum method prescribed under § 417(e)(3) can be  significantly smaller than the lump sums that would be necessary to  repurchase an annuity that matches the benefit forgone under the  participant’s plan. In this case, and because retail annuity data is not  easily available, we used a group annuity methodology consistent with   For example, a 55-year-old female  PBGC section 4044 assumptions. would receive a lump sum payment of $67,020 under the § 417(e)(3)  minimum, while she would need $114,460, or a 71 percent larger lump  sum, to purchase an annuity that would have been provided under her  plan (in this case, a $10,000 annual, or $833 monthly, benefit starting at  age 65). As noted earlier in the report, group annuities are generally only  available to large pension plans, and retail annuities are generally more  expensive due to adverse selection and administrative charges or other  fees, so an individual would likely need an even larger lump sum payment  to replicate their prior benefit on the retail market.
Additionally, a loading factor consistent with 4044 assumptions is added to the lump sum.  In the case of the annuity prices, which are all less than $200,000, this is a charge of 5  percent of the preliminary annuity price plus $200. For a more detailed description of  loading assumptions for all annuity prices, see Appendix C to 29 C.F.R. Part 4044.
section_title: Appendix III: Agency Comments
section_title: Appendix IV: GAO Contact and Staff Acknowledgments
subsections: section_title: GAO Contact
section_title: Staff Acknowledgments
paragraphs: In addition to the contact named above, Kimberly Granger (Assistant  Director); Frank Todisco (Chief Actuary); Amy Buck; Chuck Ford; David  Perkins; Walter Vance; Roger Thomas; and Sheila McCoy made key  contributions to this report. Also contributing to this report were Gene  Kuehneman; James Bennett; Sue Bernstein; Margie Shields; Amber  Yancey-Carroll; Angie Jacobs; David Lin; and Marissa Jones.