Lump-Sum Pension Buyout Offers Likely to Increase in the Future

The term “perfect storm” is often used to describe a rare confluence of circumstances that produce an event of unusual magnitude, particularly as it relates to weather. Many of you may have seen the 2000 film, The Perfect Storm, starring George Clooney, Mark Wahlberg and Diane Lane which retells the story of the real-life sinking of the Andrea Gail, a commercial fishing boat that encountered a “perfect storm” off the coast of Gloucester, Massachusetts in October of 1991. But the term can also apply to non-weather related events, and private industry pensions may very well be facing a “perfect storm” very soon.

The future of the private pension has looked bleak for quite some time, with roughly one-in-six employees in private industry covered by a pension. In fact, the number of workers covered by private pensions has been steadily declining for the past three decades. A rare confluence of factors is likely to create a dramatic increase in the number of pension buyouts offered to current and former employees in the near future as companies look to take advantage of tax policies that will help them reduce their pension obligations and lower their costs of maintaining existing pension plans.

One large reason for the potential boom in pension buyouts is the ballooning liability of pension plans currently in existence. According to the Wall Street Journal, the pension liabilities of the companies that comprise the S&P 500 grew from $224.5 billion in 2013 to $389.1 billion at the end of 2014; a 73% increase! Years of very low interest rates and lackluster investment returns have led to a significantly higher increase in pension obligations. One quick way companies can reduce the amount of pension liabilities the face is to get them off the books through buyout offers.

Another factor shaping the likelihood of increased pension buyout offers is the rising cost of servicing pensions. While the annual flat-rate fees that the government’s Pension Benefit Guaranty Corp. (PBGC) remained essentially flat through the 2007 to 2012 time period, more recently the premiums have increased dramatically. The cost of the premium for each pension plan participant was $49 in 2014, but increased by 16% to $57 this year. In 2016 the premium increases again, by 12% to$64 according to the PBGC and Towers Watson.

Another factor we have all been watching as of late will play into many companies’ decisions to offer lump-sum pension buyouts: interest rates. If the Federal Reserve increases interest rates later this year or early in 2016 like most expect, companies may be more likely to offer lump-sum pension buyouts. When interest rates rise, companies can offer smaller lump sum buyout offers because their pension obligations decrease. Stuart Schulman, a consulting actuary with Buck Consultants, a company that advises companies with pensions recently said, “Interest rates are the single most important factor in the size of a lump sum.” So if we experience significant interest rate hikes in the near future, expect an increase in pension buyout offers as obligations shrink.

The final factor that increases the likelihood of pension buyouts rests with a recent IRS decision. The IRS stated in July that it would delay implementing new mortality-rate calculations until 2017. The new mortality rate calculations will be based on longer life expectancies and will make it more expensive for companies to offer lump-sum buyouts in the future as the pension obligations increase with longer life expectancies.

We just examined four reasons why many companies offering private pensions could trigger a lump-sum pension buyout frenzy before 2017. But what should you do if you are fortunate enough to receive a lump-sum pension buyout offer? As is often the case with financial matters, the answer is: it depends, and there are few one-size fits all rules in these situations.

Each lump-sum pension buyout offer is unique, and must be looked at from both the parameters of the buyout offer as well as the specific financial needs and circumstances of the buyout offer recipient. Some buy-out offers may end up being a bad deal for former employees because they may not be able to replicate the same benefits offered through their investment options. In other cases, a former employee’s circumstances may be such that taking the lump-sum benefit provides him or her with the best possible financial outcome. The only way to know for sure which choice is the best for you is to examine all the facts and scenarios.

Bollin Wealth Management’s advisors stand ready to help you navigate the complicated choices that you face in life, including pension benefit decisions. Please call our office at 419-878-3934 to schedule a free consultation to discuss your lump-sum pension benefit offers or any other questions that you may have regarding your finances and/or retirement.