Advise DB Plan Participants Carefully on Lump Sum Window Opportunities


There are sound reasons why defined benefit (DB) plan sponsors may offer participants lump sum payout windows. Principal among them: lowering the plan’s financial exposure, thereby providing greater long-term financial security to participants who elect to stay in the plan. However, the consequences of accepting a lump sum payout can be good or bad for participants.

Suggestions from the GAO

Concern that many employees are making bad decisions has prompted scrutiny of lump sum windows. A report last year by the Government Accountability Office (GAO) found that, although sponsors’ decisions to make certain lump sum window offers may be legally permissible, participants’ understanding of the financial tradeoffs associated with their choice was questionable.

The GAO urged the U.S. Department of Labor (DOL) to improve oversight by requiring plan sponsors to notify the DOL when they implement lump sum windows. The report also encouraged the IRS to review interest rates and mortality tables used in calculating lump sums and reassess regulations governing relative value statements.

Considerations for participants

Regardless of what regulators do, DB plan sponsors can take steps to ensure that participants have enough information to make a smart choice before opting for a lump sum payout. Here are some factors participants should consider when making their decision:

Investment management. When participants take a lump sum payout, they’ll need to invest the proceeds wisely to avoid being worse off than if they’d left the money in the plan. Are they confident of their ability to take on that challenge?

Value comparison. How does the present value of the anticipated pension annuity benefit compare to the value of the lump sum? If a participant could buy a larger retirement benefit from an annuity provider with a single premium purchased with the lump sum proceeds, the participant might consider taking the lump sum and buying the annuity. If not, declining the offer might be a better idea.

Health considerations. If participants are fit and have a long life expectancy, they’ll generally come out ahead staying with the pension. Otherwise, because pension benefit calculations are based on average life expectancy, participants might do better by taking the lump sum.

“Last chance” possibility. A lump sum opportunity may be attractive because of unique employer circumstances indicating that no other lump sum window will open in the future.

Estate planning. With a DB pension annuity, the benefit ends when the participant (or possibly a surviving spouse) dies. With a lump sum, any residual assets can be willed to heirs.

Tax considerations. Lump sum distributions can be taxable if not rolled over to a qualified retirement plan. Also, participants younger than age 59½ can face an additional 10% premature-distribution penalty unless the distribution is made after separation from service during or after the calendar year in which a participant attains age 55.

Provision of sound guidance

These are just some of the considerations plan participants will need to weigh if given the opportunity for a lump sum payout. Providing sound guidance to participants is a fiduciary obligation. In addition, if the GAO’s request for increased oversight happens, you’ll be ready to make the correct notification to the DOL.

BPM is one of the largest California-based accounting and consulting firms, ranking in the top 50 in the country. It has served the San Francisco Bay Area's emerging and mid-cap businesses, as well as high-net-worth individuals, since 1986. Our Employee Benefits team consists of professionals with extensive knowledge of ERISA guidelines and deep expertise performing employee benefit plan audits. We can help you craft a smooth-running plan that serves your employees while mitigating associated risk. For more information or for a free expert consultation, Jenise Gaskin at (925) 296-1016 or Mike Spence at (408) 961-6303 or visit us at www.bpmcpa.com/ebp.