Sweet Spot For Advisors: Lump Sum Distributions

By Linda Koco
InsuranceNewsNet

Private defined benefit plans could represent an expanding market opportunity for advisors, according to Cerulli Associates.

The opportunity comes from the sweet spot that opens up when people “separate” from their traditional employer-based pension plans, Cerulli indicates.

Many of those “separated participants” will be looking for a new home for the assets they will take out of the old plan. Advisors having the expertise to help reposition those assets could be looking at an influx of new business.

The opportunity

The opportunity is not insignificant. "The number of separated participants in private DB plans totaled more than 12.4 million at the end of 2011, up from 10 million in 2004," pointed out Kevin Chisholm, associate director at Cerulli. 

Furthermore, over the past year, there has been a steady increase in the number of lump-sum distributions taken from DB plans, “and we expect that number to continue to increase," he said.

When plans offer separated participants the option of taking distribution as a monthly payout (annuity) or a lump sum, most will likely select the lump sum, Chisholm said.

If they do, that’s when the sweet spot opens up. "Lump-sum distributions put a significant amount of assets in motion," he explained.

"DB plan sponsors could offer lump sums to participants that amount to larger payouts, which create a new pool of prospects for financial advisors, or an infusion of cash to advisors whose current clients accept the one-time payment." 

The period when the offer is active provides opportunity as well—the opportunity to help clients decide whether to take the offer or not.

Another opportunity can emerge after the fact. These participants are not retired, the Cerulli researchers pointed out. Rather, the participants are separated from their former DB plan but likely to be still working and contributing to a defined contribution plan. This will yield additional rollover dollars in the future, the Cerulli researchers predicted.

Another researcher, Aon Hewitt, also sees lump-sum distribution activity heating up. A few weeks ago, the human resources consulting firm reported that 39 percent of DB plan sponsors it surveyed are “somewhat or very likely” to offer terminated vested participants and/or retirees a lump-sum payout during a specified period (a “window”) in 2013. 

That’s up from 7 percent of DB plan sponsors that added a lump-sum window in 2012, Aon Hewitt said.

Contributing factors

"There is no question, employers are looking for new ways to aggressively manage their pension volatility," said Rob Austin in a statement. He is a senior retirement consultant at Aon Hewitt.

Pension Benefit Guarantee Corporation (PBGC) premiums will begin to increase in 2013 and 2014, Austin pointed out. That will increase the carrying cost of pension liabilities, he said. That in turn will give plan sponsors “an economic incentive to transfer those liabilities off their balance sheet."

In 2012 new rules went into effect that made lump-sum distribution offers a financially attractive option for some employers. The rules derive from provisions in the Pension Protection Act (PPA) of 2006. Among other things, the rules permit amendments to plans to allow full lump sum distributions on a favorable interest rate basis.

The numbers being reported by Cerulli and Aon Hewitt suggest that employers are in fact taking advantage of the change. Headlines from last year support that conclusion too. For instance, big auto makers General Motors and Ford made news when they came out with lump sum distribution offers to retirees.

Some firms, when making the offers, stress that this is a one-time-only offer. So it’s essentially a take it or leave it option for employees.

Take-up of the offers can make a financial difference to the employer. Consider Kaydon Corp. of Ann Arbor, Mich., a firm that designs and manufactures custom engineered products for various industries. It made such an offer in third quarter of last year.

“The company offered certain former non-retiree employees with vested pension benefits the option of receiving a lump sum payment or an immediate annuity in settlement of all future pension obligations,” the company wrote in its year-end report. “This de-risking of our pension obligations reduced future pension liabilities by $9.2 million.”

If plans do not offer a lump sum distribution option, separated workers will still receive distributions—as the traditional monthly annuity payouts. This too presents opportunity for advisors, in the sense that they can counsel clients on how to manage the client’s other assets as advisors have done for years.

The Internal Revenue Service (IRS) defines a lump-sum distribution as the “distribution or payment, within a single tax year, of a plan participant's entire balance from all of the employer's qualified pension, profit-sharing, or stock bonus plans.” Participants can roll over all or part of the distribution, with no tax due on the part rolled over, IRS said. Any part not rolled over is reportable as ordinary income.

Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].

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Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].