Next Steps After an Annuity Purchase

by | Dec 12, 2018 | bytesize, Defined Benefit

You’ve just completed an annuity purchase for your pension plan. Congratulations, you reduced your plan’s risks (e.g. investment, regulatory, mortality, discount rate risks) and significantly saved PBGC premiums and administrative expenses! The contracts have been signed, the check has been written, and responsibility for paying a group of participants has been transferred to a quality insurer. So what’s next for the plan? Now is a good time to build a strategy for your plan which will differ depending on your funded status.

Well funded Frozen Plans: If a near term (think < 3 years) plan termination is in the cards, it’s time to get the plan in order. Make sure all benefit calculations are certified. Dig up the details of old benefit calculations. Track down good addresses for every participant. Make sure you know who all the covered beneficiaries are, and that they are all still alive. Fix any compliance issues, getting the plan document “up to code”, and using the IRS’s EPCRS system to remedy any prior failures. Then re-evaluate the plan’s funding, and come up with a contribution and investment strategy to fully fund the plan. Begin to think about the partners that will get you through the plan termination (ERISA counsel, actuary, annuity placement consultant, trustee, administration team, etc.). R&M’s Plan Termination Readiness Assessment can take care of much of this work for you.

Ongoing and not so well funded frozen plans: These sponsors will likely want to take another chunk out of the plan’s administrative expenses and there are a few things to consider. 1. Small lump sums are an easy option. Be sure your plan allows for de minimis lump sums (currently < $5,000), and pay these out on a regular basis. 2. Consider adding an elective lump sum up to a slightly higher amount (e.g. $10,000 or $15,000). Participants with relatively small benefits can take the entirety of their benefits and the sponsor will not need to track them for years to come or pay $650 or more in annual PBGC premiums. 3. Frozen plans with a large number of active participants should consider “a spin-term” which allows the active participants, typically with the smallest benefits to get a lump sum or have an annuity purchased. Eliminating these participants again reduces PBGC premiums and reduces plan risk. 4. If you’re not paying the maximum per-participant cost to the PBGC, be sure you’re getting the most out of your contributions, allocating each contribution (like those April & July quarterly contributions) to the prior plan year whenever possible – you’ll get an extra 4%+ savings by doing this.

For all plans, re-consider investments. After removing a good portion of your retirees via an annuity purchase, the demographics of the plan will be different, perhaps drastically different. The investment approach that made sense prior to the annuity purchase should be revisited. For those plans heading quickly towards a plan termination your investment strategy should be guided by a consultant with knowledge of how plan liabilities will move (or not move) with changing interest rates during the termination process. For plans with a longer time horizon the ongoing investment decisions will also change following the annuity purchase. Perhaps the plan can be more aggressive, since the plan’s population will be younger (allowing for a higher expected return for accounting purposes as an added benefit)! Or maybe the purchase was just a first step towards reducing risk, where hedging with investments takes on a different level of difficulty given fewer participants in pay status.


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