The federal budget deal could speed the long, lingering death of old-fashioned defined-benefit pension plans, in which employers reward years of service by providing a guaranteed stream of income in retirement.
The deal could affect any pre-retiree in a former employer's pension plan1 by increasing the per-head premiums that plan sponsors must pay to the Pension Benefit Guaranty Corp. If it goes through as written, every person in a plan will get more expensive at the stroke of a pen.
Employers are already deeply concerned about the extent and uncertainty of future pension liabilities and are trying to shed them. The proposed increase in the budget legislation would push even more pension plans to manage costs any way they can, including reducing participant head count, said Alan Glickstein, a senior retirement consultant with Towers Watson.
The budget deal calls for a 22 percent hike, spread out over three years, in flat-rate, single-employer premiums paid to the PBGC, which acts as a backstop to a company's pension liability should the company become insolvent. Those premiums will already have risen from $31 in 2007 to $64 in 2016; by 2019 they will reach $782.
An increasingly common way companies get rid of those liabilities is by offering participants a chance to take their pensions all at once, as lump sums based on the present value of their future benefits.3 After strong years for such offers in 2013 and 2014, the activity rose dramatically in 2015, said Matt McDaniel, who leads Mercer’s U.S. defined-benefit risk practice.
More lump-sum deals aren't good news for employees, about 40 percent to 60 percent of whom take the deals. Most who take lump sums of less than $50,000 cash those retirement funds out rather than roll them into an IRA, paying income tax and a 10 percent penalty if they aren't at least 59½. While it depends on individual circumstances, it usually makes more financial sense to leave the money in the plan and have it trickle out during retirement.
Perversely, the premium hikes could wind up hurting, not helping, the Pension Benefit Guaranty Corp., because they may not fully offset shrinking head count in pension plans. Benefit consultants are frustrated. "This has nothing to do with pension policy, but is simply a device to raise revenue," said Towers Watson's Glickstein. Higher premiums "would be a factor that causes a move away from these plans, and the whole point of the PBGC is to strengthen the employer pension system, so it's kind of ironic."
A statement by the Erisa Industry Committee, an association that advocates for the employee benefit and compensation interests of large employers, said it was "outraged." Its Oct. 27 statement quoted the committee's president as saying that "even the PBGC’s own analysis does not call for an increase in premiums on single-employer defined benefit plans. PBGC premium increases like the one announced today do nothing to encourage single-employers to continue defined benefit plans or improve benefits for retirees; in fact, the increases only work to further weaken the private retirement system.”
In response to the criticism, an Obama administration official spoke with Bloomberg BNA's Pension & Benefits Daily, telling David Brandolph that with the underfunding in the PBGC's single-employer program, "the proposed premium increases are necessary to ensure that PBGC will be able to pay retiree benefits when pension plans fail. Even with these changes, premiums would likely remain a relatively small percentage of a company's annual pension contribution and a tiny fraction of total compensation costs." The official noted that the increases take effect over three years to allow companies to plan for the new costs.