Last month, Ford Motor Company broke new ground when it announced an offer through its pension plan. For a specific window of time, some 90,000 retirees and active employees with terminated vested rights for future benefits can take a lump sum pension payout rather than a monthly benefit. This offer involves the company's traditional defined benefit pension plan, not its 401(k) plan.
The offer was apparently motivated by Ford's desire to reduce its pension obligations and create a smaller pension plan "footprint." The point of this move is to downsize the pension plan to make the plan and its assets more manageable, particularly in the wake of any catastrophic event, such as a replay of the 2008 financial market meltdown.
"This way, if something happens, it still will not be good for the plan, but the plan's smaller footprint" allows it to more easily make moves to manage the fallout from the event, says Stewart Lawrence, national retirement practice leader for Sibson Consulting in New York. Or as Lawrence put it more simply, volatility surrounding a smaller financial obligation is better than volatility surrounding a larger financial obligation.
It also helps that the lump sums will be calculated solely using corporate bond rates, which will yield a smaller amount than the mix of Treasury bond rates and corporate bond rates that pension plans were required to use before the 2012 plan year. Moreover, by moving these assets out of the plan and into participants' hands as a lump sum, the plan is essentially transferring the risks of managing those assets, as well as any mortality and longevity risk, to the recipient.
Of course, that is assuming enough employees take the company up on the offer. How many employees take the lump sum will depend on a number of factors, including the type of benefits and incentives being offered, how well the company communicates the lump sum offer and the support for employee decision making, such as call center support and other information provided. "If the communications are very technical, that will not engender trust from employees," says Lawrence. "Employees may decide that they will not take the offer because they do not understand it."
Offering this type of window is not the right move for every company sponsoring a traditional defined benefit pension plan. Before moving forward on such a window, Lawrence urges pension plan sponsors to consider a number of key issues. For example, once the company has determined whether the window makes sense economically, the plan sponsor should consider the specific elements of the lump sum window design. This includes the terms of the lump sum, such as any early retirement subsidies to be included and the details of the interest rate assumption. Other issues to consider include the terms of the immediate annuity that the plan must offer participants, who will be eligible for the lump sum, and how this will impact applicable nondiscrimination rules.
A brief explaining the issues surrounding these lump sum windows is available from Sibson Consulting.