Private Pensions: Participants Need Better Information When Offered Lump Sums That Replace Their Lifetime Benefits

 Dickens’ Dream”, unfinished painting by Robert W. Buss, circa 1874 

“I lay very great stress upon that honourable characteristic of the charity, because the main principle of any such institution should be to help those who help themselves. That the Society`s pensioners do not become such so long as they are able to support themselves, is evinced by the significant fact that the average age of those now upon the list is seventy-seven; that they are not wasteful is proved by the fact that the whole sum expended on their relief is but 500 pounds a-year; that the Institution does not restrict itself to any narrow confines, is shown by the circumstance, that the pensioners come from all parts of England, whilst all the expenses are paid from the annual income and interest on stock, and therefore are not disproportionate to its means.“

Editor’s Note: The above is from a speech given by Charles Dickens in London, in the year of 1852. It was in honor of  The Ninth Anniversary Dinner of the Gardeners’ Benevolent Institution; Dickens, Charles. “Speeches: Literary and Social.” Great Literature Online. 1997-2015

What GAO Found

Little public data are available to assess the extent to which sponsors of defined benefit plans are offering participants immediate lump sums to replace their lifetime annuities, but certain laws and regulations provide incentives for use of this practice. Although the U.S. Department of Labor (DOL) has primary responsibility for overseeing pension sponsors’ reporting requirements, it does not require sponsors to report such lump sum offers, making oversight difficult. Pension experts generally agree that there has been a recent increase in these types of offers. By reviewing the limited public information that is available, GAO identified 22 plan sponsors who had offered lump sum windows in 2012, involving approximately 498,000 participants and resulting in lump sum payouts totaling more than $9.25 billion. Most of these payouts went to participants who had separated from employment and were not yet retired, but some went to retirees already receiving pension benefits. Sponsors are currently afforded enhanced financial incentives to make these offers by certain laws and regulations issued by the U.S. Department of the Treasury (specifically the Internal Revenue Service) governing the interest rates and mortality tables used to calculate lump sums.

Participants potentially face a reduction in their retirement assets when they accept a lump sum offer. The amount of the lump sum payment may be less than what it would cost in the retail market to replace the plan’s benefit because the mortality and interest rates used by retail market insurers are different from the rates used by sponsors, particularly when calculating lump sums for younger participants and women. Participants who assume management of their lump sum payment gain control of their assets but also face potential investment challenges. In addition, some participants may not continue to save their lump sum payment for retirement but instead may spend some or all of it.