DB plan participants need better information when offered lump sums replacing their lifetime benefits, GAO says

Packets of informational materials provided to retirees and others by sponsors offering lump sums consistently lack key information needed to make an informed decision or were otherwise unclear, according to a recent study by the U.S. Government Accountability Office (GAO).

As a result, the GAO called on the Labor Department (DOL) to improve its oversight by requiring plan sponsors to notify the agency when they implement lump-sum windows, and coordinate with the Treasury Department to clarify guidance on the information sponsors provide to participants. Further, the GAO recommended that the Treasury Department should reassess regulations governing relative value statements, as well as the interest rates and mortality tables used in calculating lump sums.

GAO findings

Little public data is 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 DOL has primary responsibility for overseeing pension sponsors’ reporting requirements, it does not require sponsors to report such lump sum-offers, making oversight difficult, the GAO indicated. Pension experts generally agree that there has been a recent increase in these types of offers.

By reviewing the limited available public information, the 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 IRS 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, the GAO found. In addition, some participants may not continue to save their lump-sum payment for retirement but instead may spend some or all of it.

The GAO reviewed 11 packets of informational materials provided by sponsors offering lump sums to as many as 248,000 participants and found that the packets consistently lacked key information needed to make an informed decision or were otherwise unclear. Using various sources, including financial advisors, federal agency publications, laws, and regulations, the GAO identified eight key types of information that participants need to have a sound understanding of a lump-sum offer.

While the GAO did not review the packets for compliance or legal adequacy, most packets provided a substantial amount of these eight key types of information. However, all of the packets the GAO reviewed lacked at least some key information. For example, the relative value notices were often unclear about how the value of the lump sum compared to the value of the lifetime monthly benefit provided by the plan. Similarly, many packets did not clearly indicate the interest rate or mortality assumptions used, limiting participants’ ability to assess how the lump-sum payment was calculated. Further, few of the packets informed participants about the benefit protections, full or partial protections provided by the Pension Benefit Guaranty Corporation (PBGC), which they would keep by staying in their employer’s plan. This omission is notable, said the GAO, because many participants interviewed by the GAO cited fear of sponsor default as an important factor in choosing the lump sum.

Source: GAO-15-74, February, 2015.

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