What are the risks and challenges of a lump-sum distribution option for a plan termination?

1 Regulatory requirements

One of the challenges of offering a lump-sum distribution option is complying with the complex and changing regulatory requirements that govern plan terminations. You must follow the rules and procedures set by the Internal Revenue Service (IRS), the Pension Benefit Guaranty Corporation (PBGC), and the Department of Labor (DOL) to ensure that your plan is fully funded, that you notify and inform your participants and other stakeholders, and that you protect the rights and interests of your plan beneficiaries. Failure to comply with these requirements can result in penalties, delays, or legal challenges.

2 Market conditions

Another risk factor that can affect the viability and attractiveness of a lump-sum distribution option is the market conditions at the time of the plan termination. The amount of the lump-sum payments depends on the interest rates and mortality assumptions that are used to calculate the present value of the future benefits. If the interest rates are low, the lump-sum payments will be higher, which means that you will need more assets to fund them. On the other hand, if the interest rates are high, the lump-sum payments will be lower, which means that your participants may prefer to keep their annuities or roll over their benefits to another plan.

3 Participant behavior

A third challenge of offering a lump-sum distribution option is predicting and influencing the behavior of your participants. You need to consider how many of them will elect to take the lump-sum option, how they will use or invest their payments, and how they will cope with the loss of guaranteed income and protection from inflation and longevity risks. You also need to provide them with adequate education and guidance to help them make informed choices and avoid potential pitfalls, such as taxes, fees, or fraud. Moreover, you need to balance the interests of your participants with those of your plan and your organization, and avoid any perception of coercion or discrimination.

4 Operational issues

A fourth risk factor that can affect the execution and success of a lump-sum distribution option is the operational issues that may arise during the plan termination process. You need to have accurate and updated data on your participants, their benefits, and their preferences. You need to have sufficient cash flow and liquidity to make the lump-sum payments on time and in full. You need to have reliable and secure systems and processes to handle the transactions, the records, and the reporting. You also need to coordinate with your service providers, such as actuaries, consultants, and custodians, to ensure that they deliver their services efficiently and effectively.

5 Legal implications

A fifth challenge of offering a lump-sum distribution option is dealing with the legal implications that may result from your decision. You need to be aware of the potential liabilities and claims that you may face from your participants, their beneficiaries, or other parties, such as creditors or regulators. You need to have a clear and consistent policy and communication strategy to explain the rationale and the consequences of your option. You also need to have a strong and competent legal team to advise you on the risks and opportunities, and to defend you in case of any disputes or litigation.

6 Strategic considerations

A sixth factor that can affect the feasibility and desirability of a lump-sum distribution option is the strategic considerations that may influence your long-term goals and vision. You need to evaluate how your option will affect your financial position, your reputation, your culture, and your relationship with your employees, customers, and stakeholders. You need to consider how your option will align with your mission, values, and objectives, and how it will support your growth, innovation, and sustainability. You also need to assess how your option will compare with other alternatives, such as maintaining or freezing your plan, or purchasing annuities from an insurer.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?