There has been a growing trend among pension plan sponsors offering former employees the opportunity to receive the value of their vested benefit as a one time lump sum. The benefit otherwise would be payable at a normal retirement date, usually age 65, as a monthly benefit for life. The offer is usually made as part of a limited time “window” and is based on a maximum threshold, such as $25,000.
Plan sponsors are making these offers for various reasons, a large one being the ongoing annual administrative cost associated with these former employees’ benefits. For example, sponsors are required to pay ever increasing annual insurance premiums to the Pension Benefit Guaranty Corporation (“PBGC”), the federal agency that insures pension benefits. In addition, continuing to track and provide required disclosure items to former employees can be burdensome.
Here’s How it Works
The specifics of the offer will be communicated to the individual participants along with general guidelines and instructions. In many cases if the lump sum is below $5,000 (“cash out limit”), the plan will provide that an immediate lump sum distribution is to be paid. The individual will have the choice of how that distribution is to be paid, in the form of a rollover or in cash. However if the individual does not make an affirmative election, the plan will automatically roll over the distribution to an Individual Retirement Account (“IRA”) on behalf of the participant. For those participants, whose lump sum value is above $5,000 (or other cash out limit in the plan), they will have a choice of receiving a lump sum now, or deferring the monthly benefit until retirement. Alternatively they would have the choice of receiving a reduced monthly benefit starting immediately.
Individuals presented with an offer should review their situation carefully before making a decision. They should be encouraged not to use this as an opportunity to access funds for non retirement related expenditures or expenses. A participant’s decision to elect either a lump sum distribution or monthly income for life should factor in an individual’s health and heredity, as well as their comfort level with managing a pool of assets. If after a thorough review, an individual determines that they will elect a lump sum distribution, then a rollover to another qualified plan or IRA is the most tax effective option. This allows for the deferral of income tax until a later date when distributions from the rollover account are taken. Otherwise receipt of the lump sum distribution in cash will result in a mandatory 20% withholding as well as possible state taxes or early distribution penalties.
Review Your Options
There are IRA options available at most banks and financial institutions and an individual can, and should, consult with a financial advisor. In fact, BPAS can work with Plan Sponsors and their Financial Advisors to offer employees an IRA Rollover program that best suits the needs of electing plan participants. By presenting a simple rollover solution, participants are more encouraged to rollover their benefits, preserving their retirement savings.