The Annuitized Future is Another Step Closer
By Linda Koco
The Pension Benefit Guaranty Corporation (PBGC) has made another move to beef up lifetime income streams for certain retirement plan participants.
It did this by issuing a new rule. It’s a rule that insurance and financial advisors probably won’t bump into very often but that will nevertheless get an advisory heads-up. That’s because it represents another indication of the “annuitized future” that is unfolding right before the eyes.
The change amends existing PBGC rules aimed at rollovers from 401(k) plans into defined benefit (DB) plans. Created by the Employee Retirement Income Security Act of 1974, PBGC administers private-sector, single-employer DB plans that have terminated due to underfunding.
If the phrase “401(k) rollover into DB plans” makes you skeptical, you are not alone. I wondered when I saw it too. Normally, the industry talks about rollovers into IRAs or IRA annuities, not into traditional DB plans. But guess what? Rollovers into traditional DB plans can also occur in certain circumstances. This builds up funds that will enhance a participant’s guaranteed retirement income stream via a pension, essentially annuitizing the assets.
The new rule seeks to remove the financial pinch that could occur with such rollovers—if, that is, PBGC were to take over an underfunded private pension that includes 401(k) rollover assets.
Here is a simple boil-down on how this works. (Brace yourself, it gets techie.) PBGC takes over a terminated DB plan’s monthly benefit payments to retirees, provided that the plan has paid it PPGC premiums. These payouts are subject to an annual maximum guaranteed amount per participant. For a DB plan terminating in 2015, the maximum guaranteed benefit for a 65-year-old retiree will be just over $60,000 a year, according to PBCG.
But what happens if the 401(k) rollover creates an excess amount over the guaranteed maximum payout? The benefits earned from the rollover would, under the new rule, generally not be affected by PBGC’s maximum guarantee limits. This could help plump up the participant’s lifetime payout amount.
There are some qualifiers on this. For instance, mandatory contributions made by employees are free from the guarantee limits but not the contributions made by the employer.
Here is an example: Assume a 65-year-old DB participant has an $80,000 total annual plan benefit. Of this amount, $15,000 came from mandatory employee contributions associated with rollovers and $5,000 from employer contributions associated with rollovers. To determine the maximum guaranteed annual benefit, exclude the $15,000 employee contribution. That leaves $65,000 that is subject to the maximum guaranteeable benefit limitation ($60,000 + $5,000 from the employer contributions).
If this plan terminates in 2014, the participant’s maximum “guaranteeable benefit” would be about $59,000, according to PBGC. As a result, this retiree’s total benefit would be about $74,000 (the $59,000 yearly maximum + the $15,000 employee contribution).
You can read more about the example in the rule here, but the above does show the income generating potential. As PPGC put it in a statement: “The agency hopes to encourage people to get lifetime income by removing potential barriers to moving their benefits from defined contribution plans to defined benefit plans.”
Onlookers may well wonder why PBGC is even talking about moving 401(k) money into DB plans. After all, DB plans have been on a steady decline for over a decade. In 2012, for instance, only 30 percent of Fortune 100 companies offered a DB plan, according to data from PBGC and LIMRA. That’s down from 90 percent in 1998.
But other voices are pushing for a DB rebound. For example, Milliman, the consulting firm, has been nudging employers to start offering DB plans again, maintaining that the plans are good for employees (e.g., retirement security) and for employers (e.g., a way to attract and retain employees).
What do advisors get from this new rule? At least three things: 1) another endorsement of the importance of lifetime income planning; 2) a reminder that the retirement benefits arena is continually changing; and 3) a possible spur to discuss retirement income with clients.