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Transferring risk from your pension plan

Transferring risk from your defined benefit (DB) plan can be part of a wind down strategy for a terminating plan, or simply a way to help make the size of your overall pension obligation—and associated future risk—more manageable.

There are 2 primary ways to transfer risk out of your pension plan:

  • Offering lump sum payments
  • Purchasing an annuity

What is risk transfer?
Risk transfer removes a portion of the pension plan’s liabilities, along with corresponding assets and future risk, from the plan and places it either with an insurance company (by purchasing an annuity) or with the plan participant (using a lump sum payment).

How the 2 options to transfer risk work

Lump sum payments

Participants accept a one-time payment that replaces the lifetime benefits originally offered under the plan. Generally, they can choose to either accept the payment in cash or roll it over into a qualified retirement plan or an individual retirement account (IRA).

Lump sums can’t be forced. Participants must voluntarily choose to accept a lump sum payment once it’s offered. And the value of the lump sum must be no less than the actuarial equivalent of a participant’s pension as defined under the law.

Lump sums can be added to your plan in 2 ways:

  • Permanent lump sum: Vested employees are offered a lump sum payment as they terminate or retire. You can apply the lump sum offer to all participants or limit it to only those whose lump sums fall below a certain amount. Adding a permanent lump sum transfers risk gradually over time, reducing the likelihood you’ll be subject to special settlement accounting.

  • Lump sum window: For a limited time—typically 3 to 6 months—a group of former employees (and/or employees terminating during the window period) are offered a lump sum payment. You have some flexibility defining the eligible group within discrimination rule guidelines. However, offering a lump sum window does increase the likelihood of special settlement accounting because a relatively large amount is paid from the plan over a short period of time.  

Annuity purchase

By purchasing an annuity, the responsibility for paying the future pension benefits of a specific group of participants (along with their associated liabilities and assets) are transferred to an insurer—removing them from your balance sheet permanently. The insurance company is then responsible for managing the benefit payments to participants.

Unlike lump sums, annuity purchases don’t require consent from plan participants, so you have the flexibility to decide what portions of the plan to transfer. Remember, however, that you have a fiduciary responsibility as the plan sponsor to choose an insurance company that’s financially strong enough to pay the future benefits.

Pros and cons of transferring risk

The pros and cons of any risk transfer must be carefully weighed before taking any action. In addition to the benefits of reducing your pension plan’s exposure to risk, there are some potential downsides to consider too. A pension risk transfer:

  • Can result in higher minimum contributions, accounting expenses, and even PBGC premiums depending on a plan’s funding strength and the size of the transfer
  • May trigger a special settlement accounting charge for the fiscal year
  • Removes PBGC insurance coverage for those included in the transfer

Learn more about the advantages and disadvantages of offering lump sum payments vs. purchasing an annuity.

We can help

Because each DB plan is different, it’s important to choose the pension risk transfer strategy that could work best for you. Give us a call at 800-952-3343 or contact your financial professional to get started.

The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, investment advice or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, investment or accounting obligations and requirements.

Insurance products and plan administrative services provided through Principal Life Insurance Co., a member of the Principal Financial Group®, Des Moines, Iowa 50392.

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