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…So this evening I read another great white paper from Aon Hewitt on retiree lump sum windows. You can read the full piece here, but in summary for those unfamiliar with the concept; the utilization of lump sum windows is a pension management strategy wherein a company de-risks its pension by offering lump-sum buyouts to retirees currently receiving annuities (and/or terminated vested employees that will be eligible for an annuity in the future). The strategy can make sense for employers because it allows them to reduce long-term liabilities, while it can add value for employees by giving them greater flexibility in how they manage earnings in retirement.

^The IRS actually recently released guidance effectively eliminating the ability for defined benefit plan sponsors to offer lump sum cash-outs to retirees, so companies no longer have the ability to offer retiree lump-sum windows. Conversely, windows for ‘terminated vested’ participants is still allowed, which means that the lump sum is still an option that can be offered by companies to former (pension qualified) employees that haven’t started drawing their benefits yet.

…The chief argument against the lump sump window offering (and part of the reason for the IRS ruling, I think) is that not all retirees have the financial literacy to appreciate the risks of taking a lump sum in lieu of an annuity. Mismanagement of the funds in retirement could result in a retiree outliving the benefit, making the option mainly attractive to retirees that are either (i) savvy investors with other nest eggs in addition to their pensions or (ii) those likely to have health conditions which make it likely they will have lower than average life 1. 1. Morbid, I know. expectancies. 1

^Put another way, taking a lump sum offering is something that can make sense for a retiree, but for the un-initiated it can be a big mistake with long-term financial consequences. In the Hewitt study above, the average election rate for employees offered the lump sum in 2014 was 58%. I am sure it was a good decision for some of that 58% to utilize the lump sum… but there was also no doubt a contingent of this population that spent the money on a new boat or something instead (just 55% of the lump sum participants in the Aon study rolled the funds directly into a tax qualified account – accounting for about 70% of the total dollars).

…With all that said, the challenge that many retirees electing to take lump sums faced (and will continue to face in the case of terminated-vested parties) is one that most retirees will have to confront going forward. With annuity based plans going away, the new normal is that everyone is going to need to start becoming savvier from an investment standpoint; because the days of employer paternalism are fast coming to an end, if they are not already over. With cash balance pension plans, 401(k)s, and personal savings most likely to make up the majority of future retiree earnings, future retirees that aren’t financially literate are going to fast burn through their savings (and there won’t be any annuities for them to fall back on).

^The question is where the employer falls in this picture: Starting from the place that the retirement paradigm has changed, I think that while it is fair to expect employees to have much greater agency in managing their retirement funds… it is also fair to expect employers to provide their employees with the tools to make educated decisions. This means more (free) resources to educate the workforce on just how much they need to save in retirement, and different strategies they can partake in to manage their resources as retirees.

…I went on a bit of a tangent here  – I know this was supposed to be about lump sums – but I think they’re part of a bigger picture that is the modern retirement landscape. In this new world, employees need to manage their finances in a way that post-world war generations were never asked to. Employers and employees alike are going to have to navigate this process together, and I’m excited to see exactly how they will.

As always, please share your thoughts in the comments section below.

Best,

Rory

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