Longer life expectancies raise the bar on pensions

Implications for Pensions

The new SOA projections underscore the need for retirees to focus on longevity risk as they set goals for retirement saving and withdrawal rates. And, when considering the numbers, it’s important to remember that the mortality data simply reflects averages; many of us–especially women–can expect to beat those numbers.

But the new SOA projections also will have direct implications for defined-benefit pensions. Maintaining pension plans will become more expensive for plan sponsors, because the longer life spans will require them to increase projected future costs on their balance sheets. The value of payouts will rise anywhere from 4% to 8%, depending on the age of the annuitant (see table).

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“It raises the bar,” says Rick Jones, a senior partner at Aon Hewitt, the employee benefit consulting firm. “We think the audit community will require plan sponsors to consider the new mortality tables at the end of 2014.” The new SOA projections also will be adopted over the next few years by federal regulatory agencies that oversee pensions and will require plan sponsors to increase funding levels to meet expected rising obligations.

That, in turn, likely will accelerate a major trend among plan sponsors to adopt de-risking strategies. Sometimes, that simply means reducing equity exposure in plan portfolios. But it also can mean offering lump-sum buyouts to retirees and former workers, or transferring their obligations to private insurance companies by buying huge group annuities to pay out benefits.

Deciding whether to accept a lump-sum offer is a highly personal decision. A key factor is how healthy you think you are in relation to the rest of the population. If you think you’ll beat the averages, a lifetime of pension income will always beat the lump sum. The bigger picture of your retirement assets also matters; some people decide to take lump-sum deals when they have other guaranteed income streams, such as a spouse’s pension or high Social Security benefits.

Others think they can do better by taking the lump sum and investing the proceeds. That’s possible, but it needs to be weighed against the risks of withdrawing too much, market setbacks, or living far beyond the actuarial averages. And “doing better” on a risk-adjusted basis means you would have to consistently beat the rate used to calculate the lump sum by investing in nearly risk-free investments–certificates of deposit and Treasuries–since the pension income stream you would receive is guaranteed, with the exception of failed plans.

Another factor: New mortality projections may boost the value of lump-sum offers. The Internal Revenue Service will adopt tables within the next few years–2016 at the earliest–that govern the minimums required for lump-sum distributions. Those tables will be based on the SOA tables. That prospect likely will motivate some plan sponsors to offer lump-sum deals now, while they are less expensive.

Workers offered lump sums now might want to wait for a better deal down the road. But there’s a caveat: The value of future offers also will be affected by interest rates, which are at historic lows. Higher interest rates would be reflected in higher discount rates, which are used to calculate lump-sum values, and lower payouts. Wilshire Consulting has estimated that a 50-basis-point jump in rates would offset the payout increases generated by the new mortality tables.

Although lump-sum buyouts are take-it-or-leave it deals, there could be additional buyout windows down the road in many cases, as sponsors work to reduce their pension obligations.

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