lump sum versus monthly payments?

[Lori H]

from a trustee perspective for what reason would i want to NOT make monthly payments to a participant and provide a lump sum? is there any incentive? a participant is retiring this calendar play year, her monthly benefit has been calculated at $642 or $7704 a year, what would be the benefit of leaving her funds in the plan as opposed to just paying her in lump sum. the plan doc allows for both formats. finally, if they did make a lump sum payment, would there be any adjustments necessary on next years contribution? meaning is it possible the contribution would need to larger/smaller due to the lump sum dist.? i don't believe that would have any bearing, but would like a second opinion.

the plan has 1.8 mil in assets and about 400,000 in cash.

[Effen]

First, it’s not the trustee’s decision. The decision lies solely with the participant. If the Plan contains a lump sum option, it must be offered along with the annuity. Make sure to read the doc carefully as the lump sum may only apply if the value is < $5,000. When offered, 99% of the participants will take it.

Second, the impact on the future contributions is based on the actuarial assumptions used for funding. If you actuary is funding the plan assuming it will be paying annuities at 7.5% and in reality the plan pays a lump sum at 5.0%, then the plan will incur a loss, and the future contribution will increase. If the actuary has been recognizing the lump sum option in the funding assumptions, the payment could produce a gain or a loss depending on how the assumptions relate to reality. Generally lump sums are very expensive options for plans to pay. Many plans are funded ignoring the lump sum option in order to keep the contributions lower. You really need to ask your actuary how he/she is doing it.

[mwyatt]

I'd second Effen's analysis, especially given the switch to 94 GAR and the predominately low interest rates that you would use for 417 purposes. Unless your post-retirement funding assumptions were pretty conservative, you will most likely generate an actuarial loss if the participant elects a lump sum. However, as Effen noted, this is a decision by the participant, not the trustee, to elect the lump sum (assuming that this an allowable option under the plan; given the annual benefit you mentioned, clearly the $5k bar has been passed).

I would note that if your plan takes care of retiree payments by the purchase of an annuity contract, you may find that the lump sum option may be less expensive, given prevailing interest rate conditions on single contracts.

[Guest Blueglass]

Also, would you want to pay the lumpsum at the beginning of the year or at the end of the year? If you paid it at the beginning of the year and the participant passes away a few months later, the participant was over paid. If you pay the lumpsum at the end of the year, would you add interest to the lumpsum since the participant couldn't invest their monthly annuity elsewhere? Another thought, correct me if I am wrong or way off base, if the lumpsum is over $5000, I believe they also have the option to rollover their funds into an IRA, etc.

[david rigby]

Effen and mwyatt have supplied excellent commentary.

Of special note is the comment about participant decision. If the plan does have a lump sum option, and it has not been observed in past practice, then you may have a problem. In that case, the plan should seek advice from its ERISA attorney.

[Effen]

Blueglass,

Any lump sum is eligible to be rolled over, regardless of the amount.

I'm not sure I understand your comment about "beginning of year" or "end of the year". The lump sum is simply the present value of the annuity as of the date paid. If I pay it on July 1, 2004, then that is when I calculate the present value as of. "Beginning" and "end of the year" are not relevant.

[Guest Blueglass]

I guess I am a little confused as you can tell. All she did is take the monthly annuity amount times 12 to get the lumpsum in her example. It appears that the participant will continue to get a benefit for the rest of their life. I think it would be a waste of time and money to determine the PV of the lumpsum for the same participant each year. If it was a one time lumpsum, I could see doing the PV. Other wise, uggggggg, can you imagine doing the PV each year for each participant in the plan that chose a lump sum option.

[Guest guppy]

Agreed on the points regarding the "cost" of paying lump sums in today's market, but there are advantages to allowing them, such as:

- lower future pbgc premiums

- ease of plan administration

- lump sums are attractive to participants

[Effen]

Oops, maybe I was confused.... 12 times monthly payment is NOT "Lump Sum" as defined in the Code and would not be eligible for rollover. A Lump Sum is a one time payment equal to the present value of the lifetime annuity.

After re-reading the question, I think its about annual vs. monthly annuities. To which I say..... no, I won't say it.

If the Plan contains both options, the Plan Admin. must offer both options. It should also clearly define how/when the annual annuity is paid. Again, it is not the Trustees decision.

[mwyatt]

Say what?

12xmonthly annuity ain't a lump sum (unless I've been sorely mistaken over the last few years). Lori, please clarify, although I think you don't need to except for one poster...

The day after posting:

Sorry Blueglass, I shouldn't be on message boards after company christmas parties. I think what everyone here has understood the question to be is the difference between keeping the monthly annuity payments in the trust vs. settling the benefit as a lump sum (one big payment eligible to be rolled over, whether over or under $5k), which cancels any future payments from the trust. How does this choice impact the trust (and remember, the participant not the trustee, is the one who makes this decision)?

One, you have to contrast the liability held for the retiree using the funding assumptions vs. the amount calculated using the lump sum assumptions. As previously mentioned, the low 417 rates and 94GAR will most likely result in the lump sum being more expensive. Hence, an actuarial loss will probably be generated if the lump sum is elected.

Two, in the long run, if the participant has a long payment stream (say lives to 90), then overall the plan will eventually incur a loss if annuity payments are elected. However, we're talking about an experience loss well in the future.

Three, on the other hand, if the participant passes away relatively early (and any death benefits don't continue for a long period of time) then the plan would be losing any future mortality gains if the participant had elected an annuity payment.

However, if the plan is in the habit of purchasing an annuity contract to settle retiree benefits, then given the prevailing market rates, you may find that the cost of the annuity contract could potentially be higher than the lump sum payment. You may still be generating an actuarial loss depending on what assumptions were being used to value the benefit in the prior valuation, but in practical terms the plan is expending more dollars to settle.

Now, if somehow the majority of posters here have misread the original question and the issue of monthly v. annual payment (which is NOT a lump sum), then you could be seeing some losses/gains depending on how the plan document is constructed (are the annual payments for the year in the future v. arrears? any interest adjustment made since payments are being made sooner rather than later). However, the gain/loss will definitely be smaller than contrasting via the lump sum.

In point of fact, assuming interest adjustments for annual v. monthly bring things into equivalence, the only point I could see where you could argue one for the other is when death ultimately kicks in (ie, if payments for year are made BOY, and participant dies receiving more benefits than they otherwise would have, assuming that there isn't some sort of recapture mechanism for overpayment specified in the plan document). Other than that, can't really see where this would make much of a difference in comparision to annuity v. true lump sum.