NEW PENSION REFORMS IMPACT LUMP-SUM PAYOUTS

by Mark A. Krohn, Partner
Jacobowitz & Gubits, LLP

On August 17, 2006 President Bush signed into law the Pension Protection Act of 2006 (sometimes referred to hereafter as the “Act”). The new law affects benefits under defined-benefit pension plans, which provide monthly payments for life based upon years of service, but also offer a lump-sum payout option. The new law will not affect those who elect to receive their pension in monthly installments. Only those who elect to receive a lump-sum payout will be affected. Overall, it is estimated that over 10 million Americans will be given the option to take their pension benefit as a lump-sum payout.

The changes came about by issuing new rules beginning January 1st, 2008 dealing with how a company calculates a retiree’s lump sum payout based upon assumptions about investment returns and life spans. Under the new law higher investment returns can be utilized, which will produce a smaller lump-sum payout. Transition rules require that the new rules be phased in for plan years beginning in 2008 through 2011. Thus, people who retire in 2008 will see little affect on their payout. Certain “anticutback” rules apply which would prohibit a decrease in accrued benefits to plan participants. However, if certain requirements are met a plan amendment may be made retroactively without violating the rules.

The provisions provided under the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”), set to expire in 2011, were made permanent. Thus, the permissible maximum annual benefit of a qualified defined benefit plan remains the lesser of $160,000. subject to a cost-of-living adjustment ($175,000. for 2006), or 100 percent of compensation for the retiree’s highest three (3) consecutive years of service. If a participant retires before age 62 (commercial airline pilots excepted) or after age 65, the maximum annual benefit is increased or decreased, respectively. Thus, for 2006, a person age sixty-two (62) to sixty-five (65) may only receive one-hundred and seventy-five thousand ($175,000.00) dollars. Under the Act, when calculating how much the annual capped amount is worth when converting same into a lump sum, a higher interest rate of five and one-half (5 ½) percent is used, which is higher than the variable rate used in most of the prior years. This has the effect of lowering the lump-sum payment to be made. One solution to the problem would be to delay retirement. Another would be to forget about taking a lump-sum payout, electing instead to take benefits in monthly installments.

This is not to say that all of the provisions of the Act are bad. For example, the Act requires employers that offer traditional “defined benefit” plans to fully fund the plan and bring them up to fully-funded status within seven (7) years. The Act also encourages personal retirement savings for individuals. A large portion of the Act makes permanent many of the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) that were due to expire after 2010. Among those provisions the Act makes permanent the saver’s credit and the higher limits for contributions to IRAs. Other provisions include changes to the rules for IRAs and extensive changes to the record-keeping rules for charitable contributions.