Does your defined benefit plan have a lump sum option? Nearly forty percent of U.S. employers who sponsor defined benefit pension plans are at least “somewhat likely” to offer lump sums to retirees and vested terminated participants in 2013, according to an Aon Hewitt survey released earlier this month. It is safe to say that an even larger group of defined benefit plan sponsors is considering whether to offer lump sums after hearing about the lump sum offers implemented by General Motors and Ford last year.

The attraction of these lump sum payouts is that once these participants have been cashed out, they will no longer be an obligation of the plan. Therefore, the consideration of lump sum elections for terminated participants is part of the larger trend of de-risking pensions and reducing balance sheet liabilities.

That same Aon Hewitt study also indicated that 60% of the surveyed plan sponsors intend to adjust the plan’s investments to better match liabilities, such as through liability-driven investing, and 7 percent were somewhat likely to purchase annuities for terminated participants in 2013, compared with 1 percent in 2012.

Why Lump Sums?

Why the difference between the percentage interested in lump sum options and the percentage interested in annuities? Annuities are relatively more expensive, because they use lower interest rates than are used to calculate lump sum values. According to Aon, annuitization is also more expensive because the insurer uses its own mortality tables and has a profit margin built in.

What to Keep in Mind

What are some of the considerations plan sponsors need to take into account in considering whether to add a lump sum option?


  • ­A plan must be at least 80 percent funded to offer unlimited lump sums. IRS funding rules restrict “prohibited payments”, which include lump sums, once the funding percentage falls below that level.

Tax Rules

  • ­IRS issued private letter rulings in 2012 clarifying that lump sums could be offered during a defined window period to participants who were already receiving pension payments.
  • ­Before those rulings, many questioned whether plans could offer any lump sums to this group, so there is no clear authority for allowing an ongoing lump sum option to participants who have already begun their pension payments. Further, private letter rulings are not binding authority for taxpayers who didn’t receive them. Plan sponsors considering offering a lump sum to those participants currently being paid should think about whether to ask for their own private letter ruling.


  • ­The communications explaining the lump sum option should be as clear as possible and take into account current IRS regulations on explaining the “relative value” of optional forms of payment.
  • Spousal consent should also be required of married participants.
  • Since these elections are not easy to understand, plan sponsors should plan on making special assistance available.

Professional Team

  • Implementing any lump sum option should be a team effort with the plan’s actuary, legal adviser, accountants and investment professionals taking part.
  • ­A plan amendment will be required to implement any window period election, and the plan will need to have sufficient cash to make the lump sum payments. Accounting treatment may depend on the size of the group offered the lump sum election. No one professional can deal with all of the ramifications.


  • ­ Will you defer the decision? Consider the possibility that the law could change.

Osler will be offering a complimentary webinar, “Managing Risk in Defined Benefit Plans: What U.S. Sponsors Have Done and What’s Next?”, which will focus on the U.S. de-risking experience, on March 13. I will discuss legal issues and our guest speaker from Mercer will provide insight into the actuarial and investment aspects. For further information, please contact Vaughna MacKenzie, Meetings & Conferences Planner at or click here for the invitation.