Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, July 17, 1995 TAG: 9507180124
SECTION: MONEY PAGE: A-8 EDITION: METRO
SOURCE: MAG POFF STAFF WRITER
DATELINE: LENGTH: Long
The Retirement Protection Act, passed by Congress as part of the legislation that enacted the General Agreement on Trade and Tariffs, includes provisions to make pension funds safer. That's the good news, according to the institute.
The flip side of the legislation is that GATT reduces the benefits for some retirees to help pay for the loss of tariff revenue under the new tract pact, the institute said.
Donald J. Potter Jr. of Financial Strategies, a Roanoke pension and investment consulting firm, said employers can elect to come under the new law or remain with the old rules. He is advising his clients to adopt the new legislation.
A large number of employers in Roanoke are affected, he said.
Potter said they are those companies, generally small businesses, that have defined benefit pension plans (as opposed to defined contribution plans with variable benefits such as 401(k) programs) and also issue lump payments to departing employees and retirees.
The Institute of Certified Financial Planners said the provisions intended to make the funds safer include use of a longer, standardized mortality table.
When a company funds its pension plan, the institute explained, it must make actuarial assumptions about how long its retirees will live - and therefore how much money it needs to put aside to pay for their lifetime retirement benefits.
Many plans have assumed shorter lifespans than the federal mortality table does, thus requiring less money to be put aside. The new table forces them to put more money into their plans.
The act also requires underfunded company pension plans to pay higher insurance premiums to the Pension Benefit Guaranty Corp. This federal agency steps in to pay benefits to retirees whose company pension plan has failed.
The corporation recently estimated that 8 million Americans work for companies whose plans are underfunded by a total of $71 million. The planners said the corporation itself is nearly $3 billion in the hole after bailing out nearly 2,000 pension plans since the agency was created in 1974.
But the planners said the GATT legislation also has an impact on the amount of money some departing employees and retirees will receive. This is to help pay for the loss of tariff revenue under the new trade pact.
One move, the planners said, is to freeze for at least a year the increase in the maximum contribution limit of 401(k) plans, which is supposed to adjust annually with inflation.
And future increases will be able to rise only in minimum increments of $500. The planners said the result is that some workers will be able to contribute fewer tax-deferred dollars than they would have been able to under the old rules.
Another, more significant change may shrink the size of lump-sum payments to retirees. The planners said one-third of all pension plans allow a lump-sum payment in lieu of monthly annuity benefits. In theory, the retiree invests the payout and uses its earnings to help pay for retirement.
The size of a lump-sum payment depends on what interest-rate assumption the plan uses so that the payment and its projected lifetime earnings equal what the retiree would have received in lifetime annuity payments.
The act requires plans to use an interest-rate assumption based on 30-year Treasury bonds. These rates are higher than the interest rates many plans have assumed. A higher interest-rate assumption would mean a smaller lump sum because the payout would be expected to earn more interest over the retiree's lifetime.
In the past, Potter said, employers used capital discount rates that "have really come down in recent years." The lower the interest rate assumed, he said, the larger the amount of money required to produce specific earnings.
This was significant for small businesses with small pension plans, he said, because larger companies could better withstand the larger payouts in pension funds.
As interest rates have continued to drop, Potter said, the more money the employer was required to give to departing and retiring workers. "A lot of plans were underfunded all of a sudden."
The rates used in the past few years have hovered at 4 or 5 percent, Potter said. But the present 30-year Treasury yield is 61/2 percent, he said, allowing employers to pay out less money. That's why he recommends that businesses switch now to the new system.
The Institute of Financial Planning said the lump-sum provision won't affect retirees receiving annuities, but the legislation will slow company contributions to pension plans and result in smaller annuity payouts.
The GATT legislation won't affect retirees who already have taken lump sums or are receiving annuity payments.
But the institute said future retirees and departing workers should talk to their financial planners and to their company's pension benefits experts.
Find out how soon the company will institute the new rules and what interest-rate assumptions and mortality tables they use.
Also, the planners advised, take a hard look at the various annuity options. These may be more attractive under the new law than a lump-sum payment.
by CNB