There are situations, however, when it could make sense to cash out pension benefits for certain terminated participants who no longer have ties to the union, trade or employer. Given recent legislative changes and the current interest rate environment, expanding small benefit cash-out rules may produce significant savings on PBGC premiums and other costs related to plan administration.

This article discusses various considerations for trustees of multiemployer plans that may wish to expand their small benefit cash-out rules.

Expanding small benefit cash-out rules

The SECURE 2.0 Act, signed into law in 2022, increased the automatic cash-out threshold for defined benefit and defined contribution plans from $5,000 to $7,000, effective for distributions made after December 31, 2023. (See our January 4, 2023 insight.) The higher limit allows plan sponsors to automatically distribute benefits to terminated vested participants if the present value of their benefits is $7,000 or less. Participant and spousal consent is not required for this distribution. Benefits over $7,000 cannot be distributed without the participant’s consent.

Note that federal law prohibits multiemployer plans in critical status (the “red zone”) from making lump-sum distributions above the small benefit threshold of up to $7,000. In other words, multiemployer plans in the red zone are permitted to cash out benefits up to the automatic small benefit threshold.

Higher interest rates result in smaller present values. Therefore, given the current interest rate environment, multiemployer plan trustees may consider expanding their rules for automatically cashing out participants with small benefits, as more participants may now be eligible for a cash-out. Implementing changes now — before a possible reduction in market interest rates — may result in greater savings to the plan.

There are two key changes to consider:

• Increasing the automatic cash-out limit to $7,000 as permitted under SECURE 2.0
• Applying the small benefit determination to terminated vested participants after a defined break in service, not just at commencement of benefits

Making these two changes could produce significant savings on premiums paid to the PBGC and reduce costs related to plan administration. It could also help address concerns over locating missing participants.

Many single-employer plan sponsors have already made these changes to their plan rules, as doing so usually generates cost savings with reduced PBGC premiums. Multiemployer plan trustees may wish to consider making these changes as well, if they haven’t already. It is important to note, however, that the decision to expand small benefit cash-out rules is often more nuanced for a multiemployer plan than for a single-employer plan.

For multiemployer plans, there may be costs associated with expanding cash-out rules, due mainly to the difference between the mandated interest rates used to calculate the lump sum amounts and the plan’s actuarial interest rate assumption. In many cases, the savings and other benefits outweigh the costs.

Every plan is different. It is important for multiemployer plan trustees to work with their actuary and other professionals to make an informed decision.

PBGC premium savings

Perhaps the most compelling reason to expand cash-out rules is the annual savings it will generate on PBGC premiums by reducing the number of covered terminated vested participants.

For multiemployer plans, annual PBGC premiums are calculated as a flat rate per participant. The flat-rate premium is the same for all multiemployer plans, regardless of their benefit amount or how well funded they are. The flat-rate premium is currently $39 per participant for 2025 and is indexed annually with inflation. There is also a scheduled increase in the flat-rate premium to $52 per participant in 2031.

Importance of interest rates to cash-outs

In determining lump-sum, cash-out amounts, qualified defined benefit pension plans must comply with minimum present value rules under Section 417(e) of the Internal Revenue Code. These rules require that the lump-sum amounts be calculated using interest rates and mortality assumptions prescribed by the IRS. The mandated interest rate assumptions are tied to high-quality corporate bond yields.

When interest rates rise, the present value of a stream of future pension payments declines. Therefore, with higher interest rates, more participants will be subject to automatic cash-out because the lump-sum value of their benefit is below the $5,000 or $7,000 threshold.

As we highlighted in another article on pension de-risking opportunities, interest rates rose in late 2022 to levels not seen in the previous 15 years. Though the Federal Reserve has signaled interest rate cuts may be on the horizon, IRS minimum present value rates remain around 5.0 percent. Plan trustees may consider changing their cash-out rules before interest rates decline.

For multiemployer plans, the interest rate used to measure funding obligations is the plan actuary’s best estimate of long-term investment returns on plan assets. Therefore, if the IRS minimum present value interest rates are lower than the actuarial interest rate assumption, in a cash-out situation, the plan would pay out more in assets than it offloads in liabilities, resulting in a cost to the plan. Note that the difference between the prescribed IRS mortality assumptions and the plan’s mortality assumptions is also a consideration.

As illustrated below, however, in the current interest rate environment, the cost related to differences in interest rates is often less than the long-term savings from reduced PBGC premiums and other administrative costs.

Balancing savings and costs when considering small benefit cash-outs

As an example, consider a hypothetical multiemployer plan with an actuarial interest rate of 7.0 percent. The following chart illustrates the costs and savings associated with implementing small benefit cash-outs for this hypothetical plan.

Note that the example above focuses only on potential savings from PBGC premiums. Any additional reductions in administrative costs would further increase the long-term savings for the plan.

Results will vary for each plan, depending on factors such as participant demographics, current market interest rates and the plan’s actuarial assumptions.

Selecting an IRA provider

By law, small benefits valued above $1,000 and up to $7,000 must be rolled over to an individual retirement account (IRA) unless the participant elects either a direct rollover to an eligible retirement plan or to receive a lump-sum, cash payment with applicable tax withholding. Therefore, selecting an IRA provider is an important part of the process for plan trustees that decide to cash out terminated vested participants with small benefits.

Selecting an appropriate IRA provider carries fiduciary responsibilities under the Internal Revenue Code and ERISA. Plan fiduciaries should work with their legal counsel to conduct due diligence to ensure the selected provider is in the best interest of the affected participants. Note that Department of Labor regulations (29 CFR 2550.404a-2) provide a safe harbor for automatic IRA rollovers.

Key factors to consider in selecting an IRA provider include:

• Low fees and transparent pricing
• Capital preservation investment options
• Participant account access and support
• The provider’s capabilities for recordkeeping and locating missing participants

Plan fiduciaries should work with legal counsel to ensure their process for selecting an IRA provider is documented appropriately.

Participants returning to active service

Expanding small benefit cash-out rules as widely as possible will result in cashing out more terminated vested participants — and potentially greater savings to the plan. It is important to note, however, that there is a possibility that some cashed-out individuals will later return to active service with a contributing employer and once again become a participant in the plan. In these situations, if the participant does not repay their cashed-out benefit, their service and accrued benefit under the plan will restart at zero.

Many participants who elect to receive their benefit as a lump-sum cash-out will not be able to make this repayment upon returning to active status. Boards of trustees typically view this situation, where a returning active participant must restart at zero, as a highly undesirable outcome. To minimize this risk, trustees may increase the length of the break in service after which a terminated vested participant is subject to cash-out. In some cases, especially in industries where it is common for terminated participants to return to active service, the trustees may determine the risk outweighs the potential savings from expanding the plan’s small benefit cash-out rules.

Next steps for plan trustees that want to consider expanding their plan’s small benefit cash-out rules

Plan trustees that are interested in exploring an expansion of their small benefit cash-out rules should reach out to their actuary, administrator and legal counsel to help them make an informed decision.

One of the first steps is to perform an actuarial analysis to evaluate the potential costs and savings of the change. Other factors could play into the ultimate decision as well, such as administrative simplification, reducing the risk of federal agency audits, and the effect on participants.

If a decision is made to move forward, the board of trustees should then coordinate with their administrator and plan professionals to ensure a smooth implementation. A plan amendment will be required. Other key steps for implementation include administrative procedure updates, participant communications, death audits and coordinating with the selected IRA provider.