On February 2, 2012, in a stated effort to encourage retirement savings and manage longevity risks, the Department of Treasury, the Internal Revenue Service (IRS) and the White House released a package of guidance and commentary. The package took the form of IRS proposed regulations, revenue rulings, a Treasury fact sheet, and both a report and statement from the White House. The guidance is aimed at making it easier for defined benefit plans, defined contribution plans, IRAs, 403(b) plans and 457(b) plans to offer benefit options such as partial annuities and longevity annuities.

The Guidance in Brief

The new and proposed guidance consists of the following:

  • Proposed regulations that make it easier for defined benefit pension plans to offer, under better terms than currently exist, an annuity for a portion of an individual’s retirement benefit and a lump sum for the remainder of the benefit.
  • Proposed regulations that allow defined contribution plans to offer qualified longevity annuity contracts (QLACs) by exempting such contracts from certain required minimum distribution (RMD) rules. The proposed regulations do not apply to defined benefit plans, which already offer such annuities, or to Roth IRAs because the RMD rules do not apply to them.
  • A revenue ruling that provides rules to permit rollovers from a 401(k) or other defined contribution plan to an employer’s defined benefit pension plan in order for the participant to be able to obtain an annuity distribution of all or part of the account balance of the profit-sharing plan.
  • A revenue ruling that clarifies how to apply qualified joint and survivor annuity (QJSA) and qualified preretirement survivor annuity (QPSA) rules to a profit-sharing plan that provides for a deferred annuity benefit option.

Partial Annuity Distributions for Defined Benefit Plans

As explained in the Treasury Department’s fact sheet, the proposed regulations regarding the option of partial annuities remove a regulatory barrier. While continuing to require plans to use statutorily mandated actuarial assumptions for the calculation of the partial lump sum benefit payment, a defined benefit pension plan will now be permitted to use its regular conversion factors to calculate the partial annuity benefit. It should be noted that the preamble to the proposed regulations specify that if a defined benefit plan currently provides for partial annuities, and chooses to amend the provision in accordance with these regulations when they are finalized, the plan also will need to provide for the protection of the benefits accrued prior to the date of the amendment to satisfy Code section 411(d)(6).

Longevity Annuity Contracts in Defined Contribution Plans

A regulatory barrier to longevity annuities has been the requirement that defined contribution plans and IRAs determine RMDs by dividing a participant’s entire account balance in the plan by his or her life expectancy (or the life expectancies of the participant and a designated beneficiary). The proposed regulations permit a QLAC that begins by age 85 and costs no more than 25 percent of the participant’s account balance or (if less) $100,000 to be disregarded in calculating the RMDs before the annuity begins. Other requirements of a QLAC include a life annuity death benefit, a statement that the annuity intends to be a QLAC, and the QLAC issuer must meet certain reporting and disclosure requirements.

Rollovers from Defined Contribution Plans to Defined Benefit Plans

Revenue Ruling 2012-4 provides for an employer that maintains both a defined benefit pension plan and a 401(k) or other defined contribution plan to be able to offer employees the option of rolling over some or all of the defined contribution plan benefits to the defined benefit pension plan in exchange for an annuity from that plan. The resulting annuity would be the actuarial equivalent to the lump sum amount from the defined contribution plan by using the same assumptions that are used to convert annuity benefits to lump sums in the defined benefit pension plan. Both traditional and hybrid (such as cash balance) defined benefit pension plans can accept such rollovers.

Deferred Annuities in Defined Contribution Plans

Finally, Revenue Ruling 2012-3 removes the uncertainty that has discouraged 401(k) or other defined contribution plan sponsors from offering lifetime income options in their plans. The uncertainty arose from the Code’s requirement that a plan participant who elects certain optional forms of benefit obtain the written, notarized consent of the participant’s spouse to the election, and the fact that a lifetime income option would begin some time in the future. Plan sponsors were uncertain of when and how to require spousal consent and how the QJSA/QPSA rules apply when a deferred annuity is purchased. The ruling specifies plan and annuity terms that will protect spousal rights before the annuity begins and requires that the insurance company issuing the deferred annuity contracts, including longevity annuities, will assure compliance with the spousal consent rules.

Conclusion

This package of guidance is a good first step to ease the way for the provision of retirement income options that further promote retirement savings and address the unavoidable fact that Americans are increasingly risking outliving their retirement savings. Importantly, the regulations will not be effective until finalized. Comments regarding each of the two sets of regulations must be received by May 3, 2012.