The IRS has changed its position on lump-sum windows for retirees in pay status.

On July 9, the Internal Revenue Service (IRS) issued Notice 2015-49, which prohibits sponsors of qualified defined benefit plans from adopting lump-sum windows for participants and beneficiaries who receive annuity payments. Certain lump-sum window amendments adopted or authorized before July 9 are not affected by the new guidance.

Background

Over the last few years, some sponsors of qualified defined benefit plans have offered lump-sum windows that included retirees who receive annuity payments as part of a strategy to “de-risk” the plan. Under these arrangements, retirees in pay status may be offered a limited opportunity to change the form of payment to a lump sum. Cashing out annuitants is one way to shift investment and longevity risks from a plan sponsor to the retirees.

The IRS previously issued a series of Private Letter Rulings that allowed lump-sum window amendments to include retirees in pay status. The most recent such ruling was issued in May 2014. One important issue addressed in the Private Letter Rulings is how a lump-sum window complies with required minimum distribution requirements set forth in Internal Revenue Code (Code) section 401(a)(9). Regulations under Code section 401(a)(9) generally prohibit any change in the period or form of distribution after benefit commencement. In particular, payments must not increase after commencement, except for certain limited exceptions, such as an increase in a participant’s benefit (e.g., conversion of a monthly annuity to a single lump sum) as a result of a plan amendment. In its series of Private Letter Rulings, the IRS ruled favorably that the lump sums offered to retirees in pay status under these window programs resulted from a plan amendment, and therefore comply with required minimum distribution regulations.

Section 401(a)(9) Regulations to Be Amended

In Notice 2015-49, the IRS indicated that it intends to amend the regulations under section 401(a)(9)-6, effective July 9, to prohibit the acceleration of ongoing annuity payments under most circumstances, even if the commuted lump-sum payment is due to a plan amendment. This essentially reverses the ruling position that the IRS took in its earlier series of Private Letter Rulings. With very limited exceptions, lump-sum window amendments for retirees in pay status will no longer be permitted under this change to the regulations.

"Grandfathering" Exceptions to the New Guidance

Although Notice 2015-49 signals the end to future lump-sum window offerings for retirees in pay status, the IRS grandfathered certain existing and authorized arrangements. Specifically, it indicated that the amendment to the section 401(a)(9)-6 regulations will not prohibit lump-sum windows for retirees in pay status if one of the actions or events occurred before July 9:

  1. The amendment adding the lump-sum window was adopted (or specifically authorized by a board, committee, or similar body);
  2. The IRS issued a private letter ruling or determination letter on the lump-sum window;
  3. Participants affected by the lump-sum window received written communication before stating an explicit and definite intent to implement a lump-sum window; or
  4. The lump-sum window was adopted pursuant to a binding agreement between the sponsor and a union specifically authorizing the lump-sum window.

Conclusion

Although lump-sum windows for retirees in pay status are now off the table as a de-risking strategy, other de-risking strategies (lump-sum windows for deferred vested participants not yet in pay status, liability-driven investment strategies, annuity "buy-ins" and "buy outs," etc.) continue to be viable.