On February 3, 2012, the U.S. Department of the Treasury (Treasury) and the IRS released a package of proposed regulations and rulings intended to remove impediments and otherwise ease the offering of lifetime income choices for retirees. According to an accompanying Treasury fact sheet on the new regulations and rulings, the package is intended to reduce regulatory barriers in order to increase interest in lifetime income, encourage innovation among stakeholders and expand choices for individuals with a view of promoting greater retirement security.
Determination of Value of Partial Annuities
The first new proposed regulation changes a regulatory requirement to make it simpler for defined benefit pension plans to offer participants the ability to elect to receive a portion of their retirement benefits in an annuity form while also receiving accelerated payments (i.e., a single-sum cash payment) for the remainder of the benefit. Current regulations require the use of the statutorily prescribed actuarial assumptions (interest rates and mortality assumptions) for both portions. This means that the plan is unable to use its regular conversion factors to determine the amount of the partial annuity. The proposed regulations would provide an exception to this rule in the case of a plan with a "bifurcated accrued benefit" (as defined in the proposed regulation). The statutorily prescribed actuarial assumptions would be required to apply only to the portion of the distribution being paid as a lump sum. Plans would be allowed to determine the remainder of the benefit – the partial annuity – using the plan's regular conversion factors. The primary impact of this proposed change would be to make it simpler and easier for a plan to offer an optional form of benefit that is a combination of a single-sum payment and an annuity. To provide for such bifurcated treatment, a plan sponsor would be required to amend its plan to provide for use of the plan factors that generally apply to annuity distributions instead of the statutorily prescribed actuarial assumptions in these circumstances. A copy of this proposed regulation can be found at https://federalregister.gov/a/2012-2341.
Longevity Annuities Contracts
Another new proposed regulation expands on the combination approach by removing a regulatory impediment to purchasing a deferred "longevity" annuity. This change would make it easier for retirees to use a limited portion of their savings to purchase guaranteed income for life starting at an advanced age, such as average life expectancy. In general, under the Internal Revenue Code's (Code) required minimum distribution rules, a qualified employer-sponsored retirement plan (a plan qualified under Code section 401(a), Code section 403(b) plans and eligible governmental section 457 plans) and traditional IRAs must begin distributions of a participant's interest soon after reaching the age of 70 1/2. Under the current regulations, defined contribution plans and IRAs determine the required minimum distribution by dividing the employee's entire account balance in the plan by the employee's life expectancy (or that of the employee and a designated beneficiary).
The proposed regulation modifies these required distribution rules in order to facilitate the purchase of deferred annuities that begin at an advanced age. Under the proposed regulation, prior to annuitization, the value of "qualified longevity annuity options" would be excluded from the account balance used to determine required minimum distributions. The proposed regulation sets forth a number of requirements an annuity must satisfy to be considered a "qualified longevity annuity contract," including the requirement that distribution commences no later than after the participant reaches age 85. A copy of this proposed regulation can be found at https://federalregister.gov/a/2012-2340.
Spousal Protection Rules for Defined Contribution Plans with Deferred Annuity Contract Investment Options
New Revenue Ruling 2012-3 clarifies how profit sharing plans can offer participants the option to purchase deferred annuity contracts and still satisfy the spousal protection rules (the qualified joint and survivor annuity (QJSA) and the qualified preretirement survivor annuity (QPSA) rules) with minimal administrative burdens. These rules require that an employee who elects certain optional forms of benefits obtain the written, notarized consent of the participant's spouse to that election. The new revenue ruling provides various arrangements permitting employees who are not yet ready to retire to invest their account balances in lifetime income benefits – either on a one-time basis or incrementally over a period of years – under deferred annuity contracts that will begin payments at retirement or later (including longevity annuities). The guidance identifies plan and annuity terms that will automatically protect spousal rights without requiring spousal consent before the annuity begins. When the annuity begins, the insurance company issuing the annuity would assure compliance with the spousal consent rules, thus allowing the plan to avoid being subject to such rules. The new Revenue Ruling is available at http://www.irs.gov/pub/irs-drop/rr-12-03.pdf.
Rules for Rollovers to Purchase Annuities
For employers that sponsor both defined contribution plans and a defined benefit plan, new Revenue Ruling 2012-4 clarifies how certain qualified plan rules apply when employees are given the option to use a single-sum payout from the defined contribution plan to purchase an annuity from their employer's defined benefit pension plan. The ruling makes clear that amounts directly rolled over must be treated as mandatory contributions, and the accrued benefit derived from those amounts must be nonforfeitable. Furthermore, the ruling clarifies that the annuity must be at least "actuarially equivalent" to the amount the plan received, based on specified actuarial assumptions. These are the same assumptions that are used to convert annuity benefits to lump sums. The revenue ruling does not apply with respect to rollovers made before January 1, 2013. However, plan sponsors are permitted to rely on the holdings of the ruling with respect to rollovers made prior to that date. The Revenue Ruling is available at http://www.irs.gov/pub/irs-drop/rr-12-04.pdf.