On March 6, 2019, the IRS issued Notice 2019-18 and reversed its previous position that offering defined benefit plan retirees an opportunity to convert their annuities into lump-sum payments, often referred to as “retiree lump-sum windows,” would violate Internal Revenue Code section 401(a)(9). In Notice 2015-49, the IRS previously expressed its intent under the required minimum distribution (RMD) regulations to prohibit amendments to qualified defined benefit plans that provided for such retiree lump-sum windows. Notice 2019-18 withdraws Notice 2015-49 and its statement of IRS intent, as further explained below.
Code section 401(a)(9)(A) requires employer-sponsored retirement plans to include RMD rules in their plan documents and comply with those rules to maintain their tax-qualified status under the Code. Under the RMD rules, plan participants must begin taking distributions from those plans annually, starting with the later of the year in which the participant (i) reaches 70.5 years of age or (ii) retires from employment (this date is called the required beginning date or RBD).
Under the RMD regulations, once the periodic annuity payments begin, those payments generally (i) cannot be changed and (ii) must not increase over time. One exception, however, allows annuity payments to increase if the increased payments are the result of a plan amendment (“increase in benefits” exception).
In several private letter rulings (PLRs) issued before Notice 2015-49, the IRS stated that the increase in benefits exception applied to plan amendments implementing retiree lump-sum windows, as long as certain requirements were met.
Given these PLRs, and although a PLR cannot be cited as precedent for an employer that it is not addressed to, a number of defined benefit plan sponsors amended their plans to offer retirees who were receiving annuity payments a one-time opportunity, or window, to elect to convert the annuity into a lump-sum payment as a permissible increase in benefits under the RMD regulations. By reducing the number of participants entitled to receive benefits from the plan, lump-sum windows are viewed as a useful option for defined benefit plan sponsors that want to “de-risk” their plans.
Opponents of the lump-sum window de-risking strategy voiced their concern that retirees would be shortchanged on the value of their vested benefits if they switched from annuitization (as in monthly payments for life) to a lump-sum distribution once payouts were underway and would outlive their lump-sum income.
As a result, on July 16, 2015, the IRS issued Notice 2015-49 and announced its intent to amend the RMD regulations to provide that an amendment accelerating annuity payments (such as a retiree lump-sum window) was not covered under the increase in benefits exception to Code section 401(a)(9)(A). The Notice stated that the effective date of the revised RMD regulations was expected to be the date of the Notice, which effectively prohibited this type of de-risking amendment and essentially stopped the practice of offering lump sums to those retirees receiving annuities.
IRS’s Current Stance on Retiree Lump-Sum Windows
Notice 2019-18 retracts the IRS’s previous position and states that the IRS no longer intends to amend the RMD regulations to prohibit retiree lump-sum windows. Furthermore, until further guidance is issued, the IRS announced that it will not assert that a plan amendment providing for a retiree lump-sum window will cause a plan to violate Code section 401(a)(9). However, the IRS will continue to evaluate whether such a plan amendment continues to satisfy other Code sections including 401(a)(4) (nondiscrimination rules), 411 (non-forfeiture requirement), 415 (benefit limitations), 417 (spousal protections), and 436 (funding-based benefit restrictions).
Practical Implications Going Forward
In light of the IRS’s rescission of its opinion under Code section 401(a)(9)(A) prohibiting retiree lump-sum windows, some plan sponsors are evaluating the possibility of implementing a retiree lump-sum window. This de-risking strategy might be an appealing way to reduce pension funding risks for employers, as well as an opportunity to reduce premiums paid to the Pension Benefit Guaranty Corporation (PBGC). However, plan sponsors who are considering such a strategy should proceed cautiously. As illustrated by the lack of IRS endorsement for these cashouts in Notice 2019-18, there are a myriad of potential compliance issues that need to be considered when offering a lump-sum cashout window to plan participants.
We are continuing to monitor this issue for further guidance.
In the meantime, Reed Smith’s employee benefits attorneys have experience working with plan sponsors on de-risking strategies, including lump-sum cashout windows. Please do not hesitate to reach out to any member of our benefits team if you are considering a de-risking option for your defined benefit plan.
Client Alert 2019-091