On March 6, 2019, the Internal Revenue Service (IRS) issued Notice 2019-18 (Notice), announcing that it is retracting its previous position that prohibited pension plan sponsors from offering lump-sum cashouts to retirees who are receiving annuity payments from defined benefit plans. The Notice provides that the IRS will no longer assert that a plan amendment providing for a retiree lump-sum window program causes the plan to violate the required minimum distribution rules. The Notice states that the IRS and Treasury Department will continue to consider the issue of retiree lump sums generally, will not issue private letter rulings on this topic while it remains under consideration, and will continue to evaluate whether plans offering these lump sums satisfy other tax qualification requirements. As a result, plan sponsors can once again consider whether to offer lump-sum windows to retirees in pay status.
In the years leading up to 2015, defined benefit plan sponsors increasingly made limited-time offers of a lump-sum cashout to retirees in pay status as a way of managing liabilities, PBGC premiums and administrative costs. Initially there were concerns that this practice could violate the Internal Revenue Code’s required minimum distribution rules, which provide that once a participant or beneficiary begins receiving lifetime annuity payments, his or her monthly payment amount may not increase and his or her payment period may not be modified except in specific, limited circumstances.
One of the limited circumstances in which the minimum distribution rules permit payments to increase after an annuity has started is a plan amendment that provides for the payment of increased benefits. Between 2012 and 2014, the IRS issued a series of private letter rulings that concluded that a retiree’s election to cash out the remainder of a lifetime annuity is permissible under this exception if the lump-sum cashout option is offered pursuant to a plan amendment and is only available during a limited window period. As a result, plan sponsors generally became more comfortable that retiree lump sums were permitted, though a number of plan sponsors who offered retiree lump sum windows still opted to obtain a private letter ruling covering the practice.
In July 2015, however, the IRS issued Notice 2015-49, which stated that allowing retirees to cash out their remaining annuity payments undermines the general intent of the required minimum distribution regulations, and that the IRS and Treasury Department intended to propose amendments to the regulations to prevent this practice. The amendments would have been effective July 9, 2015.
After the IRS issued Notice 2015-49, plan sponsors stopped offering retiree lump-sum windows, but limited-time lump-sum offers to deferred vested participants who had not yet commenced payments continued to be a relatively common practice.
In Notice 2019-18, the IRS announced that it no longer intends to propose amendments to the minimum required distribution regulations. Importantly, the Notice states:
Until further guidance is issued, the IRS will not assert that a plan amendment providing for a retiree lump-sum window program causes the plan to violate § 401(a)(9), but will continue to evaluate whether the plan, as amended, satisfies the requirements of §§ 401(a)(4), 411, 415, 417, 436, and other sections of the Code.
The Notice provides that the IRS will not issue private letter rulings regarding retiree lump-sum windows while the issue remains under consideration. However, the Notice states that if a plan is eligible and applies for a determination letter, any favorable determination letter would not include a caveat regarding the retiree lump-sum window – in other words, the letter would cover the tax-qualification of the plan amendment providing for the window.
In light of the Notice, defined benefit plan sponsors can consider whether a lump-sum cashout for retirees in pay status may be desirable. Sponsors interested in such a program should:
- Work with counsel to assess any risks associated with a lump-sum offer under the required minimum distribution rules, particularly because a determination letter will not be available in many situations under the current determination letter program.
- Take into account other tax qualification requirements in offering such a window, including nondiscrimination testing, spousal consent rules, and restrictions on underfunded plans.
- Keep in mind ERISA fiduciary considerations regarding the form and content of the disclosure that accompanies a lump-sum offer. Both the Department of Labor and a Government Accountability Office report have expressed concerns with the adequacy of disclosures regarding lump-sum windows.