The IRS recently issued Notice 2019-18, reversing its prior position set forth in Notice 2015-49 that offering retirees in pay status the opportunity to elect a "cash out" of annuity benefits during a limited "window" violates the required minimum distribution ("RMD") requirements of section 401(a)(9) of the Internal Revenue Code (the "Code"). Notice 2019-18 provides that the IRS no longer intends to amend the RMD regulations to prohibit the practice of offering retiree lump sum windows, and until further guidance is issued, will not assert that a plan amendment providing for a retiree lump sum window causes the plan to violate section 401(a)(9) of the Code. However, the IRS intends to continue to evaluate whether such windows might violate other Code provisions, including nondiscrimination, minimum vesting, benefit limitations, spousal protections and distribution restrictions.
The RMD regulations generally prohibit any change in the period or form of an annuity after distribution of the annuity has started, and requires that annuity payments be "non-increasing," subject to specific exceptions set forth in the regulations. One exception allows annuity payments to increase if the payment of increased benefits results from a plan amendment. In private letter rulings issued prior to Notice 2015-49, the IRS ruled that the addition of a lump sum payment window constituted an increase in benefits that fit within the exception, with the result that a change in the annuity payment period would be permitted under the RMD regulations.
However, in July 2015, the IRS announced in Notice 2015-49 that it was going to amend the RMD regulations to provide that a plan amendment adding a retiree lump sum window would not be treated as a payment of increased benefits described in the exception. The Notice explained that if a participant has the ability to accelerate annuity distributions at any time, then the actuarial cost associated with that right would result in smaller initial benefits, which would contravene the purpose of section 401(a)(9).
Notice 2019-18 reversed the IRS' position, retracting Notice 2015-49 and stating that the IRS no longer intends to amend the RMD regulations. While the IRS will not assert that an amendment adding a retiree lump-sum window violates IRC 401(a)(9) until further guidance is issued, the IRS intends to continue studying the issue, including whether such an amendment could cause a plan to violate other Code requirements. In addition, the IRS will not issue private letter rulings with respect to lump sum windows.
Plan sponsors desiring to "de-risk" their pension plans (i.e., shifting the longevity and investment risk out of the pension plan) have historically either annuitized benefits or implemented a lump-sum window giving participants an election to forego annuity payments in exchange for an "actuarially equivalent" lump sum benefit. After Notice 2015-49, such lump sum windows were limited to terminated vested participants whose benefits are not in pay status. But with Notice 2019-18, the IRS has expanded the "de-risking" tools available to plan sponsors by again permitting lump sum windows for retirees in pay status.
Employers who may be interested in adding a retiree lump sum window should check with their actuary first because it may not always be the best approach. Depending on annuity and interest rates, paying lump sums pursuant to a window program may be more expensive than purchasing annuities. Further, retiree lump sum windows can lead to adverse selection (i.e., retirees in poor health choose the lump sum, while healthy retirees elect to remain in the plan) which could increase the cost of maintaining the plan. Employers should also consult with their attorneys to consider all of the plan qualification requirements that may be implicated by adoption of a retiree lump sum window--especially since the IRS will not issue a PLR on the issue. Finally, employers that move forward need to be aware of their fiduciary obligations and make sure that participant communications are clear and adequately disclose the consequences of accepting a lump sum cash-out.