On July 9, 2015, the Treasury Department and IRS announced plans to implement a significant regulatory change that will effectively prohibit “lump sum risk-transferring programs” for defined benefit pension plans. These programs typically permit a participant receiving annuity payments from the plan to elect, during a pre-established election period (a “window”), to have future annuity payments accelerated into a single, lump sum payment. The lump sum payments made under such a program help reduce the plan’s overall benefit liabilities.
Many employers have implemented programs of this type in the past few years. Interest began in earnest in 2012 when the IRS issued a pair of private letter rulings addressing some of the tax-qualification issues associated with accelerating annuity payments. One of the issues addressed in the rulings (and which was reiterated in five other private letter rulings issued over the following two years) was whether the lump sum payment of the future annuity payments complied with the required minimum distribution rules of Code Section 401(a)(9). The particular concern was that the lump sum acceleration would violate regulations that require that annuity payments under a defined benefit plan either be non-increasing or increase only in accordance with certain limited exceptions. The IRS concluded in each of the private letter rulings that accelerating the annuity into a single, lump sum payment did not violate the “no increase” requirement because offering the lump sum option during a limited window period met a specific exception for “increased benefits that result from a plan amendment.”
An IRS private letter ruling may be relied upon only by the specific taxpayer that requested it. However, many employers and their advisors concluded that the reasoning expressed in the seven private letter rulings concerning the Code Section 401(a)(9) requirement minimum distribution rules represented the IRS’s official position with respect to this issue.
Change in Position
In Notice 2015-49, the Treasury Department and IRS have announced a complete change in their position. The notice explains that the Treasury Department and IRS will amend the existing required minimum distribution regulations to clarify that the only permitted increases in annuity payments are increases in the ongoing annuity payments, not an acceleration of annuity payments to a lump sum payment. In addition, the Treasury Department and IRS will revise existing regulations to clarify that an annuity payment period cannot be accelerated by plan amendment for the payments a participant was entitled to receive before the amendment, even if the amendment also increases annuity payments.
The Treasury Department and IRS have announced that this new position is effective July 9, 2015, and that revised regulations will be retroactively effective to that date. As a result, lump sum programs for participants in pay status generally are prohibited beginning July 9, 2015.
However, the notice states that the IRS will not challenge a lump sum program under this new position if the program is in connection with a plan amendment “specifically providing for implementation” of the program, and if one of the following conditions is met:
- The amendment was adopted before July 9, 2015, or was “specifically authorized” by a body with authority to amend the plan before July 9, 2015;
- The amendment was the subject of an IRS private letter ruling or favorable determination letter issued before July 9, 2015;
- Written communication related to the amendment stating “an explicit and definite intent to implement” the program was received by affected participants before July 9, 2015; or
- The amendment was or is adopted pursuant to an agreement between the plan sponsor and a union with which the plan sponsor has a collective bargaining agreement, the agreement with the union specifically authorizes implementation of the program, and that agreement was entered into and binding on the parties before July 9, 2015.
This change of position effectively prohibits lump sum programs targeted to plan participants in pay status. However, it does not affect programs that are targeted to terminated participants who have not yet commenced benefit payments. Consequently, employers with plans that do not otherwise offer a lump sum distribution option at benefit commencement may continue to be interested in offering lump sums during a window period to participants who have not yet commenced benefit payments.
An employer that was planning to implement a lump sum program for participants in pay status should determine whether actions taken to date are sufficient to qualify the program for the grandfathering treatment described above. The notice indicates that future determination letters generally will not express any opinion on the consequences of a lump sum program on the plan’s tax-qualified status. However, the notice leaves open the possibility that plan sponsors with grandfathered programs may be able to obtain private letter rulings that address the issue of the program’s compliance with the required minimum distribution rules. Therefore, plan sponsors with grandfathered programs that are not already the subject of a favorable IRS determination letter (or a private letter ruling) may want to consult with their advisers concerning the possibility of seeking a private letter ruling from the IRS.
Other forms of plan “de-risking” strategies likely will receive greater attention from plan sponsors as a result of this announcement. For example, more employers may become interested in transferring benefit liabilities to insurance companies through an annuity purchase transaction, or may consider freezing plan benefits or eligibility and possibly plan termination.