The IRS recently issued two Private Letter Rulings (PLR 201228045 and PLR 201228051) addressing whether the minimum distribution requirements of Section 401(a)(9) of the Internal Revenue Code (the “Code”) would be violated by a company if it amended its defined-benefit pension plans to offer a lump sum payment option, during a limited “window” period, to the plans’ participants and beneficiaries for whom annuity payments had already begun.
The IRS described the company in each of the rulings as one that manufactures, assembles, and sells goods both in the United States and throughout the world. Much speculation has tied the rulings to the recent retiree cashout programs announced by General Motors and Ford.
In each of the rulings, the company proposed to amend its plans to offer the covered participants a period (between 60 and 90 days in one of the rulings and between 30 and 60 days in the other) during which to elect to receive the actuarial present value of their remaining plan benefits in the form of a lump sum payment. As an alternative, the covered participants were given the ability to elect to receive the actuarial present value of their remaining benefits in either a qualified joint and survivor annuity or a qualified optional survivor annuity. The elections by the covered participants were to be subject to applicable spousal consent, and any covered participants electing a new distribution option were to be considered to have a new annuity starting date as of the first day of the month in which their new benefit was payable.
In one of the rulings, the company explained that the benefit obligations attributable to its plans and reported on its financial statements were disproportionately large and very sensitive to swings in interest rates, that over time the obligations skewed disproportionately towards retirees, that the company’s industry is susceptible to global economic changes, that swings in interest rates and changes in economic conditions have caused the plans’ pension obligations to be very volatile, and that this volatility increased the cost of financing, making cash flow management (including plan contributions) more difficult and making the company less competitive in the marketplace.
The company argued that the proposed amendment would reduce the impact of the volatility of the large pension obligations.
The IRS in both rulings noted that Code Section 401(a)(9), which provides rules relating to required minimum distributions from qualified plans, was enacted to ensure that the amounts contributed to qualified retirement plans were used for retirement by requiring benefit payments to begin by a certain date with no less than a certain amount distributed each year. The IRS then explained that the Code Section 401(a)(9) regulations allow an annuity payment period to be changed, and the annuity payments to be increased, in association with a plan amendment that increases plan benefits.
The IRS concluded in both rulings that because the ability to elect the lump sum option would only be available during a limited period, the increased benefit payments would result from a plan amendment increasing plan benefits, and the change in the annuity payment period would be in association with that plan amendment, each as permitted by the regulations.
The IRS noted in the rulings that any participant who elects the lump sum option will be considered to have a new annuity starting date. This means that the participant must also be given the right to elect a qualified joint and survivor annuity form or a qualified preretirement survivor annuity form in lieu of the lump sum payment form, and that applicable spousal consent rules will apply. In addition, the Code Section 415 limitations would need to be satisfied as of the new annuity starting date, taking into account the benefits that have been provided at each of the annuity starting dates.
Moreover, the IRS noted in one of the rulings that any portion of the lump sum payment that constitutes a required minimum distribution under Code Section 401(a)(9) would not constitute an eligible rollover distribution and thus could not be rolled over tax-free to an individual retirement account or any other eligible plan.
Finally, note that certain IRS rules may restrict the ability of a defined benefit pension plan to pay lump sums, depending on the funded status of the plan.
It is important to note that an IRS Private Letter Ruling may not be used or cited as precedent, and is applicable only to the taxpayer who requested it.
Before any company considers implementing a retiree cashout program under a defined benefit pension plan, we recommend the company seek its own IRS Private Letter Ruling approving the program. While obtaining an IRS Private Letter Ruling can be an expensive and time-consuming process, the protections offered by such a letter to the requesting company outweigh the risks of disqualifying the plan.