An amendment to the regulations under IRC §411(d)(6), published in the Federal Register on November 8, 2012, creates a narrow exception to the prohibition against cutting back accrued benefits, optional forms of benefit and retirement-type subsidies:  A PBGC-covered defined benefit plan may be amended to eliminate lump sum distribution options if the sponsor is in bankruptcy proceedings, the plan is less than 100 percent funded, and both the bankruptcy court and the PBGC determine that the elimination of the optional form of benefit is necessary to enable to plan to continue rather than terminate and be taken over by the PBGC.

The immediate impetus for the new regulation was the American Airlines bankruptcy.  The pension plan for the company’s pilots is underfunded, and it seemed likely that the company would elect to terminate it.  A major reason for termination was that the ability to retire with a large lump sum payout ($2 or $3 million in some cases) encouraged experienced pilots to leave.  That is not a problem while the bankruptcy is in progress, as IRC §436 bars underfunded plans from paying lump sums, but it would be potentially disastrous once the airline emerged from reorganization.  The obvious solution was plan termination, which would permanently eliminate lump sums, as the PBGC pays them only if the amount is $5,000 or less.

For pilots, however, termination would mean more than the elimination of a benefit option.  Many would lose benefits in excess of the level guaranteed by the PBGC.  For the PBGC, too, the prospect was unappealing.  It already has a $26 billion deficit in its insurance fund.  The IRS’s regulatory action will make it possible for the pilots’ plan to continue, without lump sum distributions but also without benefit losses.

American Airlines’ situation will not be frequently replicated.  The IRS’s action is, however, an encouraging sign that it can be persuaded to soften the often sharp and painful edges of the anti-cutback rule in sufficiently sympathetic cases.