Yesterday, the IRS issued Notice 2015-49, which abruptly announced the IRS’s intention to prohibit lump-sum cashout windows for pension plan retirees already in pay status. In recent years, many pension plan sponsors have offered retirees the opportunity to elect to receive a single lump-sum payment that is the actuarial equivalent of their future pension (annuity) payments. These lump-sum payments were made in lieu of any future pension payments. Plan sponsors have used these types of programs to stabilize the plan sponsor’s ongoing pension funding obligations. Anyone who has followed this issue knows that lump-sum windows have become a popular and effective strategy for pension plan sponsors to reduce their pension funding risk.
Oddly enough, the IRS has issued several private letter rulings in recent years that approved such lump-sum window programs, which makes Notice 2015-49 a somewhat abrupt change in policy. It appears that the IRS’s change in thinking is at least in part a response to ongoing criticism of lump-sum windows from various interest groups, which allege that lump-sum cashout payments (in lieu of lifetime annuities) are not financially beneficial for retirees. Whether a lump-sum cashout payment is financially beneficial for any particular retiree depends largely on the retiree’s own unique circumstances, and the IRS’s guidance unfortunately takes this choice away from retirees and leaves plan sponsors with one less pension de-risking strategy to consider.
From a technical perspective, the IRS intends to prohibit lump-sum windows for retirees by proposing amendments to the “required minimum distribution” regulations under Section 401(a)(9) of the Internal Revenue Code. These proposed regulations would, according to the Notice, entirely prohibit lump-sum windows for retirees in pay status, unless the plan sponsor took certain concrete steps to offer a lump-sum window by July 9, 2015.
It is important to remember that lump-sum windows may still be offered to deferred vested participants/beneficiaries who have not yet begun receiving benefits. Finally, it is very possible that this guidance may be modified or withdrawn in the future, given that the plan sponsor community will almost certainly object to it and ask the IRS to consider other alternatives.