On July 9, 2015, the IRS released Notice 2015-49 (the “Notice”) informing taxpayers that the Service and the Treasury intend to amend the required minimum distribution regulations to eliminate the recent defined benefit (“DB”) plan risk management strategy of offering lump sum payments to replace annuity payments to retirees currently receiving joint and survivor, single life, or other life annuity benefit payments. The regulations will provide that DB plans generally will not be permitted to offer retirees an option to replace any annuity currently being paid with a lump sum payment or other accelerated form of distribution. According to the Notice, the amendments to the regulations will be effective as of July 9, 2015, with limited exceptions aimed solely to protect those employers who have already taken sufficient action to announce or establish a limited lump sum payment conversion program for existing in-pay status retirees. The proposed amendments were motivated by growing concerns over the prevalence of these lump sum conversion programs that transfer the investment and life longevity risk from the plan to retirees and whether participants were adequately advised and understood the financial tradeoffs when electing to forego the lifetime annuity for the lump-sum payment.
Over the last few years, since the modest rebound in market conditions and limited increase in interest rates, DB plan sponsors have been exploring affordable options to reduce or transfer risk out of their DB pension plans. One risk management strategy has been to amend their pension plans to offer a limited period (“window”) during which retirees who are currently receiving annuity payments from those plans may elect to convert the annuity into an immediately payable lump sum. This particular, so-called “de-risking” strategy emerged only within the last few years, after the IRS had sanctioned the practice in a couple high-profile private letter rulings (PLRs) that generated significant media attention in light of the notable plan sponsors involved, the number of plan participants affected, and the value of the benefits transferred off the balance sheet. Before these PLRs, the practice of offering retirees an option to convert in-pay status annuities to lump sums was almost nonexistent because of uncertainty over whether these conversion offers to retirees would violate required minimum distribution (RMD) rules under Code Section 401(a)(9). The PLRs eliminated much of the uncertainty by approving these retiree lump-sum conversion offers as falling within a broad RMD regulation exception for post-retirement “increases in benefits.”
IRS Announces Intent To Revise RMD Regulations
Now, with Notice 2015-49, the IRS has announced a change in policy marked by an intent to amend the RMD regulations retroactive to July 9, 2015 that will significantly narrow the RMD regulations to foreclose future use of these retiree lump-sum conversion programs. Accordingly, the Notice explains that the proposed amendments will provide that the types of permitted post-retirement benefit increases described in the RMD regulations will include only those that increase ongoing annuity payments, and do not include those that accelerate annuity payments, as is the case with the conversion of annuity payments to lump sum payments to retirees who are currently receiving benefits.
Announcement Has No Impact On Other Lump Sum De-Risking Programs
It is important to note that Notice 2015-49 has no impact on the ability to offer DB plan lump sum de-risking programs to either terminated vested (non-retired) participants, or to actively employed participants upon plan termination. The Notice indicates only that the IRS will amend the minimum required distribution regulations so as to prohibit a defined benefit plan from offering immediate lump sum payment conversions (or similarly-styled accelerated payments) to defined benefit plan retirees currently in pay status receiving a form of life contingent annuity.
There are a wide range of corporate financial and plan funding reasons for choosing and designing a lump sum distribution window program. Those factors remain relevant for employers seeking to “de-risk” their pension liabilities by removing liability through payment of lump sums at any time for terminated vested participants, and for active participants only at plan termination. The IRS Notice’s reach is limited; it only forecloses future use of these pension de-risking programs to allow for consensual lump sum cash out of in-pay status retirees.