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In this Current outlook we review the finalized regulation for longevity annuities, the defined benefit plan funding stabilization proposal in the House transportation bill and the Pension Benefit Guaranty Corporation’s moratorium on ERISA section 4062(e) enforcement.
On July 1, 2014 IRS released its final regulation on longevity annuities. Below we provide a brief background on the issue and then summarize the final regulation, noting some changes from the proposal.
For some time, practitioners, providers, and plan sponsors have considered the possibility of offering some sort of deferred annuity product in a defined contribution plan. In this context, a deferred annuity would, typically, provide for payment of a life annuity beginning at age 85. The idea is that a participant retiring at age 65 (with, more or less, a 20 year life expectancy), could allocate a ‘modest’ portion of her account to the purchase of the deferred annuity and then draw down the remaining balance of her account over 20 years, secure in the knowledge that if she lives beyond age 85 the deferred annuity will provide retirement income for her. This sort of deferred annuity is what IRS is calling a ‘longevity annuity.’
There is, however, a problem with using deferred annuities with respect to qualified DC plan distributions. Under Tax Code required minimum distribution (RMD) rules, the distribution of a participant’s account in a DC plan generally must be made over a period not longer than the participant’s life expectancy. The amount of the account allocated to a deferred annuity is, for purposes of this rule, still counted as part of the participant’s account. As a result, there will be circumstances in which a portion of the participant’s benefit (under the deferred annuity contract) will not be distributed until after the end of the participant’s life expectancy period.
Like the proposal, the final regulation provides a limited exception to the RMD rules for qualifying longevity annuity contracts (QLACs). Under the final regulation, a QLAC would not be considered part of the participant’s account for purposes of the RMD rules. For this purpose, a QLAC is an annuity that is purchased from an insurance company for an employee that satisfies each of the following requirements:
Generally, the premiums paid for the contract do not exceed the lesser of $125,000 or 25% of the employee’s account balance. The $125,000 limit is an increase from the proposal (which limited the premium to $100,000). There are rules for the adjustment of the $125,000 limit to reflect inflation. There are also rules for netting against these limits QLAC contributions under other plans, IRAs, etc. In that regard, the plan administrator may rely on the employee’s written representation as to the amount of the QLAC premiums paid under arrangements not sponsored by the employer.
Distributions under the contract must start not later than age 85.
Distributions must satisfy the RMD rules generally applicable to annuities (e.g., that periodic annuity payments must be nonincreasing).
The contract does not make available any commutation benefit, cash surrender right, or other similar feature. In response to comments, however, the final regulation does allow a QLAC to provide a return of premium benefit – “a single-sum death benefit paid to a beneficiary in an amount equal to the excess of the premium payments made with respect to the QLAC over the payments made to the employee under the QLAC.”
No benefits are provided under the contract after the death of the employee other than certain life annuities payable to a designated beneficiary. (There are several technical rules with respect to the amount of benefit that may be paid on death.)
The contract, when issued, states that it is intended to be a QLAC. In response to comments, the final regulation provides “that this requirement will be satisfied if this language is included in the contract, or in a rider or endorsement with respect to the contract,” and it provides a transition rule for contracts issued before January 1, 2016.
The issuer of the annuity contract is subject to detailed reporting and disclosure rules.
QLACs may, under the proposal, be provided under tax-qualified defined contribution plans, 403(b) plans, individual retirement annuities and accounts (IRAs), and eligible governmental section 457 plans. They may not be provided under DB plans.
Under the Pension Protection Act (PPA), the amount an employer must contribute to a plan is (oversimplifying somewhat) the present value of plan liabilities minus plan assets (the funding shortfall) amortized over seven years. Generally, under PPA, valuation interest rates are determined using a corporate bond yield curve, averaged over 24 months and then broken down into three segment rates – short-, medium- and long-term.
2012’s Moving Ahead for Progress in the 21st Century Act (MAP-21) put a ‘floor’ under the PPA rates. The floor makes plan valuation rates higher than they otherwise would be, which generally reduces the required minimum contribution. The floor is equal to the average of rates for the 25-year period ending with September 30 of the preceding calendar year, reduced by multiplying it by a percentage beginning at 90% in 2012 and ‘phasing down’ 5% per year to 70% in 2016 and later.
On July 15, 2014 the House of Representatives passed the Highway and Transportation Funding Act of 2014. This bill includes, as a ‘pay for,’ a provision extending the funding stabilization relief originally granted under MAP-21. The House bill would extend this relief by applying the 90% percentage through 2017.
The following chart compares current and proposed phase-down percentage rules.
| #### Phase- down % | #### Applicable Year (current rules) | #### Applicable year (House proposal) |
| 90% | 2012 | 2012-2017 |
| 85% | 2013 | 2018 |
| 80% | 2014 | 2019 |
| 75% | 2015 | 2020 |
| 70% | After 2015 | After 2020 |
This extension would significantly reduce DB plan funding requirements and provide additional funding ‘certainty,’ over the medium term. If (as appears likely) this extension or something like it passes, we will provide a detailed analysis.
Generally, ERISA section 4062(e) applies if “an employer ceases operations at a facility in any location and, as a result of such cessation of operations, more than 20% of the total number of his employees who are participants under a plan established and maintained by him are separated from employment ….” Oversimplifying somewhat, a 4062(e) event triggers a reporting obligation and allows the PBGC to assess plan liability on a ‘termination basis’ (generally higher than any reported ‘ongoing’ liability) and to require funding, escrow or a bond with respect to a portion of that liability. PBGC may also negotiate other concessions in connection with a 4062(e) event. The liability calculations under 4062(e) assumptions can produce some very unusual results.
In recent years, PBGC’s practice with respect to 4062(e) had become very aggressive. It has applied a very expansive definition of ‘cessation of operations’ and required sponsors, e.g., to waive credit balances as part of a settlement. There have been a number of complaints from sponsors about this practice, and legislation has been introduced in Congress to rein it in.
On July 8, 2014 PBGC announced a moratorium on enforcement of 4062(e) cases through the end of 2014. According to PBGC, “The moratorium will enable PBGC to ensure that its efforts are targeted to cases where pensions are genuinely at risk. The six-month period will also allow us to work with the business community, labor, and other stakeholders. … During the moratorium, from July 8 to December 31, 2014, PBGC will cease enforcement efforts on open and new cases. Companies should continue to report new 4062(e) events, but PBGC will take no action on those events during the moratorium.”
This is a promising development, but it is only a moratorium, and it’s not clear that PBGC will come up with a new approach to 4062(e) enforcement that adequately addresses sponsor concerns.
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We will continue to follow these issues.