IRS guidance on de-risking transactions invloving retireees
IRS recently released four Private Letter Rulings (PLR Numbers 201422028, 201422029, 201422030 and 201422031) holding that in certain circumstances the payment of lump sums to retirees currently receiving annuities does not violate Tax Code minimum distribution rules. The rulings deal with an important issue in de-risking transactions involving retirees. In this article we discuss the rulings in detail. (Tax Code minimum distribution rules are very technical, and we are going to get into the weeds some on these PLRs. So, apologies in advance.)
At the end of 2013 we posted an article on how increases in interest rates and in the Pension Benefit Guaranty Corporation’s flat-rate premium have made ‘de-risking’ more attractive in 2014. Regulatory challenges to de-risking and a likely increase (perhaps as early as 2016) in mortality table life expectancies may also make de-risking an option sponsors consider sooner rather than later.
There are, of course, a variety of strategies that go by the name of de-risking. Most commonly de-risking is understood to mean paying lump sums to terminated vested participants. But in 2012 and 2013 several high profile companies offered lump sums to retirees as part of de-risking transactions. As we discussed in our article Concerns over pension de-risking, this strategy has been criticized by a number of participant advocates.
One regulatory issue presented by de-risking transactions that involve paying lump sums to retirees (that is, participants who are currently receiving an annuity) is whether converting the participant’s benefit from an annuity to a lump sum violates the minimum distribution rules under Tax Code section 401(a)(9). Generally, to deal with this issue, sponsors have sought Private Letter Rulings (PLRs) from IRS confirming that the proposed transaction does not violate Tax Code section 401(a)(9).
According to the IRS Internal Revenue Manual:
Thus, PLRs generally have no precedential value and cannot be relied on by taxpayers other than the applicant.
The de-risking PLRs involve plans at four different companies that pay benefits in a variety of forms, including single life annuities, joint and survivor annuities, years certain and life annuities and lump sums. The plans involved include ‘traditional’ DB plans and cash balance plans.
In each PLR application the company represents that it has undertaken the de-risking program because of economic exigencies. For example:
The de-risking programs reviewed in the letters all involve ‘window’ programs under which:
- a ‘one-time’ offer for a limited period (the ‘window’ –30 or 60 or 90 days) is made,
- involving an opportunity to elect a change in the method of distribution, including a lump sum distribution, representing the actuarial value of the participant’s remaining monthly benefits, calculated at the time of such election,
- to certain retired plan participants. In this regard IRS notes that participants “in objectively determined and nondiscriminatory categories, may be excluded on account of administrative practicalities.”
- The election is treated as a new distribution with a new annuity starting date, subject to applicable spousal consent. If no election is made, the ‘old’ benefit payments simply continue.
Tax Code section 401(a)(9) generally requires that distributions under a qualified plan must begin as of the required beginning date and continue over a period not exceeding the life (or life expectancy) of the participant or joint life (or joint life expectancy) of the participant and a designated beneficiary. The ‘required beginning date’ is, for 5% owners, the April 1 of the year following the year the participant reaches age 70 1/2 and, for others, the later of this date or April 1 of the year following the year of actual retirement.
In a DB plan, a retired participant who does not take a lump sum distribution at retirement is typically receiving an annuity that began at retirement (the annuity starting date). Applicable regulations provide that once payments have commenced over a period (e.g., over the life of the participant as a life annuity), the period may only be changed in certain circumstances. One of those circumstances is an increase in benefits that is the result of a plan amendment.
The private letter rulings generally hold that the de-risking program involves a plan amendment permitting the change in payment:
There are some tricky elements to the approach IRS is taking. The lump sum offer is in effect a new benefit with a new annuity starting date. If the offer is taken (that is, if the new benefit is elected), then:
The normal form of the new benefit must be a qualified joint and survivor annuity (if the participant is married) or a single life annuity (if the participant is single). If another benefit is elected (e.g., the lump sum), the participant’s ‘spouse’ must consent to the election (in accordance with standard J&S spousal consent rules). ‘Spouse’ here can be a tricky concept. It includes, according to the IRS, “both the current spouse and a former spouse if the annuitant has remarried since the [original] annuity starting date.”
A new set of annuity starting date disclosures, including, e.g., relative value disclosures, must be provided.