IRS final regs provide limited exception to anti-cutback rules for plan sponsor in bankruptcy

The IRS has issued final regulations that provide an additional limited exception to the anti-cutback rules of Code Sec. 411(d)(6) to permit a plan sponsor that is a debtor in a bankruptcy proceeding to amend its single-employer defined benefit plan to eliminate a single-sum distribution option (or other optional form of benefit providing for accelerated payments) under the plan if certain specified conditions are satisfied. The regulations are effective on November 8, 2012 and apply to plan amendments that are adopted and effective after November 8, 2012.

Conditions for amending plan

Under Code Sec. 436(d)(2), a single-employer defined benefit plan must provide that, during any period in which the plan sponsor is a debtor in bankruptcy, the plan may not make any “prohibited payment.” Code Sec. 436(d)(5) defines a “prohibited payment” as: (1) generally, any payment, in excess of the monthly amount paid under a single life annuity; (2) any payment for the purchase of an irrevocable commitment from an insurer to pay benefits; and (3) any other payment specified by regulations.

The final regulations permit a single-employer plan that is covered under ERISA §4021 to be amended to eliminate an optional form of benefit that includes a “prohibited payment,” provided that four conditions are satisfied on the later of the date the amendment is adopted or effective. The four conditions are:

1. The enrolled actuary of the plan has certified that the plan’s adjusted funding target attainment percentage for the plan year that contains the applicable amendment date is less than 100%.

2. The plan is not permitted to pay any prohibited payment, due to application of the requirements of Code Sec. 436(d)(2) and ERISA §206(g)(3)(B), because the plan sponsor is a debtor in a bankruptcy case (that is, a case under title 11, United States Code, or under similar Federal or State law).

3. The court overseeing the bankruptcy case has issued an order, after notice to each affected party and a hearing, finding that the adoption of the amendment eliminating that optional form of benefit is necessary to avoid a distress termination of the plan or an involuntary termination of the plan before the plan sponsor emerges from bankruptcy (or before the bankruptcy case is otherwise completed).

4. The PBGC has issued a determination that the adoption of the amendment eliminating that optional form of benefit is necessary to avoid a distress or involuntary termination of the plan before the plan sponsor emerges from bankruptcy (or before the bankruptcy case is otherwise completed) and that the plan is not sufficient for guaranteed benefits.

Notice and hearing requirements

Under the final regulations, a judicial determination must be made, after notice to each affected party (including each plan participant and beneficiary, each employee organization representing plan participants, and the PBGC) and a hearing that the amendment is necessary to avoid termination of the plan in a distress or involuntary termination before the plan sponsor emerges from bankruptcy. The primary purpose of this notice and hearing requirement is to afford plan participants who may be affected the opportunity to be heard on whether the amendment is necessary to avoid plan termination.

At the suggestion of a commenter, the language concerning the notice and hearing requirement has been modified from the proposed regulations to clarify that a failure to notify a particular participant or beneficiary does not automatically invalidate the amendment. Specifically, the change clarifies that the standard in 11 U.S.C. 102(1) applies for purposes of determining whether adequate notice has been provided under the requirement in the final regulations that there be a notice and a hearing before the order is issued by the Bankruptcy Court.

Imposition of additional conditions

The IRS noted that the preamble to the proposed regulations requested comments on whether the regulations should impose additional conditions on the prospective elimination of the single-sum distribution option (or other optional form of benefit that includes a prohibited payment), such as a condition that, after the amendment, the plan must offer certain annuity distribution options that provide substantial survivor benefits to give participants who have “substandard mortality” the opportunity to protect their survivors. After considering the comments received, the IRS and the Treasury Department have decided not to impose this requirement as a condition of permitting a plan amendment under the regulations.

However, if a plan sponsor eliminates a single-sum distribution option (or other optional form of benefit that includes a prohibited payment) pursuant to the regulations under a plan that does not offer other optional forms of benefit that provide substantial survivor benefits, then, in order to continue to provide participants who have substandard mortality the opportunity to protect their survivors, the plan sponsor may add other optional forms of benefit that provide substantial survivor benefits (including other optional forms of benefit that are prohibited payments under Code Sec. 436(d)(5)) as part of the same amendment that eliminates the single-sum distribution option (or other optional form of benefit that includes a prohibited payment). According to the IRS, all provisions of such a plan amendment (including both the elimination of the single-sum distribution option and the addition of optional forms of benefit that provide substantial survivor benefits) would be considered together for purposes of determining whether the plan amendment would be permitted to take effect in accordance with the rules of Code Sec. 436(c).

Source: 77 FR 66915, November 8, 2012.

For more information, visit http://www.wolterskluwerlb.com/rbcs.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

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