IRS takes aim at DB plan lump-sum risk-transferring programs

The IRS intends to amend the required minimum distribution regulations under Code Sec. 401(a)(9) to provide that qualified defined benefit (DB) plans generally are not permitted to replace any joint and survivor, single life, or other annuity currently being paid to retirees with a lump-sum payment or other accelerated form of distribution. The changes apply as of July 9, 2015, though an exception will be provided for “pre-notice accelerations.”

Generally, after distributions have commenced, changes in the period or form of the distributions are prohibited. However, there are limited exceptions. One exception under IRS Reg. §1.401(a)(9)-6, A-14(a)(4) permits annuity payments to increase “[t]o pay increased benefits that result from a plan amendment.” A number of defined benefit plan sponsors have amended their plans to provide a limited period during which certain retirees who are currently receiving joint and survivor, single life, or other life annuity payments from those plans may elect to convert that annuity into a lump sum that is payable immediately. These arrangements are sometimes referred to as lump-sum risk-transferring programs because longevity risk and investment risk are transferred from the plan to the retirees. The IRS explains that the addition of the right to convert a current annuity into an immediate lump-sum payment has been treated in some instances as an increase in benefits that is described in Reg. §1.401(a)(9)-6, A-14(a)(4).

The IRS now plans to amend Reg. §1.401(a)(9)-6, A-14(a)(4) to provide that the types of permitted benefit increases described in that paragraph include only those that increase the ongoing annuity payments, and do not include those that accelerate the annuity payments. According to the IRS, the regulations under Code Sec. 401(a)(9) reflect an intent to prohibit, in most cases, changes to the annuity payment period for ongoing annuity payments from DB plans, including changes accelerating or providing an option to accelerate ongoing annuity payments. The IRS has concluded that a broad exception for increased benefits in Reg. §1.401(a)(9)-6, A-14(a)(4) that would permit lump-sum payments to replace rights to ongoing annuity payments would undermine that intent.

The IRS notes that this notice does not provide guidance with respect to the federal tax consequences of a lump-sum risk-transferring program under any other section of the Code except for Code Sec. 401(a)(9).

Effective date

The IRS intends that the amendments to IRS Reg. §1.401(a)(9)-6 will apply July 9, 2015. However, the IRS expects that the amendments will not apply to the acceleration of ongoing annuity payments under a plan amendment specifically providing for the implementation of a lump-sum risk-transferring program that: (1) are adopted prior to July 9, 2015; (2) with respect to which the IRS issued a private letter ruling or determination letter prior to July 9, 2015; (3) with respect to which a written communication to affected plan participants stating an explicit and definite intent to implement the lump-sum risk-transferring program was received by those participants prior to July 9, 2015; or (4) are adopted pursuant to an agreement between the plan sponsor and an employee representative (with which the plan sponsor has entered into a collective bargaining agreement) specifically authorizing implementation of such a program that was entered into and was binding prior to July 9, 2015. The IRS refers to these four exceptions as “pre-notice accelerations” and states that the annuity payment periods under the pre-notice accelerations will be permitted to be changed.

Source: IRS Notice 2015-49.

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