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.)
Context
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:
A Private Letter Ruling (PLR) represents the conclusion of the Service for an individual taxpayer. The application of a private letter ruling is confined to the specific case for which it was issued …. A private letter ruling to a taxpayer … should not be applied or relied upon as a precedent in the disposition of other cases. However, they provide insight with regard to the Service’s position on the law and serve as a guide.
Thus, PLRs generally have no precedential value and cannot be relied on by taxpayers other than the applicant.
Factual background
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 Company represents that because of various factors, including sensitivity to large shifts in interest rates and investment returns and the fact that the industry in which the Company participates is susceptible to global economic changes, the pension benefit obligations under the plans have become increasingly volatile. Such volatility has widespread effects on the Company, including increased difficulty with respect to cash flow forecasting and management. In order to reduce the impact of the volatility of the pension obligations with respect to benefits under the plans, the Company proposes [the de-risking transaction].
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.
IRS’s holding
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:
The proposed Plan Amendment [providing for the lump sum offer] will result in a change in the annuity payment period. The annuity payment period will be changed in association with the payment of increased benefits as a result of the addition of the lump sum option. … Because the ability to select a lump sum will only be available during a limited window, the increased benefit payments will result from the proposed plan amendment and, as such, are a permitted benefit increase under [the regulation].
Nuances
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 new benefit must be recalculated as of the new annuity starting date. That benefit is “the current actuarial present value of their accrued benefits in the normal form of benefits, as a qualified optional survivor annuity or an immediate lump sum payment.”
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.
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Rumor had it that IRS was considering holding up de-risking PLRs because of the emerging controversy over de-risking. Thus, the release of these PLRs is good news. Sponsors considering de-risking transactions that involve the offer of lump sums to retirees should consider getting a PLR applicable to that transaction – as noted above, the recently released PLRs have no precedential value and therefore cannot be relied on.