IRS no longer intends to issue regulation prohibiting payment of lump-sums to retiree-annuitants
In recent years, defined benefit plan sponsors have employed a variety of “de-risking” strategies, broadly defined as strategies that reduce the effect the DB plan on sponsor cash and financial disclosure. In many cases, the simplest and least expensive way to de-risk a given participant’s DB benefit is to pay it out as a lump-sum. The alternative of buying an annuity from a carrier is often more expensive: annuity carriers generally underwrite plan liabilities more conservatively than the plan's sponsor does for funding purposes; the carrier has a margin for administration and profit; and regulatory costs increase the annuity price.
IRS has issued Notice 2019-18, stating that it no longer intends to amend current required minimum distribution (RMD) regulations to prohibit the payment, as part of a “lump-sum window program,” of a lump-sum to a retiree currently receiving an annuity. The new Notice appears to authorize offering a lump-sum option to retirees in de-risking transactions – something that had been effectively prohibited since 2015 (under Notice 2015-49).
In this article we provide background on the issue and then briefly summarize the new Notice.
Background
In recent years, defined benefit plan sponsors have employed a variety of “de-risking” strategies, broadly defined as strategies that reduce the effect the DB plan on sponsor cash and financial disclosure. In many cases, the simplest and least expensive way to de-risk a given participant’s DB benefit is to pay it out as a lump-sum. The alternative of buying an annuity from a carrier is often more expensive: annuity carriers generally underwrite plan liabilities more conservatively than the plan’s sponsor does for funding purposes; the carrier has a margin for administration and profit; and regulatory costs increase the annuity price.
The “lowest hanging fruit” for this sort of de-risking is lump-sum payouts to terminated vested participants. Some sponsors, however, have gone further, offering lump-sums to current retirees. That latter tactic has been viewed as controversial by some.
One regulatory issue presented by retiree lump-sums is whether they violate the RMD rules. Those rules require (among other things) that once plan annuity payments have begun they may not, with certain limited exceptions, be changed. One of those limited exceptions is an increase in benefits that is the result of a plan amendment.
Pre-2015 private letter rulings
Prior to 2015, IRS issued several private letter rulings (PLRs) addressing this issue and finding that the programs considered did not violate the RMD rules. The PLRs held that the de-risking transactions reviewed, which generally involved offering a lump-sum to retiree-annuitants during a limited “window” period, constituted “the payment of increased benefits as a result of the addition of the lump-sum option. … Because the ability to select a lump-sum [would] 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].”
PLRs generally only apply to the specific transaction under consideration, have no precedential value and cannot be relied on by taxpayers other than the applicant.
IRS Notices 2015-49 and 2019-18
Notice 2015-49 reversed the position IRS took in the pre-2015 PLRs. Under it, effective July 9, 2015, sponsors could not offer lump-sums to retirees receiving annuity benefits that had already commenced under the RMD rules. The Notice stated that “the Treasury Department and the IRS intend to propose amendments to [the RMD regulations] to provide that the types of permitted benefit increases described … include only those that increase the ongoing annuity payments, and do not include those that accelerate the annuity payments.”
The 2015 Notice effectively stopped ongoing retiree lump-sum de-risking.
The new Notice 2019-18 reverses Notice 2015-49, stating that IRS will not amend the RMD rules in the way indicated in the earlier Notice. It went on to say that IRS “will not assert that a plan amendment providing for a retiree lump-sum window program causes the plan to violate [the RMD rules].”
The Notice states that Treasury and IRS “will continue to study the issue of retiree lump-sum windows” and “will continue to evaluate whether the plan, as amended, satisfies the requirements of §§ 401(a)(4), 411, 415, 417, 436, and other sections of the [Internal Revenue] Code.”
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Sponsors considering de-risking transactions will want to consult with counsel about the effect of Notice 2019-18 and whether, under its terms, they may now pay out lump-sums to retirees currently receiving annuities.