Many defined benefit plan sponsors are interested in “de-risking” their plan: shedding liabilities for retirees and deferred vested participants. This helps eliminate future longevity and investment risk. Although adding a lump sum option for deferred vested participants who had not yet started to receive monthly benefit checks is widely viewed as an acceptable move under the tax qualification rules, the acceptability of adding such an option for retirees is not as clear. This uncertainty stems from an IRS regulation issued under the Code section dealing with the minimum distribution rules.
How’s that you ask? Aren’t the minimum distribution rules designed to stop people from stretching out plan payments to continue deferring taxes for an inordinate amount of time?
Right. But the minimum distribution regulations circle the wagons around the conditions for changing the form of payment once the participant’s benefits have begun. There are some exceptions such as plan termination, but a revised benefit option is not in the list. That’s in question 13 of IRS’ regulation. In question 14 there’s an exception for amendments that increase benefits under the plan. That exception is the key to the favorable private letter rulings (PLRs) that some employers have received in support of their mission to allow plan participants to accept lump sum payments in lieu of future annuity checks after benefits have started.
Seven employers have obtained PLRs giving a favorable nod to this interpretation — two in 2012 and five recently in 2014. And now, rumor has it, they will be the last. Apparently, the IRS has indicated that they will no longer rule on this qualification issue in PLRs. Some speculate that the moratorium is a policy reaction to discourage putting participants in charge of managing their retirement annuities. Others speculate that IRS has now concluded that this is no longer a novel issue that requires consideration in PLRs. Given these uncertainties as well as various other technical considerations that need to be addressed, you may find it wise to consult with legal counsel before proceeding without a PLR.
Another professional to consult before moving forward with a cashout offer is your pension actuary. That professional will likely confirm that offering to cash out retirees in pay-status can be costly when seeking to buy annuities for the remaining population. That’s because, in addition to the extra costs for taxes, expenses, and profits, the insurer will price in antiselection to reflect the fact that retirees with a pessimistic view about their remaining life expectancy have already removed themselves from the pool. Make sure this is part of the conversation before pursuing discussion with counsel over whether the lack of a PLR or calculation details are a stumbling block.
Principal, Knowledge Resource Center
For more on current de-risking considerations, see our April 23, 2014 FYI on Employers finding more reasons to de-risk retirement plans. See our August 27, 2012 FYI on Evaluating Retiree Cash-out Windows for more information on issues about making offers to retirees.