The Internal Revenue Service and the Treasury Department have thrown a wrench into the pension de-risking plans of many corporations with new regulations aiming to eliminate the lump-sum payout option for retirees who already are receiving retirement benefits from their defined benefit plans.
The regulations, as amended, will provide that qualified defined benefit plans generally are not permitted to replace any joint and survivor, single life, or other annuity currently being paid with a lump sum payment or other accelerated form of distribution, according to the IRS and Treasury.
The amendments went into effect on July 9, 2015.
What this means is that employers who are exploring de-risking options will have to keep these new provisions in mind when implementing a lump-sum window opportunity for former employees or those who are already retired, says Anne Waidmann, a director in PwCs human resource services practice in Washington.
The types of permitted benefit increases described in the regulations include only those that increase the ongoing annuity payments and do not include those that accelerate the annuity payments, Waidmann said.
In talks with IRS personnel, we have confirmed that there is no intention to prohibit plans from paying lump sums to participants upon plan termination, though that circumstance was not discussed in the notice, she says.
Plans that already began de-risking proceedings before July 9 or adopted an agreement with a labor union specifically authorizing a lump-sum window prior to July 9 are exempt from the new rules as are those plans that were the subject of a private letter ruling or determination letter issued by the IRS before July 9. If plan participants were officially notified about the lump sum risk-transferring program prior to July 9, those companies are also exempt from the ruling, she stated.
The IRS notice did not provide guidance with respect to the federal tax consequences of a lump sum risk-transferring program.
Many in Congress and the administration have expressed concern about de-risking arrangements in which plans are amended to offer lump-sum distributions to terminated vested participants and to retirees, she says. A recent GAO report on lump-sum windows concluded that participants need better information when offered a lump-sum window and made recommendations to IRS and DOL on ways to change their rules regarding these situations.
The report, which was released in February, found that participants potentially face a reduction in their retirement assets when they accept a lump-sum offer. The amount of the lump sum payment may be less than what it would cost in the retail market to replace the plans benefit because the mortality and interest rates used by retail market insurers are different from the rates used by sponsors, particularly when calculating lump sums for younger participants and women.
The report added that even though participants gain control of their assets by taking a lump sum payment, they face potential investment challenges. Many wont reinvest the money but will instead spend some or all of it.
The GAO reviewed 11 packets of informational materials provided by sponsors offering lump sums to thousands of participants and found that they consistently lacked key information needed to make an informed decision or were otherwise unclear.
Many of the packets were not clear about how the lump-sum value compared to the value of a lifetime monthly benefit. Others didnt state the interest rate or mortality assumptions used, limiting participants ability to figure out how their lump-sum payment was calculated, the GAO said. One important omission was informing participants about the benefit protections they would keep by staying in their employer-sponsored plan. The Pension Benefit Guaranty Corporation insures DB pensions when a sponsor defaults.
This omission is notable because many participants GAO interviewed cited fear of sponsor default as an important factor in choosing the lump sum, the GAO said.
Paula Aven Gladych is a freelance writer in Denver.
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