On July 9, 2015, the IRS issued notice of their intent to amend regulations prohibiting defined benefit plans from offering a lump sum option to participants already in pay status (Notice 2015-49). At first glance, this seems like an extreme attempt to prevent defined benefit plans from providing such options to all retirees. Careful reading will demonstrate that the intent is in reference to one specific instance.
We see plan sponsors offering lump sums to current retirees in a few situations:
- Upon plan termination, plan sponsors will offer lump sums to all participants, including current retirees. This is generally a process used to avoid the expense of finding an annuity provider and paying a premium for transferring that annuity.
- When actively employed participants who are receiving benefit payments while actively employed subsequently terminate employment, they are provided an option to change their form of payment.
- When actively employed participants over the age of 70-1/2 terminate employment, they are provided an option to change their form of payment. We see this when specific employees are required to start distributions because of required minimum distribution (RMD) rules. Generally these employees have elected annual certain-period-only benefits while actively employed. At termination, they are given the option to convert that form of annuity into a one-time lump sum.
- Some plan sponsors have offered a window of time within which current retirees could change their annuity form of payment and elect a lump sum distribution. We see this scenario used when a plan sponsor is trying to reduce participant counts for PBGC premiums and/or transfer risk back to the participant.
The IRS Notice specifically addresses eliminating option d) above. While this Notice was issued without warning and is effective on the date it was published, this is not a complete surprise. The first three scenarios above have clear guidance in the regulations. Option d) has been ambiguous in the regulations, with plan sponsors relying on past practice and individual private letter rulings to move forward. The Notice clearly states this reliance is no longer allowed.
Retiree lobbyists have argued against lump sum options in defined benefit plans, stating that retirees are not given enough information to fully understand the value of a lifetime income. We may see further guidance and changes in options a) through c), but this Notice does not specifically address these scenarios. We feel that at this time, plan sponsors can continue using those scenarios.
If you are concerned how this may impact you or your plan, please contact your IAI consultant.