For years, employers have been seeking ways to lower the potential financial risks of maintaining defined benefit pension plans, including the risk of swings in interest rates and investment returns, mortality increases, funding rule changes and increasing PBGC premiums. One popular method of “de-risking” a plan has been to offer lump-sum windows which allow terminated pension plan participants a limited time to elect a lump-sum payment of their benefit. However, since 2015, the IRS has prohibited employers from offering retirees in pay status a chance to convert their annuities to immediate lump-sums. Lump-sum windows could only be offered to terminated employees who had not yet
started receiving their benefits. On March 6, 2019, however, the IRS reversed its course on the issue and announced in Notice 2019-18 that it is abandoning its previous position and is no longer going to assert that retiree lump-sum windows violate the required minimum distribution (“RMD”) rules under Section 401(a)(9) of the Code.
The RMD rules generally require that defined benefit pension plan benefits commence no later than termination of employment or the April 1st after the year a participant attains age 70-1/2. In addition, the regulations mandate that once annuity payments begin (regardless of age), they generally must continue in an even manner under the annuity form, rather than increase or decrease, except in limited cases. One of the exceptions to this requirement is that plans are permitted to pay
increased retirement benefits that result from a plan amendment.
In a series of Private Letter Rulings (“PLRs”) issued from 2012-2014, the IRS construed this plan amendment exception to permit employers to amend plans to offer retirees in current pay status a limited window to elect to convert their annuities into a lump-sum payment, provided the other qualified plan rules were met. Through this plan amendment exception, employers were able to offer lump-sum windows to retirees as a method of de-risking their pension plans.
In 2015, the IRS reassessed this issue, partly in response to concerns that pension de-risking could be viewed as shifting longevity and investment risks to retirees. In Notice 2015-49, the IRS announced their intention to amend the RMD regulations
so that the plan amendment exception would not apply to retiree lump-sum windows, effectively prohibiting employers from offering such windows to retirees receiving annuity benefits.
In Notice 2019-18, the IRS retracted its prior prohibition on retiree lump-sum windows but noted that it will continue to study the issue. Until further guidance is issued, such programs will not be deemed to violate the RMD rules. The IRS will continue to evaluate a pension plan’s retiree lump-sum windows for compliance under other provisions of the Code, though, including the nondiscrimination, minimum vesting, maximum benefit limit, qualified joint and survivor payment, and other distribution restrictions. It also announced that it would not
issue any PLRs on retiree lump-sum windows. However, if a pension plan is eligible to apply for a determination letter, the IRS will no longer include a caveat expressing no opinion regarding the tax consequences of such a retiree lump-sum window in the letter.
Employers may wish to evaluate with their actuaries and employee benefits attorneys whether a retiree lump-sum window is an appropriate vehicle to help de-risk pension plans. Careful analysis is needed to ensure offering such a window complies with nondiscrimination rules and other Code restrictions, particularly since the IRS will not issue PLRs on the subject. If a retiree lump-sum window is offered, care should be taken to provide the participants a reasonable opportunity to make an