Benefits & Compensation

IRS Reverses Itself Again to Permit DB Plan Sponsors to Offer Retiree Lump-Sum Windows

Defined benefit (DB) plan sponsors received another “derisking” tool in early March when the Internal Revenue Service (IRS) and U.S. Treasury Department unexpectedly reversed course on retiree lump-sum payouts.

On March 6, the IRS issued Notice 2019-18, which grants employer plan sponsors the right to offer retirees in pay status the chance to opt for a lump-sum cashout instead of continued annuity payments. The agency had disallowed retiree lump-sum windows in Notice 2015-49 (see July 2015 story) and indicated it would propose regulations to that effect under the required minimum distribution (RMD) rules of the federal tax code. However, these amendments were never actually proposed.

The new notice supersedes Notice 2015-49.

What the IRS Said

Specifically, the IRS said it no longer intends to propose amendments to the RMD regulations as originally announced, and that it will not say that a plan’s offering of a retiree lump-sum window violates these requirements.

Lump-sum options for retirees have been criticized by pension rights advocates and others as potentially dangerous for retirees who could outlive their cashouts taken in lieu of lifelong annuity payments. Taking this option transfers longevity and investment risk for the long term from plan sponsors to retirees, making the windows costly in the short run but appealing to plans.

Before the 2015 action limiting lump-sum options for retirees, employer DB plans seeking to reduce pension liabilities through derisking steps like retiree cashouts would seek IRS Private Letter Rulings (PLRs) to gain a measure of regulatory protection for these decisions. (A PLR is a written statement issued to a taxpayer or retirement plan that interprets and applies tax laws to the recipient’s represented set of facts. A PLR may not be relied on as precedent by other plans or by IRS personnel.)

In 2012, the IRS put out two PLRs related to retiree lump-sum payouts. In them, the agency said such a cashout would not be prohibited if: (1) it was available only during a limited window of time; and (2) annuitants did not previously have a right to cash out annuities in pay status.

“The IRS reasoned that, under the circumstances, the increase to the payment amount is caused by an amendment to increase benefits, which is one of the limited circumstances when an increase to the payment amount is permitted,” said Proskauer Rose LLP benefits attorneys Seth Safra and Malerie L. Bulot in a March 9 client bulletin on the new IRS position on lump sums.

This viewpoint aligned with RMD policy because the annuity in place would not be cut back and would, in fact, pay out faster.

Before 2015 Prohibition

The 2012 PLRs led to a number of large corporations maintaining DB plans to establish temporary window programs that allowed retirees already in payment status to receive the present value of their remaining annuity payments in a single sum. While the 2015 notice reversed this unofficial position, now, in theory, the 2019 about-face could make such programs attractive to DB sponsors again.

The IRS noted in the March announcement that any retiree lump-sum window program must continue to satisfy all of the other applicable tax-qualification requirements, such as nondiscrimination testing, funding-based benefit limitations, qualified joint and survivor (QJSA) payment, and vesting rules.

The IRS added that it would continue to study retiree lump-sum windows and would not issue any additional PLRs on these issues.

“IRS Notice 2019-18 sets to rest the mystery as to whether IRS will continue to hold hostage employer efforts to de-risk using retiree lump-sum windows,” according to a client bulletin posted March 6 by consulting firm Buck Global LLC. “[E]mployers will be able to once again add this feature to their list of options for controlling plan costs.”