IRS Notice 2015-49 Prohibits Plans from Offering Lump Sum Risk Transferring Programs for Participants in Pay Status | Practical Law

IRS Notice 2015-49 Prohibits Plans from Offering Lump Sum Risk Transferring Programs for Participants in Pay Status | Practical Law

Notice 2015-49 informs taxpayers that the Treasury Department and the Internal Revenue Service (IRS) intend to amend regulations under Section 401(a)(9) of the Internal Revenue Code (Code) to generally prohibit defined benefit pension plans from replacing annuities with lump sum payments for participants in pay status.

IRS Notice 2015-49 Prohibits Plans from Offering Lump Sum Risk Transferring Programs for Participants in Pay Status

by Practical Law Employee Benefits & Executive Compensation
Law stated as of 13 Jul 2015 • USA (National/Federal)
Notice 2015-49 informs taxpayers that the Treasury Department and the Internal Revenue Service (IRS) intend to amend regulations under Section 401(a)(9) of the Internal Revenue Code (Code) to generally prohibit defined benefit pension plans from replacing annuities with lump sum payments for participants in pay status.
On July 9, 2015, the Treasury Department and Internal Revenue Service (IRS) issued Notice 2015-49, in which the IRS states that it intends to amend the required minimum distribution (RMD) regulations under Section 401(a)(9) of the Internal Revenue Code (Code) to prohibit qualified defined benefit plans from accelerating annuity payments by replacing any joint and survivor, single life or other annuity with a lump sum payment or other accelerated form of distribution (IRS Notice 2015-49, (Jul. 9, 2015)). These amendments will apply as of July 9, 2015.

Required Minimum Distributions (RMDs)

Employer-sponsored retirement plans must include RMD rules in their plan documents and comply with these rules to maintain their tax-qualified status under the Code (26 U.S.C. § 401(a)(9)(A)). Participants in these plans are required under Code Section 401(a)(9) to begin taking distributions from those plans annually, starting with the later of the year in which the participant:
  • Reaches age 70½.
  • Retires from employment.
However, the actual payment of that first year's RMD may be deferred until the participant's required beginning date (RBD). The RBD for most participants is April 1 of the calendar year following the participant's first distribution calendar year (see Practice Note, Required Minimum Distributions from Retirement Plans: Required Beginning Date (RBD)). Once a participant's RBD is determined, he must take distributions for the first distribution calendar year and every year thereafter, unless there is an applicable exception (for more information, see Practice Note, Required Minimum Distributions from Retirement Plans: Annual Distributions Required).
Once the periodic annuity payments begin:
Code Section 401(a)(9) and the related Treasury Regulations are intended to ensure that:
  • The distribution of an employee's benefit will not be unduly tax-deferred.
  • The employee's annuity will not be converted to a lump sum payment or otherwise accelerated, except in cases of retirement, death or plan termination (Treas. Reg. § 1.401(a)(9)-6, A-13(a), (b)).
Any participant who fails to properly receive an RMD is liable for an excise tax equal to 50% of the difference between the actual amount distributed and the RMD for the relevant tax year.

Lump Sum Risk Transferring Programs

Some defined benefit plan sponsors have amended their plans to include lump sum risk-transferring programs, which provide a limited period during which certain retirees receiving joint and survivor, single-life or other life annuity payments may elect to convert the annuity into a lump sum that is payable immediately.
These arrangements transfer longevity and investment risk from the plan to the retirees. In some cases, the addition of these programs has been treated as a permissible increase in benefits under Treasury Regulation Section 1.401(a)(9)-6, A-14(a)(4).

Notice 2015-49

Notice 2015-49 provides that the IRS intends to amend the Code Section 401(a)(9) regulations to generally prohibit lump sum risk transferring programs for participants in pay status as of July 9, 2015. According to the IRS, permitting these programs would undermine the intent of the Code Section 401(a)(9) regulations that generally prohibit changes to a plan's annuity payment period. The proposed amendments to Treasury Regulation Section 1.401(a)(9)-6, A-14(a)(4) will clarify that Code Section 401(a)(9):
  • Permits only changes to the annuity payment period that increase ongoing annuity payments.
  • Does not permit changes to the annuity payment period that accelerate payments.
The proposed amendments to Treasury Regulation Section 1.401(a)(9)-6, A-13 would not permit acceleration of annuity payments to which an annuity recipient was entitled before the amendment, even if the plan amendment also increases annuity payments.
The Notice does not provide guidance on the federal tax consequences of a lump sum risk-transferring program under Code Sections 401(a)(4), 411, 415, 417 or 436, or any other section of the Code except for Section 401(a)(9).

Effective Date

The IRS intends that the proposed amendments discussed in Notice 2015-49 will apply as of July 9, 2015.

Pre-Notice Accelerations

The IRS states that these amendments will not apply to a Pre-Notice Acceleration, which is an acceleration of ongoing annuity payments that is in association with a plan amendment specifically providing for implementation of a lump sum risk-transferring program that is either:
  • Adopted (or specifically authorized by a board, committee, or similar body with authority to amend the plan) before July 9, 2015.
  • With respect to which a private letter ruling or determination letter was issued by the IRS before July 9, 2015.
  • With respect to which a written communication to affected plan participants stating an explicit and definite intent to implement the lump sum risk-transferring program was received by those participants before July 9, 2015.
  • Adopted under an agreement between the plan sponsor and an employee representative (with which the plan sponsor has entered into a collective bargaining agreement) specifically authorizing implementation of such a program that was entered into and binding before July 9, 2015.
The Notice provides that the IRS will not challenge the treatment of a Pre-Notice Acceleration as an increase in benefits that is described in the current Treasury Regulation Section 1.401(a)(9)-6, A-14(a)(4). Therefore, in a Pre-Notice Acceleration, the annuity payment period will be permitted to be changed under Treasury Regulation Section 1.401(a)(9)-6, A-13(a).

Effect on Pending IRS Private Letter Rulings or Determination Letters

In light of the proposed amendments, any IRS private letter ruling (PLR) or determination letter involving a plan that provides for a lump sum risk-transferring program will generally include a caveat expressing no opinion as to the federal tax consequences of the lump sum risk-transferring program. However, the IRS may determine that the addition of a right to make a Pre-Notice Acceleration is an increase in benefits that is described in the current Treasury Regulation Section 1.401(a)(9)-6, A-14(a)(4).

Practical Implications

Plan sponsors considering implementing a lump sum risk transferring program may need to change course as a result of Notice 2015-49, which generally prohibits these programs on or after July 9, 2015 for retirees who are in pay status. Eligibility for these programs must now be limited to participants who have not begun to receive their benefit payments.
The IRS provides certain exceptions for plan sponsors who have previously implemented these programs (see Pre-Notice Accelerations). It is not clear how the IRS will treat plan sponsors who are currently in the process of applying for a PLR or determination letter as it has retained discretion to prohibit or allow these arrangements in the Notice.
Plan sponsors must always keep in mind all RMD requirements to ensure their plans do not lose their tax-qualified status (see Practice Note, Required Minimum Distributions from Retirement Plans: Best Practices and Drafting Requirements).