PBGC Proposed Regulations Encourage Rollovers from Defined Contribution Plans to Defined Benefit Plans | Practical Law

PBGC Proposed Regulations Encourage Rollovers from Defined Contribution Plans to Defined Benefit Plans | Practical Law

The Pension Benefit Guaranty Corporation (PBGC) has issued proposed regulations that would facilitate rollovers from defined contribution plans to defined benefit plans by exempting rollover amounts from the maximum guarantee limits and the five-year phase-in limits.

PBGC Proposed Regulations Encourage Rollovers from Defined Contribution Plans to Defined Benefit Plans

by Practical Law Employee Benefits & Executive Compensation
Published on 03 Apr 2014 • USA (National/Federal)
The Pension Benefit Guaranty Corporation (PBGC) has issued proposed regulations that would facilitate rollovers from defined contribution plans to defined benefit plans by exempting rollover amounts from the maximum guarantee limits and the five-year phase-in limits.
On April 2, 2014, the Pension Benefit Guaranty Corporation (PBGC) issued proposed regulations that would amend the PBGC's valuation and benefit payments regulations to provide protections to amounts rolled over from defined contribution plans to private-sector, single-employer defined benefit (pension) plans that later terminate underfunded (that have insufficient assets to pay all benefits) (79 Fed. Reg. 18483 (Apr. 2, 2014)).

Background

The proposed regulations establish or clarify the rules for treatment of rollovers in plans that terminate underfunded. Covered plans that terminate underfunded may terminate either in a:
  • Distress termination under ERISA Section 4041(c).
  • Involuntary termination (one initiated by the PBGC) under ERISA Section 4042.
See Practice Note, Defined Benefit Plans: Distress and Involuntary Terminations: Types of Defined Benefit Plan Terminations.

Mandatory Contributions

Under IRC Section 411(c)(2)(C), a plan may generally be funded in whole or in part by mandatory contributions which are:
  • Amounts contributed to the plan by a participant, which are required as a condition of participation in the plan.
  • A condition of obtaining benefits under the plan attributable to employer contributions.
Mandatory contributions are usually:
  • Required under the plan as a percentage of a participant's compensation.
  • Withheld from the salary of the employee by the employer and deposited to the employee's credit in the defined benefit plan on an after-tax basis.
When a plan terminates in a distress termination or an involuntary termination, each participant's plan benefit is assigned to one or more of six priority categories. Participant's accrued benefits derived from mandatory employee contributions are assigned to priority category two (PC2). Benefits in PC2 have a higher claim on plan assets than almost all other benefits under the plan so that when an underfunded plan terminates, plan assets are usually sufficient to pay accrued benefits derived from mandatory employee contributions.
The PBGC generally pays benefits only in annuity form but the regulations allow a return of mandatory employee contributions in a single installment (or a series of installments).

Rollover Benefits

IRC Section 401(a)(31) requires a qualified plan to permit a distributee of any eligible rollover distribution to elect a direct rollover of any part of the distribution to an eligible retirement plan. A payment from a direct rollover to a defined benefit plan is only allowed if the defined benefit plan accepts rollover contributions.
Under Revenue Ruling 2012-4, employees receiving lump sum distribution from their defined contribution plan can transfer some or all of those amounts to their employer's defined benefit plan (if permitted under the plans' terms) to receive an annuity from the defined benefit plan (see Legal Update, IRS Proposed Guidance Simplifying the Use of Annuities in Retirement Plans).

Proposed Regulations

Following the recent IRS guidance of certain qualification requirements of rollovers, the PBGC is proposing to amend its regulations to provide guidance on the treatment of rollovers:
  • In anticipation of increased use of rollovers.
  • As part of its efforts to promote retirement security.
The PBGC is proposing to amend its regulations on Benefits Payable in Terminated Single-Employer Plans and Allocation of Assets in Single-Employer Plans that would establish or clarify the rules for the treatment of rollovers in plans that terminate underfunded. Under the proposed regulations:
  • A benefit resulting from a rollover amount from a defined contribution plan (such as a 401(k) plan) would be treated as an accrued benefit derived from mandatory employee contributions in PC2 to the extent that the benefit is determined using the rules of IRC Section 411(c)(2)(B). IRC Section 411(c)(2)(B) provides that in the case of a defined benefit plan, the accrued benefit derived from the contributions made by an employee is equal to the accumulated contributions expressed as an annual benefit commencing at normal retirement age, using an interest rate under IRC Section 417(e)(3).
  • PC2 benefits resulting from rollover amounts would generally not be payable in a lump sum. The PBGC would disregard a plan's provision for the return of employee contributions in a lump sum and would make rollover amounts payable only in the form of an annuity because the participant had the chance to take the distribution from a defined contribution plan as a lump sum and chose to roll it into a defined benefit plan to obtain annuity benefits.
  • The pension plan annuity resulting from rollover amounts would be payable at the same time, and in the same form, as the remainder of the participant's benefit under the pension plan to avoid administrative burden to PBGC. When a plan provides for a preretirement death benefit that returns the employee's mandatory contributions in a lump sum, the PBGC would:
    • not allow the spouse of a participant who dies after the plan terminates to elect to withdraw as a lump sum the mandatory contributions attributable to rollover amounts;
    • include the mandatory contributions in the value of the plan's qualified preretirement survivor annuity (QPSA) to the spouse; and
    • determine whether a payment was de minimis (currently $5,000 or less), and if it is, would determine the amount of the payment based on the lump sum value of the participant's total benefit payable by the PBGC (the benefit including rollover amounts combined with the benefit excluding rollover amounts).
  • The portion of any benefit resulting from rollover amounts that exceeds the accrued benefit derived from mandatory employee contribution would be a guaranteeable benefit in PC3, PC4 or PC5, as applicable.
  • The participant's accrued benefit resulting from rollover amounts derived from mandatory employee contributions would be exempt from the PBGC's maximum guaranteeable benefit limitation under ERISA Section 4022(b) and would not be taken into account in applying that limitation. The maximum guaranteeable benefit limitation is set by law and is updated each calendar year. For 2014, it is $59,318.16. However, this limitation would still apply to any rollover-related benefit that exceeds the accrued benefit derived from mandatory employee contributions.
  • The participant's accrued benefit resulting from rollover amounts would not be subject to the five-year phase-in limitation on the guarantee of benefit increases. The five-year phase-in limitation generally applies to a benefit increase that has been in effect for less than five years (generally 20% of a benefit increase is guaranteed after one year, 40% after two years, with full phase-in of the guarantee after five years). The phase-in limitation would apply to any benefit resulting from rollover amounts that exceeds the accrued benefit treated as derived from mandatory employee contributions, with the phase-in period beginning as of the date the rollover contributions were received by the plan.
The proposed regulations would also amend the PBGC's asset allocation regulation by establishing how it would treat rollover benefits when a defined benefit plan terminates underfunded. Under the proposed regulations:
  • The portion of a participant's accrued benefit resulting from rollover amounts derived from mandatory employee contributions would be determined using the rules of IRC Section 411(c).
  • The portion of a pension benefit in excess of the annuity derived from mandatory employee contributions would be treated as a benefit derived from employer contributions for purposes of assigning the benefits to priority categories. This portion would be a guaranteeable benefit in PC3, PC4 or PC5, because it is a nonforfeitable benefit. It would have a lower claim on plan assets than benefits from rollover amounts derived from mandatory employee contributions.
These proposed regulations would apply to pension plan terminations initiated on or after the effective date of the final rule. Until the proposed regulations are finalized, the PBGC will make determinations under the current regulations, consistent with IRS Revenue Ruling 2012-4.

Practical Implications

The PBGC wants to increase the retirement plan options available to employees who are participating in defined contribution plans. The proposed regulations promote this goal by providing guarantees to defined contribution plan participants who roll over their plan benefits to a pension plan that is later terminated by the PBGC. Defined contribution plan participants may be more willing to roll over their benefits to a defined benefit plan under these rules.