IRS Issues Proposed Regulations Providing Guidance on the Minimum Present Value Requirements for Defined Benefit Plans Under the PPA | Practical Law

IRS Issues Proposed Regulations Providing Guidance on the Minimum Present Value Requirements for Defined Benefit Plans Under the PPA | Practical Law

The Internal Revenue Service (IRS) issued proposed regulations providing guidance on the minimum present value requirements applicable to certain defined benefit pension plans under the Pension Protection Act of 2006 (PPA).

IRS Issues Proposed Regulations Providing Guidance on the Minimum Present Value Requirements for Defined Benefit Plans Under the PPA

by Practical Law Employee Benefits & Executive Compensation
Published on 29 Nov 2016 • USA (National/Federal)
The Internal Revenue Service (IRS) issued proposed regulations providing guidance on the minimum present value requirements applicable to certain defined benefit pension plans under the Pension Protection Act of 2006 (PPA).
On November 23, 2016, the IRS issued proposed regulations that would amend the regulations under Internal Revenue Code (Code) Section 417(e) to clarify the minimum present value requirements of Code Section 417(e)(3), as amended by the Pension Protection Act of 2006 (PPA) (81 Fed. Reg. 85190 (Nov. 25, 2016)).

Background: Minimum Present Value Requirements

Code Section 417(e)(1) and (2) (26 U.S.C. § 417(e)(1), (2)) provide rules for when a defined benefit plan may distribute the present value of a qualified joint and survivor annuity (QJSA) or qualified preretirement survivor annuity (QPSA) (for more information on QJSAs, see Practice Note, Beneficiary Designations in Qualified Retirement Plans: Qualified Joint and Survivor Annuity (QJSA) Rules). Under these provisions, the present value of a QJSA or QPSA can be distributed:
  • Immediately if the present value does not exceed the amount that can be distributed without the participant's consent under Code Section 411(a)(11) (26 U.S.C. § 411(a)(11)).
  • Only with the participant's written consent if the present value exceeds the amount that can be distributed without the participant's consent under Code Section 411(a)(11) (26 U.S.C. § 411(a)(11)).
Code Section 417(e)(3)(A) (26 U.S.C. § 417(e)(3)(A)) provides that the present value shall not be less than the present value calculated by using the applicable mortality table and the applicable interest rate. The definitions of applicable mortality table and applicable interest rate in Code Section 417(e)(3)(B) and (C) (26 U.S.C. § 417(e)(3)(B), (C)) were amended by the PPA.
The preamble to the proposed regulations discuss other relevant provisions of the Code that were amended by the PPA and the Worker, Retiree, and Employer Recovery Act of 2008 (Pub. L. 110-458) (to learn more about these laws and how they affect retirement plans, see Significant Employee Benefits Developments Since the Enactment of ERISA Timeline).
On September 8, 2016, the IRS issued final regulations providing guidance on the minimum present value requirements for defined benefit plan distributions to simplify the treatment of certain optional forms of benefit that are paid to a participant partly in annuity form and partly in lump sum (see Legal Update, IRS Issues Final Regulations Modifying Minimum Present Value Requirements for Defined Benefit Plan Partial Annuity Distributions).

Proposed Regulations

The proposed regulations would amend the current final regulations under Code Section 417(e) (26 U.S.C. § 417(e)) to clarify the minimum present value requirements of Code Section 417(e)(3) (26 U.S.C. § 417(e)(3)), as amended by the PPA.
Specifically, the proposed regulations would:
  • Update the regulations for the statutory changes made by PPA, including:
  • Clarify that the interest rates that are published by the IRS Commissioner under the provisions modified by the PPA are to be used without further adjustment.
  • Eliminate obsolete provisions of the regulations relating to the transition from pre-1995 law to the interest rates and mortality assumptions provided by the Uruguay Round Agreements Act (Pub. L. 103-465) (to learn more about the Uruguay Round Agreements Act and the General Agreement on Tariffs and Trade (GATT), see Practice Note, US and International Regulation of Tariffs: Free Trade Agreements). The final regulations were amended in 1998 to reflect the changes made by the Uruguay Round.
  • Make conforming changes to reflect the final regulations under Code Section 417(e) (26 U.S.C. § 417(e)) that permit defined benefit plans to simplify the treatment of certain optional forms of benefit that are paid partly in the form of an annuity and partly in a more accelerated form.
  • Eliminate certain obsolete provisions of the regulations.

Preretirement Mortality Discount

The proposed regulations also address whether a plan that provides a death benefit equal in value to the participant's accrued benefit may apply a preretirement mortality discount for the probability of death when determining the amount of a single-sum distribution. This issue was raised in West v. AK Steel Corporation Retirement Accumulation Pension Plan, 484 F.3d 395 (6th Cir. 2007) and Berger v. Xerox Corporation Retirement Income Guarantee Plan, 338 F.3d 755 (7th Cir. 2003). The proposed regulations would clarify that:
  • The probability of death under the applicable mortality table is generally taken into account when determining the present value under Code Section 417(e)(3) (26 U.S.C. § 417(e)(3)) of a participant's accrued benefit derived from employer contributions without regard to the death benefits provided under the plan, other than a death benefit that is part of the normal form of benefit or part of another optional form of benefit under 26 C.F.R. Section 1.411(d)-3(g)(6)(ii)(B) for which present value is determined.
  • A different rule applies when determining the present value of a participant's accrued benefit derived from employee contributions. For purposes of determining the present value under Code Section 417(e)(3) (26 U.S.C. § 417(e)(3)) of a participant's accrued benefit derived from employee contributions (calculated under Code Section 411(c)(3) (26 U.S.C. § 411(a)(13))), the probability of death during the assumed deferral period, if any, is not taken into account.
The preamble notes that IRS Revenue Ruling 89-60 suggests that it is sufficient for a single-sum distribution of a participant's entire accrued benefit (including both employee contributions and employer-provided benefits) to merely equal the greater of the minimum present value of:
  • The participant's accrued benefit derived from employee contributions.
  • The participant's entire accrued benefit.
The preamble clarifies that, when these proposed regulations become final, they would supersede this arguably conflicting guidance in Revenue Ruling 89-60.

Social Security Level Income Option

The proposed regulations also provide that the minimum present value requirements of Code Section 417(e)(3) (26 U.S.C. § 417(e)(3)) apply to a Social Security level income option. A Social Security level income option provides an annuity with larger payments in earlier years, before an assumed Social Security commencement age, to provide the participant with approximately level retirement income when the Social Security payments begin. The minimum present value requirements of Code Section 417(e)(3) (26 U.S.C. § 417(e)(3)) apply because:
  • The periodic payments under a Social Security level income option decrease during the lifetime of the participant.
  • The decrease is not the result of the cessation of an ancillary social security supplement.

Application of Required Assumptions

The proposed regulations would clarify 26 C.F.R. Section 1.417(e)-1(d)(1), under which the present value of any optional form of benefit cannot be less than the present value of the normal retirement benefit (both values are determined using the applicable interest rate and the applicable mortality table).
The proposed regulations would:
  • Require that the present value of any optional form of benefit cannot be less than the present value of the accrued benefit payable at normal retirement age.
  • Provide an exception for an optional form of benefit payable after normal retirement age if a suspension of benefits applies under Code Section 411(a)(3)(B) (26 U.S.C. § 411(a)(3)(B)).

Applicability Date

The proposed regulations would apply to annuity starting dates in plan years that begin on or after the date that final regulations are published in the Federal Register.

Public Hearing

The preamble to the proposed regulations includes a notice of a public hearing on the proposed regulations, which is scheduled for March 7, 2017. The preamble also includes information on how to submit comments on the proposed regulations.

Practical Implications

Attorneys advising plan sponsors, administrators and committees of defined benefit plans should familiarize themselves with these proposed regulations, which are intended to clarify the minimum present value compliance obligations for defined benefit plans.
Plan sponsors of defined benefit plans should review their plan documents and operations to determine whether changes will be required to comply with these proposed clarifications and changes to the minimum present value requirements, particularly if they interpreted IRS Revenue Ruling 89-60 to mean that it is sufficient for a single-sum distribution of a participant's entire accrued benefit to merely equal the greater of the minimum present value of:
  • The participant's accrued benefit derived from employee contributions.
  • The participant's entire accrued benefit.
If the provision in the proposed regulation that changes this interpretation is finalized (see Preretirement Mortality Discounts), the plan's current operations will need to be corrected to comply with the revised requirements of the regulations.