IRS Flip Flops DeRisking Pension Plan Options


‚ÄčThe volatility and unpredictability of an employer's obligations under a defined benefit pension plan can have a significant impact on its bottom line. This is especially true of plans with liabilities for pension benefits earned decades ago and being paid as annuities. Companies faced with this volatility have implemented various "de-risking" methods for their pension plans in order to reduce or eliminate the volatility associated with pension obligations and their impact on the balance sheet.

For the last several years, the IRS has issued Private Letter Rulings to pension plans allowing retirees to convert their annuities to lump sums. This de-risking option first hit the news in 2012 when General Motors offered lump sum conversions to 44,000 retirees.

The IRS just announced in Notice 2015-49 that it intends to propose regulations to be effective as of July 9, 2015 that prohibit all conversions of existing defined benefit plan annuity payments into lump sums, other than conversions under certain grandfathered programs.

To be grandfathered, the program has to meet one of the following requirements prior to July 9, 2015: (1) be adopted or specifically authorized by a board, committee, or similar body with authority to amend the plan; (2) been communicated to participants in writing; (3) been adopted pursuant to collective bargaining; or (4) have been approved by a private letter ruling or determination letter.

De-Risking Options Still Available

Lump sums 

Although the IRS has shut down the option of offering lump sums to retirees in pay status, other de-risking options remain available. Plan sponsors can add a permanent lump sum option to their pension plans for active employees or offer a limited lump sum window opportunity for certain categories of plan participants, the most popular being a lump sum window for deferred vested participants (DVPs). Lump sum options transfer the risk of providing a future stream of income payments from the pension plan to the retiree.

Boosting Plan Savings on Lump Sums 

If you are contemplating the addition of lump sums to your pension plan, you can boost your savings by changing your lump sum interest rate. You will have to use the Code section 417(e) rates as a minimum, but you can change the time as of which this interest rate is determined, as long as you adopt the same timing rule for both small and large lump sums. If you are contemplating a lump sum window for DVPs, it might be worth reviewing current interest rate trends and changing your timing rule to take advantage of higher rates, which result in smaller lump sums. You will have to grandfather the old timing rule for small cash-outs, if more favorable, for one year, but the grandfather does not apply to any lump sum options that previously were not offered under the plan.

Annuitizing Plan Liabilities  

Alternatively, plan sponsors can still transfer their pension plan liabilities to insurance companies, either with plan assets or without.

The remaining de-risking alternatives for pension plans raise complex legal, accounting, funding, design, actuarial, PBGC and employee relations issues for companies. Each alternative requires a significant amount of time to analyze and implement.

If your company has been considering whether to de-risk its pension plan liabilities, now may be the time to act. Although transferring pension plan liabilities to participants through lump sums and to insurance companies through annuity purchases is not a new concept, lately it has been getting more attention from politicians and regulators as more and more companies implement de-risking strategies.  

There is a real conflict between those who want to preserve annuities as the preferred source of retirement income and those who want to de-risk pension plans. It is no secret that the IRS and the DOL take a paternalistic view of the ability of retirees to manage their retirement income so that it will last throughout their retirement years. On the other hand, many corporate plan sponsors will not like this new IRS position and could lobby Congress to act to reverse it. We will be monitoring this situation and working with clients to develop the best possible strategies.

For additional information on the topic, please contact any member of Orrick's Compensation and Benefits Group.