United States: Recent IRS Guidance Prohibits Lump-Sum Windows For Pension Retirees, Updates Pension Mortality Tables For 2016

The Internal Revenue Service (IRS) recently issued two significant notices for employers that sponsor defined benefit pension plans, particularly those considering lump-sum windows as a "de-risking" option for their plans.

In Notice 2015-49, the IRS notified plan sponsors that they are no longer permitted to offer retirees in pay status the option to take a lump-sum payment in lieu of ongoing annuity payments. Plan sponsors may, however, continue to offer a lump-sum payment option to deferred vested participants not in pay status.

In Notice 2015-53, the IRS released updated mortality tables for 2016 and delayed the issuance of new regulations, which could incorporate new mortality assumptions recommended by the Society of Actuaries that many believe would increase pension funding liabilities and minimum lump-sum payments.

The following provides an overview of these two notices and their impact on defined benefit pension plans, particularly their impact on plan sponsors considering a lump-sum window.

IRS Prohibits Lump-Sum Windows for Pension Retirees


Over the past several years, many plan sponsors have considered "de-risking" their defined benefit pension plans due to concerns about market volatility, changes in accounting and funding rules, increasing Pension Benefit Guaranty Corporation (PBGC) premiums, prospective mortality table changes, and a host of other reasons. One common "de-risking" approach is to offer a lump-sum window in which a participant may elect to receive payment of his or her entire (remaining) plan benefit in a single lump sum. Paying the lump sum removes liabilities from the plan and may potentially take advantage of favorable interest rates and/or mortality assumptions.

Most lump-sum windows are opened to participants who have terminated employment, but have not yet commenced payment of their plan benefits (e.g., deferred vested participants). Certain plan sponsors also sought to extend these windows to participants who had previously commenced payment and remained in pay status. However, there was significant uncertainty about the ability of plan sponsors to offer lump sums to retirees in pay status. Regulations issued under Section 401(a)(9) of the Internal Revenue Code (Code) provide that annuity payments generally may not be changed after they have begun. An exception to this rule permits acceleration of payments as a result of an increase in benefits. A number of plan sponsors argued that this exception should apply to the replacement of ongoing, annuity payments with a lump-sum payment. In several cases (e.g., Ford and General Motors) plan sponsors received private letter rulings (PLRs) in which the IRS agreed with this position and permitted the specific plan sponsors who requested rulings to offer lump sums to retirees in pay status.

Notice 2015-49

Notice 2015-49 announces the IRS' view that the replacement of ongoing annuity payments with a single lump-sum payment is prohibited. Effective immediately upon the issuance of the notice, the IRS will no longer issue PLRs or determination letters approving plan amendments that permit participants in pay status to elect lump-sum distributions. In addition, the U.S. Department of the Treasury and IRS intend to amend the required minimum distribution regulations under Section 401(a)(9) of the Code to clarify that an acceleration of ongoing annuity payments is not a permissible increase in benefits and is prohibited under the regulations. The IRS expects these amendments to be effective retroactive to July 9, 2015.

The IRS did provide four limited exceptions under which plan sponsors who took significant steps toward offering lump-sum cashouts to retirees in pay status may still offer a lump-sum window. Specifically, plan sponsors may offer a lump-sum option to retirees in pay status if:

  • An amendment providing for the lump-sum window was adopted (or authorized by a board, committee, or other entity with authority to amend the plan) prior to July 9, 2015;
  • The lump-sum window was covered by a private letter ruling or determination letter issued by the IRS prior to July 9, 2015;
  • A written communication to affected participants stating an explicit and definite intent to implement the lump-sum window was received by participants prior to July 9, 2015; or
  • The plan sponsor entered into a binding agreement with a collective bargaining representative prior to July 9, 2015, which provided for the implementation of a lump-sum window.

Considerations for Plan Sponsors

Plan sponsors are now clearly prohibited from offering lump-sum cashouts to retirees in pay status in most cases. Presumably, future regulations will continue to permit annuitants to commute annuity payments to a lump sum in the case of a plan termination, but the notice is not clear on this point.

Plan sponsors may still offer lump-sum windows to deferred vested participants who have not yet commenced benefits. However, plan sponsors should take care when designing a lump-sum window to avoid offering lump sums to those participants who recently commenced benefits. Previously, some plan sponsors permitted participants who commenced payment during a limited period before the window was opened to "re-elect" a lump sum because the window was under serious consideration by the plan sponsor at the time such participants elected their benefits. The "serious consideration" doctrine generally requires plan sponsors to notify participants if a plan enhancement is under serious consideration by the authorized decision-maker so that participants may evaluate their options. To reduce the risk of participant claims, plan sponsors should carefully coordinate the timing of any lump-sum window with the timing of substantive discussions and decisions by those with decision-making authority, and consider how to explain to participants who might soon be commencing benefits that a lump-sum payment option may be available.

Another complication is whether plan sponsors should offer lump sums to participants after they have reached normal retirement age. Some plan sponsors have considered excluding deferred vested participants older than the plan's normal retirement age because they interpret the notice to prohibit offering lump sums to "retirees" entitled to actuarial increases after normal retirement age. However, this interpretation is not clearly supported by Notice 2015-49, and excluding participants above a certain age who otherwise are in similar circumstances (e.g., not in pay status) could raise age discrimination concerns.

IRS Updates Mortality Tables for 2016, Delays Potential Updates to Base Mortality Rates and Projection Factors Until 2017


The IRS issues mortality tables for the determination of minimum funding requirements for defined benefit pension plans. These mortality tables are also used to determine minimum present value requirements for lump-sum calculations.

In October of 2014, the Society of Actuaries released the RP-2014 Mortality Tables Report and the Mortality Improvement Scale MP-2014 Report, which contain new mortality assumptions recommended for valuing private-sector pension liabilities. These assumptions are controversial. Many believe that applying these assumptions to set the base mortality rates and projection factors used by the IRS will result in mortality tables that cause significant increases to pension funding liabilities, PBGC premiums and minimum lump-sum payments.

Notice 2015-53

Notice 2015-53 sets forth the static mortality tables for minimum funding and present value requirements for 2016. These mortality tables apply for valuation dates occurring in 2016 and for lump-sum distributions with annuity starting dates occurring during stability periods beginning in 2016. The notice also states that the Treasury Department and IRS are considering comments received on the Society of Actuaries' 2014 mortality reports and expect to issue new regulations revising the base mortality rates and projection factors used to determine the static mortality tables. However, new regulations will not apply until 2017 at the earliest.

Considerations for Plan Sponsors

Notice 2015-53 should be good news for plan sponsors who were concerned about potentially significant increases to pension funding liabilities, PBGC premiums and minimum lump-sum payments in 2016. The fact that the IRS is requesting comments on the Society of Actuaries' 2014 mortality reports suggests that the IRS may be inclined to scrutinize the use of the new mortality assumptions, which critics believe overstate mortality improvement, for future mortality tables.

Plan sponsors may also take this delay as an opportunity to further consider offering lump-sum windows in 2016 before new regulations may be issued that could change minimum present value requirements and cause significant increases in lump-sum payments.

Recent IRS Guidance Prohibits Lump-Sum Windows For Pension Retirees, Updates Pension Mortality Tables For 2016

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