Due to an Internal Revenue Service (IRS) change in course published in Notice 2019-18, plan sponsors may now offer retirees lump-sum windows as another pension "de-risking" option. Plan sponsors considering pension de-risking opportunities and options should carefully evaluate the potential benefits and risks of a retiree lump-sum window.
The Internal Revenue Service (IRS) recently announced that it no longer intends to issue regulations prohibiting defined benefit pension plans from providing a temporary option for retirees in pay status to replace periodic annuity pension payments with a single, lump-sum payment (typically referred to as a "retiree lump-sum window"). This change in course, published in Notice 2019-18, opens the door for plan sponsors to offer lump-sum windows to retirees as another pension "de-risking" option. Plan sponsors should carefully consider the potential benefits of a retiree lump-sum window, as well as the potential risks.
In 2015, the IRS issued Notice 2015-49, announcing its intent to amend the Treasury Regulations under the Internal Revenue Code (the Code) governing pension plan payments to prohibit retiree lump-sum windows. The minimum required distribution regulations generally prohibit any change in the period or form of pension payments after payments have commenced, except in narrow circumstances, such as an increase in amount of the annuity payments or a lump-sum conversion upon the death of the retiree. However, prior to issuing Notice 2015-49, the IRS had endorsed the practice of retiree lump-sum windows in several Private Letter Rulings, on the basis that accelerating annuity payments in a single lump-sum payment was an increase in the amount of payments.
Retiree Lump-Sum Windows
In Notice 2019-18, the IRS states that it intends to continue to study the issue of retiree lump-sum windows. In the meantime, though, the IRS will neither issue private letter rulings approving retiree lump-sum windows, nor assert that a retiree lump-sum window is a violation of the minimum required distribution regulations.
The potential to offer retirees the opportunity to commute the remaining value of their pension and take their entire pension at once in a lump sum may be attractive to plan sponsors because it can reduce funding uncertainty and the administrative costs associated with ongoing pension payments. In addition, the potential to shrink the number of participants receiving periodic payments can reduce the premiums that plan sponsors must pay for mandatory insurance from the Pension Benefit Guaranty Corporation. However, there are also many reasons why a plan sponsor may not want to offer a retiree lump-sum window. The savings associated with a retiree lump-sum window typically are not as great as for a deferred vested lump-sum window. For one thing, retiree lump-sum windows have an increased adverse selection cost because retirees generally have a better sense of their life expectancy than those who have not yet retired. Critics of retiree lump-sum windows also claim that participants are poorly equipped to weigh the relative value of continued annuity payments compared to a lump-sum payment.
Moreover, the IRS guidance does not insulate plan sponsors from the risk of participant litigation. For instance, a plan participant may still argue in court that the offering of a retiree lump-sum window violates the Code. While plan sponsors will certainly be able to point to Notice 2019-18 as evidence that there is no violation, Notice 2019-18 does not specifically state that retiree lump-sum windows are permitted. In addition, a plan sponsor who offers a retiree lump-sum window continues to face risk of potential litigation by participants who claim the information provided in connection with the offering was either incorrect or insufficient, and, therefore, harmed participants. Notice 2019-18 does not eliminate the potential risk associated with this type of allegation.
Plan sponsors who are looking at pension de-risking opportunities and options should carefully consider the retiree lump-sum window option and work closely with the plan's actuaries and lawyers to weigh the potential benefits and risks of a the retiree lump-sum window option.
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