Employers who sponsor both a 401(k) or other defined contribution plan and a defined benefit pension plan may be able to offer participants a lifetime income benefit that is already largely in place. Such employers can permit terminating employees who are covered under both plans to roll all or a portion of their defined contribution benefits over to the pension plan to receive a greater life annuity benefit from the pension plan. This approach may be beneficial for retirees and other terminating employees, while still helping to minimize the employer's administrative burdens.
For retirees, this rollover feature is a convenient (and tax-deferred) means to convert lump-sum defined contribution plan benefits into a guaranteed stream of retirement income. It is an optional feature that would not create any burdens for participants who wish to receive their defined contribution benefits in a lump sum. From the employer's perspective, all defined benefit plans are subject to the qualified joint & survivor annuity (QJSA) requirements under ERISA and the Internal Revenue Code (Code), but defined contribution plans that do not offer annuity forms of benefit are not. This approach allows defined contribution benefits to be annuitized indirectly through the defined benefit plan, without subjecting the defined contribution plan to QJSA complications.
Employers should be aware that this approach has a few complications and limitations of its own. In Revenue Ruling 2012-4, the IRS clarified how certain qualification requirements apply under this scenario, so that employers can be comfortable that it will not trigger compliance problems. In particular:
Underfunded Pension Plans. If the defined benefit plan's funding level is below 60 percent, the plan cannot accept rollover contributions during any year in which this level of underfunding persists. This is because the Code Section 436 funding requirements that apply to single-employer defined benefit plans mandate that benefit accruals cease if the plan has a "severe funding shortfall," and the benefit liabilities attributable to the rollovers would constitute additional accruals.
PBGC Guarantees. In the event the defined benefit plan is terminated while underfunded, all benefits (including those attributable to rollovers) become subject to the guaranteed benefit limitations set by the Pension Benefit Guaranty Corporation (PBGC). The Revenue Ruling indicates that a participant must receive a disclosure explaining this issue and the relevant PBGC limits, so that he or she is aware of the risk that some pension benefits may not be insured.
Valuation and Funding. The rollover contributions must be converted to immediate annuity benefits applying actuarial factors no less favorable than the statutory interest rate and mortality table set forth in Code Section 417(e), which are used to determine the "minimum present value" of pension benefits. Also, a separate interest crediting rate applies in the event of a delay between the rollover contribution and the participant's annuity starting date. If these factors are applied, the annuity benefit attributable to the rollover contribution will not be taken into account in determining the maximum benefit payable from the pension plan under the rules of Code Section 415(b). This may or may not be important, depending on the level of benefits the plan otherwise provides. If the plan uses more favorable conversion factors (that provide a more generous annuity than legally required), this is permissible but it may generate additional funding costs for the employer, and the "excess" will be included in calculating the maximum pension benefit the participant can receive under Section 415(b).
ERISA plan actuaries are well-qualified to deal with these intricacies and should be consulted to help identify the approach that best minimizes additional costs and complications.
Coordination with Service Providers. Implementing this rollover feature will require the involvement of the defined benefit plan's actuary or TPA who is responsible for valuation and benefit calculations, and this will result in some increased costs. Likewise, amending the plan document to reflect the associated technical requirements (and the Summary Plan Description, etc.) will require the engagement of experienced ERISA counsel.
Joshua Waldbeser has been an associate in the Employee Benefits & Executive Compensation Practice Group at Drinker Biddle's Chicago office since 2008, and prior to this, he worked for the U.S. Department of Labor, Employee Benefits Security Administration. Joshua's practice focuses on working with plan sponsors and prototype plan, investment, and other service providers with respect to Title I of ERISA and the IRS qualification requirements for retirement plans. Joshua also works with tax-exempt and governmental employers with respect to 403(b) and 457 plans, including special issues for governmental and church plans.
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