PLR 1228045: IRS approves a limited lump-sum window for pension annuitants

Plain-English summary

The IRS ruled that two defined benefit plans could offer a limited window for certain participants and beneficiaries who had already begun receiving annuity payments to elect a lump-sum payment without violating the minimum distribution rules of IRC § 401(a)(9). The window would last at least 60 days and no more than 90 days, and eligible individuals could choose the actuarial present value of their remaining benefits in a permitted annuity form or as an immediate lump sum. The ruling also addressed applicable spousal consent and treated a new distribution option as a new annuity starting date. It did not express an opinion on other federal tax consequences or on the plans’ qualification.

Ruling snapshot

• Question: May the plans offer a limited lump-sum election window to certain participants and beneficiaries already receiving annuity payments?
• Outcome: Approved
• Key authorities: IRC §§ 401(a)(9), 401(a)(11), 411, 415, 417, 436, and 6110(k)(3); Treas. Reg. § 1.401(a)(9)-6

Full text (IRS public release)

201228045

DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES

DIVISION

APR 19 2012

Uniform Issue List: 401.06-01

T: EP: RA: T2

Legend:

Company = ***
Plan 1 = *****
Plan 2 = *******

Dear ****,

This is in response to your letter dated July 26, 2011, as supplemented by information
from a Conference of Right on November 9, 2011, and correspondence dated
December 7, 2011, in which you request a Private Letter Ruling that the minimum
distribution requirements of section 401(a)(9) of the Internal Revenue Code (“Code”)
would not be violated if the Company amended Plan 1 and Plan 2 to offer a lump sum
payment option, during a limited window period, to the plans’ participants and
beneficiaries for whom annuity payments have already begun.

The following facts and representations have been submitted under penalty of perjury in
support of the ruling requested.

FACTS

Company, the taxpayer, manufactures, assembles, and sells goods both in the United
States and throughout the world. It is the sponsor of Plan 1 and Plan 2 (collectively, the
“Plans”), which are intended to be tax-qualified, defined benefit plans, each having

Page 2

received a favorable determination letter most recently in [illegible]. Each Plan covers a
significant number of employees and former employees of the Company, and
beneficiaries.

The automatic form of benefit for a single participant in the Plans is a single life annuity
and the automatic form of benefit for a married participant is a 65% joint and survivor
annuity (a 50% joint and survivor annuity for disabled participants), optional forms of
benefit in the Plans include a 50%, a 75% or 100% joint and survivor annuity.

The Company represents that the pension benefit obligations attributable to the Plans
and reported on the Company’s financial statements are disproportionately large and
very sensitive to swings in interest rates. Over time these obligations have skewed
disproportionately towards retirees. The Company’s industry is susceptible to global
economic changes. Swings in interest rates and changes in economic conditions have
caused the Plans’ pension obligations to be very volatile. The Company represents that
this volatility increases the cost of financing, makes cash flow management (including
contributions to the Plans) more difficult, and makes the Company less competitive in
the marketplace.

To reduce the impact of the volatility of the large pension obligations, the Company
proposes to amend both Plans to offer, during a limited period of time, a lump sum
payment option to certain participants and beneficiaries of the Plans.¹ The window
would be offered to a broad group of the Plans’ participants and beneficiaries in five
categories: (1) participants currently receiving benefit payments; (2) those who have
retired but have not begun receiving benefit payments; (3) terminated deferred vested
participants; (4) beneficiaries who presently are receiving either pre-retirement or post-
retirement survivor benefits, or are eligible to receive survivor benefits under the Plans;
and (5) alternate payees, collectively (“Covered Individuals”). The Company represents
that this window period to select a lump sum payment will be offered on a one-time
basis to Covered Individuals.

Under the amendment, the Covered Individuals would have a specified limited window
period of no less than 60 days and no more than 90 days during which they could elect
to receive what the Company represents is the actuarial present value of their remaining
benefits under the Plans at the time of such election in the form of a single lump sum
payment.² Those Covered Individuals receiving benefit payments would be able to elect
to receive, in lieu of their current annuity, the actuarial present value of their remaining
accrued benefits either in a qualified joint and survivor annuity, a qualified optional
survivor annuity or an immediate lump sum payment. Elections by Covered Individuals

Page 3

to receive a new distribution option will be subject to applicable spousal consent.³
Each Covered Individual would be offered optional financial counseling provided by
what Company represents will be a highly qualified and reputable financial advisor
before making his or her election decision. The Company represents that Covered
Individuals that elect a new distribution option will be considered to have a new annuity
starting date as of the first day of the month in which their new benefit is payable.

The Company represents that the funding levels of the Plans are sufficient so that the
window programs will not trigger benefit restrictions described in section 436 of the
Code. In addition, the Company represents that the amendment will not change the
ability of Covered Individuals to elect during the window period to receive qualified joint
and survivor annuities or qualified optional survivor annuities in accordance with
sections 401(a)(11) and 417 of the Code.

Based on the facts and representations stated above, Company requests a ruling that
the minimum distribution requirements of section 401(a)(9) of the Code would not be
violated if the Company amended the Plans to offer the lump sum window to
participants and beneficiaries for whom annuity payments have commenced under the
Plans.⁴

APPLICABLE LAW

Section 401(a)(9) of the Code and the regulations thereunder (“Regulations”) provide
rules relating to required minimum distributions from qualified plans. Section 401(a)(9)
of the Code was enacted to ensure that the amounts contributed to qualified retirement
plans were used for retirement by requiring that retirement payments begin no later than
a certain date, with no less than a certain amount being distributed each year of
retirement. The legislative history of the original version of section 401(a)(9) of the
Code in 1962 stated that its purpose is in “preventing lifetime accumulations which
might escape income taxation altogether.” 108 Cong. Rec. 18755, 18756 (1962)
(statement of Sen. Smathers).

In general, section 401(a)(9)(A) of the Code states that a trust shall not constitute a
qualified trust under this subsection unless the plan provides that the entire interest of
each employee -

(i) will be distributed to such employee not later than the required beginning date,

or

(ii) will be distributed, beginning not later than the required beginning date, in
accordance with regulations, over the life of such employee or over the lives of
such employee and a designated beneficiary (or over a period not extending
beyond the life expectancy of such employee or the life expectancy of such
employee and a designated beneficiary).

Section 401(a)(11) of the Code generally provides that a defined benefit plan will not be
considered a qualified plan unless vested benefits, with respect to a married participant
who dies before the annuity starting date, are payable in the form of a qualified
preretirement survivor annuity and, with respect to a married participant who dies after
the annuity starting date, a qualified joint and survivor annuity.

Section 415(a)(1)(A) of the Code provides that a trust which is a part of a pension plan
will not constitute a qualified trust if the pension plan provides for the payment of
benefits which exceed the limitation of section 415(b). Section 415(b)(2)(B) of the Code
generally provides that if the benefit under a defined benefit plan is payable in any form
other than a straight life annuity, the determination as to whether the section 415(b) limit
has been satisfied shall be made by adjusting the benefit so that it is equivalent to a
straight life annuity.

Section 417(a) of the Code provides that a plan meets the requirements of section
401(a)(11) if, among other requirements, each participant may elect during the
applicable election period to waive the qualified joint and survivor annuity form of benefit
or the qualified preretirement survivor annuity form of benefit (or both). Section
417(a)(6) of the Code defines the applicable election period as meaning, in part, in the
case of an election to waive the qualified joint and survivor annuity form of benefit, the
180-day period ending on the annuity starting date.

Treas. Reg. § 1.401(a)(9)-6, Q&A-1(a), in pertinent part, states that in order to satisfy
section 401(a)(9) of the Code, distributions of the employee’s entire interest under a
defined benefit pension plan must be paid in the form of periodic annuity payments for
the employee’s life (or the joint lives of the employee and beneficiary) or over a period
certain that does not exceed the maximum length of the period certain determined in
accordance with A-3 of this section. Once payments have commenced over a period,
the period may only be changed in accordance with A-13 or A-14 of this section. Except
as otherwise provided in this section (such as permitted increases described in A-14 of
this section), all payments (whether paid over an employee’s life, joint lives, or a period
certain) also must be nonincreasing.

Treas. Reg. § 1.401(a)(9)-6, Q&A-13(a) states that an annuity payment period may be
changed in accordance with the provisions set forth in paragraph (b) of this A-13 or in
association with an annuity payment increase described in A-14 of this section.

Treas. Reg. § 1.401(a)(9)-6, Q&A-14(a) states that except as otherwise provided in this
section, all annuity payments (whether paid over an employee’s life, joint lives, or a
period certain) must be non-increasing or increase only in accordance with one or more
of the following -

(1) With an annual percentage increase that does not exceed the percentage
increase in an eligible cost-of-living index as defined in paragraph (b) of this A-14
for a 12-month period ending in the year during which the increase occurs or the
prior year;

(2) With a percentage increase that occurs at specified times (e.g., at specified
ages) and does not exceed the cumulative total of annual percentage increases
in an eligible cost-of-living index as defined in paragraph (b) of this A-14 since
the annuity starting date, or if later, the date of the most recent percentage
increase. However, in cases providing such a cumulative increase, an actuarial
increase may not be provided to reflect the fact that increases were not provided
in the interim years;

(3) To the extent of the reduction in the amount of the employee’s payments to
provide for a survivor benefit, but only if there is no longer a survivor benefit
because the beneficiary whose life was being used to determine the period
described in section 401(a)(9)(A)(ii) over which payments were being made dies
or is no longer the employee’s beneficiary pursuant to a qualified domestic
relations order within the meaning of section 414(p);

(4) To pay increased benefits that result from a plan amendment;

(5) To allow a beneficiary to convert the survivor portion of a joint and survivor
annuity into a single sum distribution upon the employee’s death; or

(6) To the extent increases are permitted in accordance with paragraph (c) or (d)
of this A-14.

Treas. Reg. § 1.415(b)-(1)(b)(iii) provides that if a participant will have distributions
commencing at more than one annuity starting date, the limitations of section 415 of the
Code must be satisfied as of each of the annuity starting dates, taking into account the
benefits that have been provided at all of the annuity starting dates.

ANALYSIS

Section 401(a) of the Code provides a tax deferral for retirement benefits accumulated
in a qualified pension plan. Section 401(a)(9) of the Code and the Regulations ensure
that these tax-deferred accumulations are, in fact, used during retirement and do not
escape taxation.

Treas. Reg. § 1.401(a)(9)-6 sets forth the rules governing required distributions from
defined benefit plans and annuity contracts. Treas. Reg. § 1.401(a)(9)-6, Q&A-13(a)
states that an annuity payment period may be changed in association with an annuity

Page 6

payment increase described in A-14 of this section. Treas. Reg. § 1.401(a)(9)-6, Q&A-
14(a)(4) provides that annuity payments from a qualified plan may increase if the
payment of increased benefits results from a plan amendment.

The Company’s proposed amendment to the Plans adds a lump sum option for Covered
Individuals under which Covered Individuals will have the opportunity to elect, within a
window period of no less than 60 days and no more than 90 days, to receive, in lieu of
their current annuity, either the automatic annuity form of benefit (including a qualified
joint and survivor annuity and a qualified optional survivor annuity) or a lump sum
payment. Elections by Covered Individuals to receive a new distribution option will be
subject to applicable spousal consent.⁵

The proposed amendment will result in a change in the annuity payment period. The
annuity payment period will be changed in association with the payment of increased
benefits as a result of the addition of the lump sum option. In addition, Covered
Individuals who wish to change their current distribution option will be considered to
have a new annuity starting date as of the first date of the month in which their new
benefit is payable. Because the ability to select a lump sum option will only be available
during a limited window, the increased benefit payments will result from the proposed
plan amendment and, as such, are a permitted benefit increase under Treas. Reg. §
1.401(a)(9)-6, Q&A-14(a)(4).

RULING

Therefore, in this circumstance, the minimum distribution requirements of section
401(a)(9) of the Code would not be violated if the Company amended Plan 1 and Plan 2
to offer a lump sum payment option, during a limited window period of no less than 60
days and no more than 90 days, to the plans’ participants and beneficiaries for whom
annuity payments have already begun.

Except as specifically ruled above, no opinion is expressed as to the federal tax
consequences of the transaction described above under any other provision of the
Code, including sections 411, 415, 417 and 436 or of Title I of ERISA. In addition, no
opinion is expressed regarding the qualification of either of the Plans.

This letter is directed only to the taxpayer who requested it. Section 6110(k)(3) of the
Code provides that it may not be used or cited as precedent.

Page 7

If you wish to inquire about this ruling, please contact ** at () -***.
Please address all correspondence to SE:T:EP:RA:T2.

Sincerely,

William B. Hulteng, Manager,
Employee Plans Technical

Enclosures:
Deleted copy of ruling letter
Notice of Intention to Disclose

cc: ******