Limited lump sum window did not violate minimum distribution rules

Plain-English summary

A frozen defined benefit plan proposed a 60-to-90-day window allowing participants, beneficiaries, and alternate payees already receiving annuities to elect a lump sum or another available annuity form. Elections would require applicable spousal consent, and an individual choosing a new form would receive a new annuity starting date. The IRS treated the amendment’s temporary lump sum option as a permitted benefit increase associated with a change in the annuity payment period under Treasury Regulation section 1.401(a)(9)-6. It ruled that the amendment would not violate section 401(a)(9)’s minimum distribution requirements. The IRS relied on the company’s representation that the option satisfied section 417(e) and did not rule on benefit valuation, other qualification requirements, or the plan’s overall qualified status.

Ruling snapshot

• Question: Could a defined benefit plan offer current annuitants a limited window to replace ongoing payments with a lump sum or another annuity form?
• Outcome: Approved for purposes of section 401(a)(9), subject to the stated representations and limitations.
• Key authorities: IRC § 401(a)(9); Treas. Reg. § 1.401(a)(9)-6, Q&A-13 and Q&A-14

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

APR - 8 2014

201427023

Uniform Issue List: 401.06-01

[redacted]
[redacted]
[redacted]
[redacted]
[redacted]

Legend:

Company = [redacted]

Plan = [redacted]

Dear [redacted],

This is in response to your letter dated December 20, 2012, in which you request a 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 the Plan to offer a lump sum payment option, during a limited window period, to the Plan’s participants, beneficiaries, and alternate payees 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 is in the entertainment industry and has operations in the United States and other countries. It sponsors the Plan, which is intended to be a tax-qualified defined benefit plan. The Plan is in receipt of a favorable determination letter and currently has an on-cycle determination letter request for the Plan pending. The ruling requested in your December 20, 2012, letter is not part of that determination letter request. The Plan has been amended to freeze benefit accruals as of December 31, 2012.

The normal form of benefit for a single participant in the Plan is a single life annuity, and the normal form of benefit for a married participant is a 50% joint and survivor annuity. Optional forms of benefit in the Plan include 75% and 100% joint and survivor annuities, Social Security leveling options, life and period certain annuities, and lump sum. The optional forms of benefit available to a particular participant depend on the terms of the Plan.

The Company proposes to amend the Plan to offer, during a limited period of time, a lump sum payment option to certain participants, beneficiaries, and alternate payees of the Plan who are in pay status (the “Covered Individuals”).1 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 (the “Window”) during which they could elect to receive the actuarial present value of their remaining benefits under the Plan at the time of such election in the form of a single lump sum payment. Each Covered Individual receiving benefit payments would be able to elect to receive, in lieu of his or her current annuity, the actuarial present value of his or her remaining accrued benefits either in a single life annuity, qualified joint and survivor annuity (if applicable), qualified optional survivor annuity (if applicable), or an immediate lump sum payment.

Elections by Covered Individuals to receive a new distribution option will be subject to applicable spousal consent, which will include, to the extent required by law, both the current spouse, and a former spouse if the Covered Individual has remarried since the annuity starting date. 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.

Company represents the Plan’s AFTAP exceeds 100%, and the Plan’s actuary has confirmed that the lump sum window program will not trigger benefit restrictions described in section 436 or the Internal Revenue Code, as amended (“Code”). Additionally, the amendment will not change the ability of Covered Individuals to elect during the Window to receive qualified joint and survivor annuities in accordance with sections 401(a)(11) and 417 of the Code.

Based solely 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 Plan 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 Plan’s participants, beneficiaries, and alternate payees for whom annuity payments have already begun.

1 Under the proposed amendment, it is possible that terminated participants, beneficiaries, and alternate payees with a vested benefit who have not commenced payment will be able to participate in the Window program and elect a lump sum payment, but the ruling request addresses only those Covered Individuals who have begun receiving payments.

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)(1)(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 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 Plan would add a lump sum option for the Covered Individuals under which they 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 annuities, either an available annuity form of benefit (including a single life annuity, qualified joint and survivor annuity (for married participants)) or a lump sum payment. Elections by Covered Individuals to receive a new distribution option will be subject to applicable spousal consent.2

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 distribution option will be considered to have a new annuity starting date as of the first date of the month in which the 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, is a permitted benefit increase under Treas. Reg. § 1.401(a)(9)-6, Q&A-14(a)(4).

2 Spousal consent must include, where the law requires, both the current spouse and a former spouse, if the annuitant has remarried.

In order for a plan to remain qualified under section 401(a) of the Code, the calculation of the value of the benefit elected under the lump sum window option must comply with the requirements of section 417(e) and the regulations thereunder. Under section 6.03 of Revenue Procedure 2014-4, subject to certain exceptions, the IRS generally does not issue letter rulings on matters involving qualification issues under section 401 through 420 of the Code. Qualification matters are generally handled by the Employee Plans Determination letter program as provided in Revenue Procedure 2014-6. Accordingly, we have not considered, among other matters, whether the lump sum window benefits comply with the requirements of section 417(e) and the regulations thereunder with respect to the amount of the distribution and minimum present value requirement that is applied based on the present value of the normal retirement benefit. Instead, this letter ruling is based on your representation that the lump sum window option satisfies section 417(e) of the Code and section 1.417(e)-1 of the regulations.

RULING

Therefore, in this circumstance, that the minimum distribution requirements of section 401(a)(9) of the Code would not be violated if the Company amended the Plan to offer a lump sum window option, during a limited window period of no less than 60 days and no more than 90 days, to the Plan’s participants, beneficiaries, and alternate payees 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 401(a)(4), 411, 415, 417 and 436 or of Title I of ERISA. In addition, no opinion is expressed regarding the qualification of the Plan.

In addition, no opinion is expressed on whether the method for valuing benefits under the limited window period option satisfies the requirements of section 417(e) and the regulations thereunder.

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.

If you wish to inquire about this ruling, please contact [redacted] at [redacted]. Please address all correspondence to SE:T:EP:RA:T2.

Sincerely,

William B. Hulteng, Manager,
Employee Plans Technical Group

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

cc: [redacted]