Lump-sum pension settlements do not end eligibility for retiree-benefit transfers

Plain-English summary

A company proposed offering lump-sum pension payments to retirees who were already receiving annuities, while its pension plans also funded retiree health and life insurance benefits through section 420 transfers. The company asked whether retirees whose remaining pension obligations were paid as lump sums, settled with annuity contracts, or transferred under section 414(l) would cease to be eligible for those retiree benefits. The IRS concluded that eligibility turns on having earned pension benefits and retired, not on the form or timing of the pension payout. The covered retirees, spouses, and dependents therefore remained within the class for whom qualified, qualified future, and collectively bargained transfers could fund post-retirement health and life insurance benefits. The IRS did not rule on the pension plans' qualification.

Ruling snapshot

• Question: Does settling a retiree's remaining pension benefit remove that retiree from the class eligible for health and life insurance funding under section 420?
• Outcome: Approved, the retirees and their spouses and dependents remain eligible
• Key authorities: IRC §§ 401(h), 414(l), and 420; Treas. Reg. § 1.401-14(b)(1)

Full text (IRS public release)

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

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

DEC 19 2014

Uniform Issue List: 420-00:00

TEP. RA:T2

Legend:

Company A =

Plan A =

Plan B =

Dear :

This letter is in response to your request dated December 31, 2013, submitted on
your behalf by your authorized representative, in which you request a private letter
ruling that payments of lump sums to retired participants (Covered Individuals) under
either Plan A or Plan B (the “Pension Plans”) who have already commenced annuity
payments or the otherwise settling of retired participants’ pension liability through a
section 414(l) of the Internal Revenue Code (the “Code”) transfer will not result in the
exclusion of such participants from the class of individuals with respect to whom
“qualified transfers,” “qualified future transfers” and “collectively bargained transfers”
can be made to fund post-retirement health and insurance benefits under section 420 of
the Code.

Company A sponsors Plan A and Plan B, two tax-qualified defined benefit
pension plans under section 401(a) of the Code which are the subject of this ruling
request. Each of the Pension Plans has a favorable determination letter.

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Plan A provides that Qualified Transfers (defined under section 420(b)(1) of the
Code, as set forth under the Applicable Law section) of excess pension assets
(generally in excess of 120% or 125% of the plan’s benefits liabilities, depending on the
type of transfer) may be made to an account meeting the requirements of section
401(h). Plan B provides that Qualified Transfers, as well as Qualified Future Transfers
and Collectively Bargained Transfers (both defined under section 420(f)(2), as set forth
under the Applicable Law section) may be made pursuant to section 420 of the Code.¹

Company A intends to amend the Pension Plans to make available, during a
limited window period, to certain participants who are currently receiving benefits, an
opportunity to select a lump sum distribution in lieu of their remaining annuity payments.

Both Plan A and Plan B have provisions which are represented to meet the
requirements of section 401(h) of the Code and which are used to fund post-retirement
health benefit plans. Plan B also has provisions for a Life Insurance Fund used to fund
post-retirement life insurance benefits.² Plan A and Plan B provide that health care
funds shall be credited with company contributions designated for that purpose, as well
as transfers of excess assets under the plans, to the extent and as defined and
permitted by section 420 of the Code. Under Plan B, the Life Insurance Fund shall be
credited with transfers of excess assets under the plan, to the extent and as defined and
permitted by section 420 of the Code.

Plan A and Plan B currently provide for section 420 transfers to fund and pay
post-retirement health and life insurance benefits, as applicable, for participants who are
retired and currently receiving pension benefits.

Based on the facts and representations stated above, Company A requests a
ruling that the payment of lump sums, or the otherwise settling of the pension liability to
Covered Individuals who elected to receive their remaining annuity payments in the
form of lump sum distributions, or whose remaining annuity payments have been
otherwise settled, such as through purchase of an irrevocable annuity contract, or a
section 414(l) of the Code transfer, will not result in the exclusion of such participants
from the class of individuals to whom transfers can be made under section 420 to fund
post-retirement health and life insurance benefits.

APPLICABLE LAW

Section 401(h) of the Code provides in applicable part, “[u]nder regulations
prescribed by the Secretary, and subject to the provisions of section 420, a pension or
annuity plan may provide for payment of benefits for sickness, accident, hospitalization,
and medical expenses of retired employees, their spouses and dependents[.]”

¹ The Company may amend Plan A to allow for Qualified Future Transfers.
² The Company may amend Plan A to provide for a Life Insurance Fund.

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Treas. Reg. § 1.401-14(b)(1) provides:

Under section 401(h), a qualified pension or annuity plan may provide for
the payment of medical benefits described in section 401(h) only for
retired employees, their spouses, or their dependents. To be “retired” for
purposes of eligibility to receive medical benefits described in section
401(h), an employee must be eligible to receive retirement benefits
provided under the pension plan or else be retired by an employer
providing such medical benefits by reason of permanent disability. For
purposes of the preceding sentence, an employee is not considered to be
eligible to receive retirement benefits provided under the plan if he is still
employed by the employer and a separation from employment is a
condition to receive the retirement benefits.

Section 420(a) of the Code provides, generally, that if there is a qualified transfer
of any excess pension assets of a defined benefit plan to a health benefits account,
established and maintained under section 401(h), or to an applicable life insurance
account within the meaning of section 420(e)(4) of the Code, no amount shall be
includable in the gross income of the employer maintaining the plan solely by reason of
such transfer and the transfer shall not be treated as an employer reversion for
purposes of section 4980 or as a prohibited transaction for purposes of section 4975.

Section 420(b)(1) of the Code provides, generally, that Qualified Transfer means
a transfer of excess pension assets of a defined benefit plan to a health benefits
account, or an applicable life insurance account, which is part of such plan, and which
does not contravene any other provision of the law and with respect to which certain
use, vesting and minimum cost requirements under section 420(c) are met.

Section 420(b)(3) provides, “The amount of excess pension assets which may be
transferred to an account in a qualified transfer shall not exceed the amount which is
reasonably estimated to be the amount the employer maintaining the plan will pay
(whether directly or through reimbursement) out of such account during the taxable year
of transfer for qualified current retiree liabilities.”

Section 420(e)(1)(A) of the Code provides that

“qualified current retiree liabilities” means, with respect to any taxable
year, the aggregate amounts (including administrative expenses) which
would have been allowable as a deduction to the employer for such
taxable year with respect to applicable health benefits and applicable life
insurance benefits provided during such taxable year if—

(i) such benefits were provided directly by the employer, and
(ii) the employer used the cash receipts and disbursements
method of accounting.

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Section 420(e)(1)(C) of the Code defines “applicable health benefits” as health
benefits or coverage which are provided to (i) retired employees who, immediately
before the qualified transfer, are entitled to receive such benefits by reason of
retirement and who are entitled to pension benefits under the plan, and (ii) their spouses
and dependents.

Section 420(e)(1)(D) of the Code defines “applicable life insurance benefits,” in
relevant part, as group-term life insurance coverage provided to retired employees who,
immediately before the qualified transfer, are entitled to receive such coverage by
reason of retirement and who are entitled to pension benefits under the plan, subject to
certain requirements.

Section 420(e)(1)(E) of the Code states that key employees under section
416(i)(1) are excluded in computing qualified current retiree liabilities.

Section 420(f) of the Code, which was added to section 420 in 2006, provides
special rules for Qualified Future Transfers and Collectively Bargained Transfers.
Qualified Future Transfers and Collectively Bargained Transfers mean transfers which
meet all the requirements for a Qualified Transfer with certain exceptions:

(a) In determining excess pension assets, the excess shall be determined
by reference to 120% of the Plan’s benefits liabilities. Also there is a
requirement to maintain a funded status for the Plan within the parameters
set out in section 420(f)(B)(ii) of the Code.

(b) Under section 420(f)(2)(C)(i) of the Code, the amount of excess
pension assets which may be transferred in the case of a Qualified Future
Transfer is generally limited to the sum of (1) if the transfer period includes
the taxable year of the transfer, the amount determined under section
420(b)(3) for such taxable year, plus (2) in the case of all other taxable
years in the transfer period, the sum of the qualified current retiree
liabilities which the plan reasonably estimates, in accordance with
guidance issued by the secretary, will be incurred for each of such years.

Section 420(f)(2)(C)(ii) provides that the amount of excess pension assets
which may be transferred in a Collectively Bargained Transfer is generally
limited to the amount which is reasonably estimated to be the amount the
employer will pay out of the account during the collectively bargained cost
maintenance period for “collectively bargained retiree liabilities.”

(c) The minimum cost requirements of section 420(c)(3) of the Code must
be modified as provided under section 420(f)(2)(D).

(d) In the case of a Collectively Bargained Transfer it is a transfer which—

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(i) is made in accordance with a collective bargaining agreement,

(ii) before the transfer, the employer designates, in a written notice
delivered to each employee organization that is a party to the
collective bargaining agreement, as a collectively bargained
transfer in accordance with this section, and

(iii) involves a defined benefit plan maintained by an employer which in
its taxable year ending in 2005, provided health benefits or
coverage to retirees and their spouses and dependents under all of
the health benefit plans maintained by the employer, but only if the
aggregate cost...of such benefits or coverage which would have
been allowable as a deduction to the employer [in the circumstances
described] is at least 5 percent of the gross receipts of the employer.

Section 420(f)(6)(B) of the Code defines “collectively bargained retiree liabilities”
as the present value, as of the beginning of a taxable year and determined in
accordance with the applicable collective bargaining agreement, of all collectively
bargained health benefits and collectively bargained life insurance benefits (including
administrative expenses) for such taxable years during the collectively bargained cost
maintenance period [as defined in section 420(f)(6)(A)], excluding benefits for key
employees under section 416(i)(1).

Section 420(f)(6)(C) of the Code defines, in applicable part, “collectively
bargained health benefits” as health benefits or coverage—

(i) which are provided to retired employees who, immediately before the
collectively bargained transfer, are entitled to receive such benefits by
reason of retirement and who are entitled to pension benefits under the
plan, and their spouses and dependents, and,

(ii) if specified by the provisions of the collectively bargained agreement
governing the collectively bargained transfer, which will be provided at
retirement to employees who are not retired employees at the time of the
transfer and who are entitled to receive such benefits and who are entitled
to pension benefits under the plan and their spouses and dependents.

Section 420(f)(6)(D) of the Code defines “collectively bargained life insurance
benefits” as (1) applicable life insurance benefits which are provided to retired
employees who, immediately before the transfer, are entitled to receive such benefits by
reason of retirement, and (2) if specified by the provisions of the collectively bargained
agreement governing the transfer, applicable life insurance benefits which will be
provided at retirement to employees who are not retired employees at the time of
transfer.

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ANALYSIS

The issue in this ruling request is whether individuals who have elected to
receive lump sum distributions in lieu of their remaining annuity payments, or whose
remaining annuity payments are otherwise settled, are members of the class of
individuals with respect to whom Qualified Transfers, Qualified Future Transfers, and
Collectively Bargained Transfers may be made and for whom applicable health benefits
under section 420(e)(1)(C) of the Code, applicable life insurance benefits under section
420(e)(1)(D), collectively bargained health benefits under section 420(f)(6)(C) and
collectively bargained life insurance benefits under section 420(f)(6)(D) may be paid
from the Pension Plans’ section 401(h) accounts and retiree life insurance accounts, as
applicable.

Under 420(e)(1)(C) of the Code (relating to a Qualified Transfer) the class of
individuals eligible for health benefits are those “retired employees who, immediately
before the qualified transfer, are entitled to receive such [health] benefits and who are
entitled to pension benefits under the plan.” Section 420(e)(1)(D) defines eligibility for
applicable life insurance benefits in almost identical terms. Individuals eligible are those
“who immediately before the qualified transfer, are entitled to receive such coverage by
reason of retirement and who are entitled to pension benefits under the plan...”

Similar language is also used in section 420(f)(6)(C), (relating to collectively bargained
health benefits), and section 420(f)(6)(D), (relating to collectively bargained life
insurance benefits).

It is clear from sections 420(e)(1)(C), 420(e)(1)(D), 420(f)(6)(C) and 420(f)(6)(D)
that a qualifying retiree with respect to whom a Qualified Transfer, Qualified Future
Transfer or Collectively Bargained Transfer may be made must be an individual who is
retired and who, immediately before the transfer, was entitled to receive health or life
insurance benefits by reason of retirement. What is less clear is whether such an
individual must be entitled to receive pension benefits under the plan immediately
before the transfer, or whether it is sufficient that the retiree was entitled to pension
benefits at retirement, i.e., whether the provisions also cover retirees whose pension
benefits have already been completely paid out in a lump sum prior to transfer or whose
remaining annuity payments have been otherwise settled.

Section 420(e)(1)(C) of the Code defines the applicable health benefits that may
be funded through a Qualified Transfer to section 401(h) account. Section 420(e)(1)(C)
provides further that health benefits may be provided to retired employees who,
immediately before the qualified transfer, are entitled to receive such benefits upon
retirement and who are entitled to pension benefits under the plan and their spouses
and dependents.

Treas. Reg. § 1.401-14(b)(1) explains that for an employee to be “retired” for
purposes of eligibility to receive medical benefits described in section 401(h) of the
Code he or she must be separated from service. The focus of the regulation is on
retirement. Active participants are not eligible for medical benefits under section 401(h).

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There is no indication that the manner in which pension benefits are paid out is relevant
for purposes of determining eligibility for benefits under section 401(h). Thus, any
employee who has received a distribution, is receiving a distribution or who has retired
and is entitled to receive a future distribution is a member of the class which is entitled
to pension benefits under the plan, and as such, amounts can be set aside in a 401(h)
account for them. Distributions to these members include, but are not limited to, a
monthly annuity, a term certain form of payment or a prior lump sum distribution. This
class also includes those individuals who are spouses or dependents of these
employees.

As long as an individual has earned pension benefits under the plan and retired,
his or her retiree health benefits can be funded through a section 401(h) account, even
if the pension benefit has been paid out through a lump sum or otherwise settled prior to
payments being made under the section 401(h) account. The same principle applies to
retiree life insurance benefits.

RULING

Therefore, in this circumstance, Covered Individuals who elect to receive a lump
sum distribution in lieu of their current annuity or whose remaining annuity payments are
otherwise settled, in the manner previously described, and their spouses and
dependents, are members of the class of participants with respect to whom Qualified
Transfers, Qualified Future Transfers and Collectively Bargained Transfers may be
made under section 420 of the Code and with respect to whom transferred assets (and
any income allocable thereto) may be paid from a section 401(h) account or an
applicable life insurance account.

Except as specifically ruled above, no opinion is expressed as to the federal tax
consequences of the transaction above under any other provision of the Code. No
opinion is expressed regarding the qualification of the Pension 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.

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

Sincerely,

William B. Hulteng, Manager

Employee Plans Technical
Enclosures:

Deleted copy of letter ruling
Notice of Intention to Disclose

cc: