On July 9, 2015, the IRS issued Notice 2015-49, “Use of Lump Sum Payments to Replace Lifetime Income Being Received by Retirees Under Defined Benefit Pension Plans.”
This notice prohibits a sponsor of a defined benefit (DB) pension plan from offering a lump sum to a retired participant currently receiving annuitized pension payments from the plan. Note that this ruling applies only to participants already in retired pay status and not participants who have not yet commenced annuity distributions. There has been some confusion on this issue since the IRS released this notice, particularly on social media. The information below should help clear some of the confusion.
The practice of offering a lump sum to retired participants instead of a continued annuity has been done by some very large plan sponsors as part of a de-risking strategy. There are risks associated with the future payment of lifetime income. The major risks are longevity (how long will the benefit have to be paid?) and volatile market returns (will there be enough assets to pay the benefit?). In a defined benefit plan, those risks reside with the plan sponsor, but can be shifted to the participant if a lump sum is paid.
Plan sponsors that offered retirees a lump sum cited a regulation pertaining to pension plan distributions as allowing this type of offer. The IRS does not agree with the interpretation and has taken a formal position to not permit this practice, announcing plans to amend the regulations accordingly. This amendment is effective immediately, except for certain arrangements already undertaken. In addition, as in the past, you will always be able to offer a lump sum to retirees in conjunction with a plan termination.
Plans may still offer a lump sum to terminated participants with a vested benefit who have not yet commenced distributions. Plan sponsors considering lump sums as part of a de-risking strategy should consult with their benefit plan advisors to discuss the pros and cons.Harbridge Consulting Group, a BPAS Company, continues to help plan sponsors mitigate increasing pension costs associated with PBGC premiums and the new mortality assumptions by exploring and implementing appropriate de-risking strategies. For more information, visit bpas.com