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August 25, 2015

2015-Issue 28—In a pair of rulings issued recently, the IRS announced some significant changes impacting qualified retirement plans. Notice 2015-49 would prohibit the now-common practice of allowing annuitants in pay status to elect to receive their remaining pension benefit in the form of single lump sums, while Announcement 2015-19 largely eliminates the determination letter program for individually designed plans.

Prohibition of Lump Sum Cash-Outs of Annuities in Pay Status Under Defined Benefit Plans
Once the mainstay of the U.S. retirement system, traditional defined benefit pension plans have fallen out of favor — primarily due to the statutory funding requirements that apply to such plans. Volatility in the U.S. securities markets in recent years left many sponsors of such plans with funding deficiencies, requiring substantial cash contributions. Consequently, more and more sponsors of such plans have utilized various approaches to minimize or eliminate their pension risks. Such methods include terminating such plans, freezing the plans to new participants, freezing future benefit accruals, and/or conversion of such plans into cash balance pension plans or defined contribution plans (i.e., 401(k) and profit sharing plans, in which all investment risk is borne by the plan participants).

One other method that was often used to reduce a plan sponsor’s pension liability risk was to offer current retirees who are receiving annuity benefits a limited “window” period in which they could elect to receive the present value of their remaining benefit in the form of a single  lump sum payment. In this manner, the plan would be absolved of liability to pay any further benefits to those retirees who elected to receive the lump sum benefit, and the retirees would assume any future risk of investment loss. The IRS specifically approved of this practice in a number of private letter rulings issued during the last several years.

On July 9, 2015, however, the IRS issued Notice 2015-49, which puts an end to this practice. In this notice, the IRS stated its intent to amend the regulations under Section 401(a)(9) of the Internal Revenue Code to provide that such cash-outs would violate the requirement of that section prohibiting, with limited exceptions, payment of pension benefits in the form of an increasing annuity. The IRS further stated that the amended regulations would be effective as of July 9, 2015. Accordingly, going forward, defined benefit plan sponsors will no longer be able to use this strategy to reduce their pension liability risk.

The IRS stated that certain cash-outs made in this manner would not be impacted by the revised regulations, specifically:

  • Those that are made pursuant to a plan amendment that was adopted or approved by an entity with appropriate authority prior to July 9, 2015;
  • Those with respect to which a private letter ruling or determination letter was issued prior to July 9, 2015;
  • Those with respect to which a written communication to affected plan participants stating a definite intent to implement such a program was distributed prior to July 9, 2015; and
  • Those adopted pursuant to an agreement between a plan sponsor and an employee representative under a collective bargaining agreement that was entered into and binding prior to July 9, 2015.

Note that the revised regulations will apply only to accelerated cash-outs of annuity benefits in pay status for ongoing plans, and will not affect a plan sponsor’s ability to terminate a plan and make lump sum distributions to current participants and retired annuitants.

Elimination of Determination Letter Program for Individually Designed Plans
Sponsors of qualified retirement plans have long relied on the IRS’s determination letter program to ensure compliance with the documentary requirements that apply to such plans under the Internal Revenue Code. In the past, plan sponsors were permitted to request determination letters whenever they deemed it necessary; for example, following adoption of an amendment making significant plan changes, or upon adopting a complete plan restatement. In 2007, the IRS limited the determination letter program somewhat, allowing sponsors of individually designed plans to submit their plans for a determination letter only once every five years.

In Announcement 2015-19, the IRS announced that the determination letter program for individual designed plans is, for practical purposes, being eliminated. Instead of submitting requests for determination letters every five years, sponsors of individually designed plans will now be allowed to apply for a determination letter only upon initial plan qualification (i.e., for new plans) or upon plan termination. Therefore, plan sponsors will no longer be permitted to ask for IRS approval of their amended or restated plans. This will require plan sponsors to pay special attention to the plan documentation requirements, and ensure that their plans remain up to date with all statutory requirements as they are amended from time to time.

An additional impact of the elimination of the determination letter program is that the remedial amendment period under Code Section 401(b) will no longer be tied to the applicable five-year cycle for requesting determination letters. Rather, the general remedial amendment period under Section 401(b) will apply. (This is generally the due date of the employer’s tax return, including extensions, for the tax year in which the plan amendment was adopted, or such later date as specified by the IRS in applicable guidance.) For many plans, this change means that the remedial amendment period for law changes that are already in effect will be shortened considerably. To address these concerns, the IRS has stated that the remedial amendment period for all individually designed plans will be extended to a date that is not earlier than December 31, 2017.

Alvarez & Marsal Taxand Says:
Sponsors of defined benefit pension plans may no longer eliminate actuarial risk by allowing annuitants to cash out their remaining annuity benefits. Since this method of reducing risk is no longer available, sponsors of such plans who wish to limit ongoing risk may wish to explore other methods of limiting their risk, including cash balance conversion, conversion to a defined contribution plan, or freezing and/or terminating such plans. Your Taxand compensation and benefits professionals are uniquely qualified to assist in analyzing the risks and assessing the advantages of one or more of such options.

Additionally, sponsors of individually designed qualified retirement plans must now be more attuned to documentary compliance issues, and ensure that all plan amendments are adopted in a timely (and accurate) fashion, as they will no longer be able to rely on the determination letter program to ensure that their plan amendments are timely and that they accurately reflect the requirements of the IRC and regulations. Plan sponsors should also ensure that their plans are amended for all current law changes no later than the date that the IRS may specify as the end of the current remedial amendment period for all plans. Contact your Taxand professionals if you need assistance with these or other qualified plan issues.

The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
About Alvarez & Marsal Taxand
Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M's commitment to offering clients a choice in advisors who are free from audit-based conflicts of interest, and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the US., and serves the U.K. from its base in London.Alvarez & Marsal Taxand is a founder of Taxand, the world's largest independent tax organization, which provides high quality, integrated tax advice worldwide. Taxand professionals, including almost 400 partners and more than 2,000 advisors in nearly 50 countries, grasp both the fine points of tax and the broader strategic implications, helping you mitigate risk, manage your tax burden and drive the performance of your business.
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