Internal Revenue Service
P.O. Box 7604
Ben Franklin Station Washington, DC 20044
RE: Update to Minimum Present Value Requirements for Defined Benefit Plan Distributions (RIN 1545-BK95)
Ladies and Gentlemen:
The ERISA Industry Committee (ERIC) is pleased to respond to the request by the Internal Revenue Service (“IRS”) for comments regarding the provisions contained in the proposed Update to Minimum Present Value Requirements for Defined Benefit Plan Distributions (the “proposed regulations”)1 and to request the opportunity to testify at the March 7, 2017 hearing on this subject. Our testimony will address the points made in this comment letter.
ERIC’s Interest in the Minimum Present Value Requirements
ERIC is the only national association that advocates exclusively for large employers on health, retirement, and compensation public policies at the federal, state, and local levels. ERIC’s members provide comprehensive retirement benefits to tens of millions of active and retired workers and their families. ERIC has a strong interest in proposals, such as the proposed rule, that would affect its members’ ability to provide predictable and secure pension benefits in an efficient and tax-compliant manner.
Predictability and stability are cornerstones of the voluntary pension system for both plan sponsors and participants. This is particularly true when it comes to defined benefit plans, most of which are either closed to new participants or frozen for all participants. Regulatory guidance that creates uncertainty or introduces new risk can drive plan sponsors further away from offering important and meaningful retirement benefits.
As explained below, we are concerned that the “clarifying” changes in the proposed regulations are, in fact, both substantive and problematic. With certain exceptions, the proposed changes represent significant changes to long-standing guidance and well-established plan designs and related benefit determinations that have been in place for decades. It is particularly concerning to plan sponsors that the IRS can change the rules at this late date in a manner that potentially conflicts with well-established plan designs that over the years have been sanctioned by favorable IRS determination letters. These changes could call into question years of prior benefit determinations for retirees, many of whom are currently receiving annuity payments, and cause plans to provide different levels of benefits to similarly-situated retirees.
ERIC maintains that there is no compelling reason for most of the so-called clarifying changes. We recognize that the government has a general concern about the payment of pension benefits in the form of a lump sum. However, the issuance of proposed regulations prior to discussion of the issues substantially raises the risks for plan sponsors. The characterization of the proposed changes as “clarifying” suggests a certain sense of finality and, even more concerning, a signal that plan sponsors should have heretofore been operating their plans in conformity with these changes.
We ask the IRS to also keep in mind that changes it may view as relatively minor or clarifying come with substantial costs to plan sponsors and their service providers. Administrative systems and benefit calculation programs need to be updated, plan documents need to be reviewed and potentially modified (largely without the possibility of the assurances of a favorable determination letter), and employee communications need to be prepared. Additional funding requirements and increased PBGC premiums also need to be considered.
ERIC recommends, for the reasons set forth below, that the IRS adopt the following revisions to the proposed regulations:
- Treatment of Pre-Retirement Mortality – The regulations should not prohibit plans from taking pre-retirement mortality into account when determining the single sum value of employee contributions, and alternative methods for calculating the single sum value should be permissive rather than mandatory. Further, the regulations should permit, not require, plans to take pre-retirement mortality into account when determining the single sum value of the employer-derived accrued benefit and should allow plans to apply pre-retirement mortality in a consistent manner for all relevant purposes.
- Application of Section 417(e)(3) to Social Security Level Income Options – The regulations should not apply the minimum present value requirements to Social Security Level Income options.
- Post-Normal Retirement Age Adjustments under Section 417(e)(3) – The IRS should explain why it believes that changes to the existing language are necessary and the intended impact, and it should invite comments.
- Alternative Calculation of Subsidized Lump Sum — In response to the IRS request for comments, ERIC believes that alternative calculations are permissible when determining the lump sum value of a subsidized early retirement benefit, as long as the lump sum value is no less than the immediate value of the normal retirement benefit, determined in accordance with Section 417(e)(3).
Treatment of Pre-Retirement Mortality
- Application of Pre-Retirement Mortality to the Employee-Derived Accrued Benefit
The proposed regulations would create an entirely new rule for determining the minimum present value of accrued benefits that are derived in part from employee contributions. In effect, this would overturn guidance that plan sponsors have been relying on for nearly 30 years. The regulations should not require any changes.
For the first time, the proposed regulations would prohibit the use of pre-retirement mortality when calculating the lump sum value attributable to employee contributions. The IRS’s rationale for this change appears to arise from certain cases involving cash balance plans, in which the courts held that if a participant’s beneficiary is entitled to a participant’s entire accrued benefit upon the participant’s death before normal retirement age, use of a mortality discount for the period before normal retirement age would result in a forfeiture of benefits in violation of the vesting rules under Section 411(a).
Benefits derived from employee contributions are different than other plan benefits that are not forfeited upon the participant’s death. Employee contributions are unique in that they represent a source of funding to which certain protections are attached, such as the right to an accrued benefit that is no less than the accumulated value of those contributions and the ability to have those contributions returned, with certain interest adjustments. Thus, decisions in cases involving cash balance plans should not be a driver for changes related to employee contributions.
In addition to prohibiting the use of pre-retirement mortality assumptions, the new rule would, also for the first time, require the minimum lump sum to be separately determined for the portions of the accrued benefit derived from employer contributions and employee contributions, and the lump sum value of the entire accrued benefit would be the sum of these two separately determined amounts.
The preamble to the proposed regulations states that the regulations would supersede inconsistent provisions in Rev. Rul. 89-60, which (according to the preamble) “suggests” that it is sufficient for a single sum distribution to equal the greater of the minimum present value of the accrued benefit derived from employee contributions and that of the participant’s entire accrued benefit. In fact, Rev. Rul. 89-60 contains step-by-step instructions for this methodology and has never been superseded.
ERIC believes that there is no reason to implement changes to the minimum present value requirements for employee contributions, or in the alternative, any changes should be permissive rather than mandatory. Plan sponsors have determination letters on plan designs with employee contributions and have been determining benefits in reliance on Rev. Rul. 89-60 guidance for the nearly 30 years since it was issued. This methodology has not led to any notable controversy that would suggest a substantial change in policy is necessary. Any change now would certainly call into question decades of benefit calculations, with potentially minimal benefit to affected participants.
- Application of Pre-Retirement Mortality to the Employer-Derived Accrued Benefit
The proposed regulations would provide that pre-retirement mortality is generally taken into account when determining the minimum present value of the employer-derived accrued benefit. We recommend that the IRS revise the regulation to explicitly state that this is a permissible plan design, and if implemented, would apply for all relevant purposes.
The Section 417(e)(3) calculations apply not just to voluntary lump sums but also to mandatory lump sum cash-outs under Section 417(e)(3)(1), application of the most valuable optional form of payment exception under Section 1.401(a)-20, Q&A-16, and application of substitution of annuity provisions under Section 1.430(d)-1(f). Because application of pre-retirement mortality results in a smaller lump sum than without, the regulations should give plan sponsors the option to take pre- retirement mortality into account for all relevant purposes.
- Application of Section 417(e)(3) to Social Security Level Income Options
The preamble to the proposed regulations acknowledges that questions have arisen regarding whether the minimum present value requirements of Section 417(e)(3) apply to a Social Security level income (“SSLI”) option. The proposed regulations would answer this in the affirmative by including an example, which would explain that SSLI options do not fit within the existing exceptions to the minimum present value requirements of Section 417(e)(3). Questions about the application of the minimum present value requirements to SSLI options are based on informal IRS guidance that is contrary to any reasonable reading of the statute.
Section 417 and its parallel provision, ERISA Section 205, generally provide that defined benefit plans and certain defined contribution plans must distribute benefits to a married participant in the form of a qualified joint and survivor annuity and to a single participant in the form of a single life annuity. Distributions may be made in other forms of benefit but generally only if the plan first obtains the participant’s consent and, in the case of a married participant, the spouse’s consent as well.
Section 417(e) and its parallel provision ERISA, Section 205(g), impose additional restrictions whenever a participant receives an “immediate distribution” of the “present value” of the qualified joint and survivor annuity (or single life annuity in the case of a single participant). Distributions in this form are permitted as long as the present value is no less than it would be when calculated using the interest and mortality assumptions specified in Section 417(e).
A related provision in Section 411(a)(11), and the parallel ERISA Section 203(e), impose a similar requirement on an immediate distribution of the present value of a participant’s “nonforfeitable accrued benefit.” As interpreted by the courts and the IRS, the requirements of Sections 411(a)(11) and 417(e) and ERISA Sections 203(e) and 205(g) have come to mean that a covered defined benefit plan may not make a lump sum distribution unless the lump sum is at least equal to the present value (calculated using Section 417(e) statutory assumptions) of the participant’s vested single life annuity payable at normal retirement age.
For decades, many defined benefit plans have included an SSLI option. This option is an annuity that provides, as nearly as possible, level annuity payments to the participant for life when considering the retirement benefits under both the plan and Social Security.
The statutory issue raised by the proposed regulation is whether an SSLI option is an “immediate distribution” of the “present value” of the participant’s accrued benefit that must be calculated in accordance with the valuation requirements of Section 417(e). Under an SSLI option, annuity payments under the plan “step down” or decrease once a participant reaches Social Security retirement age, or in some cases might cease altogether, in recognition of the fact that the participant has begun receiving Social Security retirement benefits in addition to any annuity payments from the plan.
The conclusion in the proposed regulation that an SSLI option is subject to Section 417(e) is based solely on a provision in the existing regulations, which states that the Section 417(e) valuation requirements apply to every optional form of distribution from a covered plan unless the IRS provides an explicit exception. See Treas. Reg. §§ 1.411(a)-11(a)(1), 1.417(e)-1(d)(1) (emphasis added). In what can only be characterized as a bald deviation from the language of the statute, those same existing regulations flatly state that the valuation rules apply “regardless of whether the accrued benefit is immediately distributable.” Treas. Reg. § 1.411(a)-11(d). The existing regulations reached this conclusion, which is at odds with the statutory language, out of concern that plans might seek to avoid the valuation requirements by not making a single lump sum payment but instead, for example, splitting a lump sum in half and offering it in the form of two separate installments, one payable shortly after the other. From there, it was easy for the IRS to imagine the further ploy of splitting the lump sum into three or more installments payable over slightly longer periods of time. Regardless of what one thinks about the statutory basis for such an anti-avoidance rule, Social Security level income options could not have been devised to circumvent the 417(e) valuation requirements because they have existed since long before the valuation requirements in Section 417(e) even existed.
The existing regulations provide explicit exceptions from the valuation rules only for certain optional forms of distribution. See Treas. Reg. § 1.417(e)-1(d)(6). The first potentially relevant exception is for non-decreasing annuities – that is, annuities under which the monthly or other periodic payment does not decrease during the life of the participant. See Treas. Reg. § 1.417(e)- 1(d)(6)(i). The IRS has previously stated informally that an SSLI option is not covered by this exception because a Social Security leveling payment might result in a temporary annuity for a short period of time, thus “approaching a lump sum.” See 1996 Enrolled Actuaries IRS/Treasury, Q&A-22. This might occur, for example, if the annuity is sufficiently small (e.g., an employee retiring at age 63 with five years of service) that the annuity payment is reduced to zero once the participant reaches Social Security retirement age. The second potentially relevant exception is for annuities that decrease during the life of the participant solely because of the cessation of a “Social Security supplement.” See Treas. Reg. § 1.417(e)-1(d)(6)(ii)(B). The IRS has previously stated informally that an SSLI option is not covered by this exception either, presumably because an SSLI option is technically distinct from a Social Security supplement. See 1996 Enrolled Actuaries IRS/Treasury, Q&A-22.
Both of these informal IRS positions are inconsistent with its regulations governing the forms of distributions that are eligible for rollover to an IRA. Those regulations treat an SSLI option as a “series of substantially equal periodic payments” despite the step down in the monthly benefit at Social Security retirement age. Furthermore, the regulations treat an SSLI option identically to a Social Security supplement for this purpose. See Treas. Reg. § 1.402(c)-2, Q&A-5(b).
Plan sponsors and administrators have reasonably relied for decades on the plain language of the statute and on numerous favorable determination letters to continue calculating Social Security level income options in accordance with the terms of their plans and without subjecting them to the Section 417(e) valuation assumptions. Changing the rules at this late stage, more than 30 years after Section 417(e) was enacted, would unleash an unwarranted and costly administrative burden on defined benefit plans that they can ill-afford. If the IRS believes that changes to Section 417(e) are warranted, it should seek legislation to amend the language of the statute, but it should do so solely with respect to future accruals.
Post Normal Retirement Age Adjustments under Section 417(e)(3)
According to the preamble, the proposed regulations would “clarify” the current requirement that the present value of any optional form of benefit cannot be less than the value of the normal retirement benefit. The clarification would be made by replacing the foregoing reference to the “normal retirement benefit” with “accrued benefit payable at normal retirement age” and a reference to post-normal retirement age adjustments (i.e., an exception where the optional form is payable after normal retirement age and the suspension of benefits requirements are satisfied). Unlike the other proposed changes, the preamble gives no indication of why the IRS believes a change is needed and what impact such change might mean for plan benefit determinations.
The current reference to the “normal retirement benefit” without any reference to post-normal retirement age adjustments has remained unchanged since the regulations were promulgated in their original temporary form nearly 30 years ago. The proposed change would result in more questions than answers (e.g., whether plans would be required to provide post-normal retirement age increases that reflect interest and mortality, without regard to any death benefit provided by the plan). Moreover, the IRS categorizes this change as “clarifying” but gives plan sponsors no reliance on the proposed regulations. This leaves plan sponsors in the untenable position of trying to guess what the proposed change is intended to clarify without the ability to make any changes to comply. For these reasons, if the IRS believes a change is necessary, clarifying or otherwise, it would be appropriate to have an explanation followed by the opportunity to comment.
Alternative Calculation of Subsidized Lump Sum
The IRS has requested comments on whether, in the case of a plan that provides a subsidized annuity payable upon early retirement and determines a single sum distribution as the present value of the early retirement annuity, the present-value determination should be required to be calculated using the applicable interest rate and mortality table to the early retirement annuity, or whether the requirement to have a minimum present value of the annuity payable at normal retirement age determined in accordance with Section 417(e)(3) provides the level of protection for the participant that is required by Section 417(e)(3). We believe that the minimum present value of the annuity payable at normal retirement age provides the intended protection of Section 417(e)(3).
We understand the issue as one where a plan offers a lump sum payment option to participants who are eligible for a subsidized early retirement benefit and where the plan utilizes a two- pronged approach to calculate the lump sum amount. Under the first prong, the plan calculates the present value of the annuity payable at normal retirement age (i.e., the lump sum without regard to any early retirement subsidy) using the Section 417(e)(3) assumptions. Under the second prong, the plan calculates the immediate value of the subsidized early retirement benefit but using an alternate set of assumptions. The lump sum payable is the greater of the two resulting lump sum amounts.
The plan in Rybarczyk v. TRW,2 for example, offered a lump sum payment option to participants who satisfied the requirements for a subsidized early retirement benefit. The plan offered a lump sum distribution of either the unsubsidized benefit calculated using the Section 417(e)(3) rate or the subsidized benefit calculated using the Moody’s rate, whichever was larger. As a result, a participant received the early retirement subsidy in a lump sum payment only where application of the Moody’s rate to that benefit resulted in a larger lump sum than that determined by the present value of the benefit payable at normal retirement age.
The Sixth Circuit found nothing wrong with the two-pronged approach for determining the lump sum, finding that it “. . . merely provided for the possibility of some icing on the early retirement cake—-and we are aware of nothing in ERISA, the Code, or the regulations that can fairly be said to make such a bonus problematic in any way.”3 Rybarczyk, 235 F.3d at 983.
ERIC agrees with the Sixth Circuit that the two-pronged approach in Rybarczyk is a permissible plan design and does not raise concerns under Section 417(e)(3). The regulations under Section 411 clearly provide that plans offering subsidized early retirement benefits may, but are not required to, include the value of the subsidy in a lump sum payment option as a matter of plan design.4 Section 417(e)(3) clearly prescribes only the minimum amount payable as a lump sum ( “ . . . the present value shall not be less than the present value calculated by using the applicable mortality table and the applicable interest rate.” Code § 417(e)(3) (emphasis added)). And the underlying regulations contemplate the use of an alternative set of assumptions. See Treas. Reg. § 1.417(e)-1(d)(5)). Thus, plans should remain able to provide a lump sum that exceeds the minimum present value prescribed by Section 417(e)(3) and they should be free to do so using any reasonable alternative assumptions.
If you have any questions concerning our comments, or if we can be of further assistance, please contact Will Hansen at whansen@ERIC.org or 202-789-1400.
Senior Vice President, Retirement Policy
1 Internal Revenue Service, Update to Minimum Present Value Requirements for Defined Benefit Plans, 81 Fed. Reg. 85190 (Nov. 25, 2016).
2 235 F.3d 975 (6th Cir. 2000).
3 Although the Sixth Circuit found nothing wrong in general with the plan’s two-pronged approach, the approach was plagued by anti-cutback issues associated with its retroactive implementation.
4 “The value of an accrued benefit is the present value of the benefit in the distribution form determined under the plan. For example, a plan that provides a subsidized early retirement annuity benefit may specify that the optional single sum distribution form of benefit available at early retirement age is the present value of the subsidized early retirement annuity benefit. In this case, the subsidized early retirement annuity benefit must be used to apply the valuation requirements of this section and the resulting amount of the single sum distribution. However, if a plan that provides a subsidized early retirement annuity benefit specifies that the single sum distribution benefit available at early retirement age is the present value of the normal retirement annuity benefit, then the normal retirement annuity benefit is used to apply the valuation requirements of this section and the resulting amount of the single sum distribution available at early retirement age.” Treas. Reg. § 1.411(a)-11(a)(2).