• New Guidance May Make Plan Sponsors Reconsider Offering Lifetime Income Options
  • March 2, 2012 | Authors: Kristina Rae Jones; Jonathan A. Kenter; Evelyn Small Traub
  • Law Firms: Troutman Sanders LLP - Atlanta Office ; Troutman Sanders LLP - New York Office ; Troutman Sanders LLP - Richmond Office
  • In an effort to help American families save for retirement and better manage their retirement savings, the U.S. Treasury Department and Internal Revenue Service have released two revenue rulings, which plan sponsors can rely on now, and two proposed regulations, which are intended to remove regulatory barriers and otherwise ease the offering of lifetime income options.

    Although plan sponsors cannot rely on the proposed regulations at this time, the proposed regulations nevertheless highlight some of the steps that the Treasury is trying to take to counteract the increasing risk of individuals outliving their assets in retirement.

    The Treasury has indicated that further guidance relating to lifetime income options should be released later this year.

    Guidance on Which Plan Sponsors Can Rely Now

    Spousal Consent Compliance for Defined Contribution Plans Offering Deferred Annuity Options

    According to the U.S. Treasury, plan sponsors have been hesitant to include lifetime income options in defined contribution plans for many reasons - one of which being uncertainty as to how to satisfy the spousal consent requirements that might apply to an employee’s election of such option. The revenue ruling provides additional guidance on how and when spousal consent requirements apply when a participant elects a deferred annuity contract under a defined contribution plan.  Interestingly, according to the U.S. Treasury’s Fact Sheet issued in conjunction with the guidance, the insurance company issuing the deferred annuity would be responsible for complying with the spousal consent rules upon the annuity’s commencement, although support for this position is not provided in the revenue ruling itself.

    Defined Contribution Plan Transfers to Employer’s Defined Benefit Plan

    The IRS’s second revenue ruling provides a roadmap for plan sponsors who desire to allow employees to use all or a portion of their vested account balance under the employer’s defined contribution plan to provide an additional annuity benefit under the employer’s defined benefit plan. The defined contribution plan participant, if the employer’s plans so permit, could elect to have his or her account balance distributed in a single-lump sum that would then, either in whole or in part, be rolled over into the employer’s defined benefit plan. Under the defined benefit plan, the participant would then be entitled to an annuity that is actuarially equivalent to that lump sum amount. In order for such rollovers to be permissible, the defined benefit plan’s adjusted funding target attainment percentage (a statutory measure of the defined benefit plan’s funded status) must be at least 60%.

    On the Horizon - Proposed Guidance

    Proposed Modification of RMD Rules to Encourage Defined Contribution Plans to Offer Longevity Annuity Options

    The IRS’s required minimum distribution (RMD) rules generally require that a participant in a defined contribution plan start to receive at least a specified portion of his or her account balance starting April 1 following the later of age 70 1/2 or termination of employment. As currently effective, the value of an annuity contract purchased with a portion of a participant’s account balance must be included in calculating these required minimum distributions - even if payments under the annuity won’t start until some later date.  This requirement raises the risk that, if the remainder of the participant’s account has been depleted too rapidly, the participant would have to commence distributions from the annuity earlier than anticipated, in order to satisfy the required minimum distribution rules. The proposed regulations provide relief by excluding certain annuity contracts from the account balance used to determine required minimum distributions, thereby permitting annuity distributions to commence as planned.

    Defined Benefit Plan Combination Lump Sum/Annuity Distribution Option

    The U.S. Treasury believes that employees typically decline the annuity choices under defined benefit pension plans in favor of lump sum cash distributions, because employees are reluctant to receive their retirement income in an annuity without also maintaining some flexible liquid assets. Treasury also believes that, given the choice, employees would prefer to receive a portion of their pension benefit as an annuity and the remainder in a cash lump sum.

    To make it easier for a defined benefit plan to offer an optional form of benefit that is a combination lump sum/annuity, the proposed regulations would permit such combination distribution options to be bifurcated for purposes of Internal Revenue Code Section 417(e) -- the rules that normally apply in determining the amount of any lump sum benefit. Such bifurcation would permit the plan to use the Section 417(e) lump sum interest and mortality table assumptions for just the lump sum portion of the benefit and the plan’s usual annuity equivalence factors for the annuity portion (rather than being required to make a special calculation of the annuity portion using the Code Section 417(e)(3) assumptions). Absent this permitted bifurcation, the Code Section 417(e) requirements would also apply to the portion of the benefit paid as an annuity - with an unanticipated potential impact on the required amount of the annuity.