The IRS issued a notice today stating that it intends to amend regulations to prohibit a pension plan from offering a lump sum distribution to participants who are receiving annuity payments. The new guidance would take effect today, except for certain lump sum offers already in progress. While de-risking through lump sum offers becomes more limited, one state’s legislature made de-risking through annuity purchase a little more attractive: Connecticut passed legislation shielding annuity benefits from creditors of retirees when paid under a group annuity contract that replaced an ERISA-covered pension.

IRS Changes Course on Lump Sum Offers

In Notice 2015-49, the IRS acknowledges that, under current regulations, a pension plan may offer a lump sum option during a limited window to participants who are already receiving monthly pension payments. The IRS has issued several rulings permitting this practice (as we have previously discussed). However, the IRS has now concluded that these lump sum windows “undermine the intent” of the minimum required distribution regulations to prohibit changes to annuity payments once they begin. Although the minimum required distribution requirements generally seek to limit delays in payments, the IRS stated that the intent of the regulation also includes prohibiting changes that accelerate payments.

Many employers have found that making voluntary lump sum distributions to participants in pay status is a cost-effective way to reduce pension risk. Pensioners also have found this option attractive in many cases. Under the IRS’s new position, employers will have to limit lump sum offers to participants who are not yet receiving annuity payments.

The new prohibition would not apply to lump sum programs that are in progress, if any of the following criteria are satisfied:

  1. The program was adopted (or specifically authorized by a board, committee, or similar body with authority to amend the plan) prior to July 9, 2015;
  2. The program is covered by a private letter ruling or determination letter issued by the IRS prior to July 9, 2015;
  3. The program was communicated to plan participants in writing and expressed “an explicit and definite intent to implement the lump sum risk-transferring program,” and the communication was received by participants prior to July 9, 2015; or
  4. The program was adopted pursuant to an agreement between the plan sponsor and an employee representative (with which the plan sponsor has entered into a collective bargaining agreement) specifically authorizing implementation of such a program that was entered into and was binding prior to July 9, 2015.

Although there may be a question as to whether the IRS has the authority to take this new position by issuing a notice, the IRS’s new position will require employers to limit future lump sum offers to participants who are not yet receiving annuity payments.

Connecticut Protects Benefits Provided under Group Annuity Contracts

The National Conference of Insurance Legislators previously created model insurance legislation regulating pension de-risking. The model legislation would impose many requirements in connection with a transfer of pension liabilities to an insurance company, including disclosure requirements and requiring lump sum offers to covered participants. No state has adopted the model legislation in its entirety, but earlier this week, Connecticut adopted one piece of the legislation. The Connecticut legislation prohibits creditors of plan participants from reaching benefits under a group annuity contract purchased by an ERISA-covered plan.

As a result of the IRS guidance, a company seeking to settle liabilities for retirees in pay status would need to transfer the liabilities to an insurance company. The Connecticut legislation makes that approach just a little safer, in Connecticut.