The Internal Revenue Service published final regulations regarding modifications to minimum present value requirements for partial annuity distribution options under defined benefit pension plans. The rules amend Income Tax Regulations under section 417(e) of the Internal Revenue Code.
The changes outlined in the regulations allow DB plan participants to elect to receive partial annuities rather than single-sum payments. The rules became effective Sept. 9.
“In the case of a defined benefit plan that offers a single-sum distribution or other form of accelerated distribution as an optional form of benefit in addition to the required QJSA, many participants have been reluctant to elect lifetime payments to insure against unexpected longevity, choosing instead an accelerated distribution form in order to maximize their liquidity,” the IRS wrote in the final regulations published in the Federal Register.
“However, participants who elect a single sum or other accelerated form of distribution may face greater challenges in protecting against the risk of outliving their retirement savings,” the IRS wrote. “The Treasury Department and the IRS believe that many participants are better served by having the opportunity to elect to receive a portion of their retirement benefits in annuity form (which provides financial protection against unexpected longevity) while receiving accelerated payments for the remainder of their benefits to provide increased liquidity during retirement.”
The modifications were proposed in 2012 and were subject to a public comment period. The final regulation takes these comments into consideration, said the IRS.
The proposed regulations offered three approaches to bifurcating the accrued benefit so that the minimum present value requirements apply only to a portion of the accrued benefit.
In the first approach, a plan could have provided for two separate portions of the accrued benefit that were determined without regard to any election of optional form of benefit and permitted a participant to select different distribution options with respect to each of those portions.
Under the second approach, a plan could provide for proportionate benefits with respect to each distribution option equal to the pro rata portion of the amount of the distribution option that would be determined if that distribution option had been applied to the entire accrued benefit.
The third approach would have allowed a plan to provide for a specified amount to be distributed as a single sum, but only if the plan satisfied a minimum benefit requirement with respect to the distribution that was not paid in a single sum.
According to the IRS, commenters generally supported the adoption of rules but raised specific issues about selecting the most appropriate bifurcation option. In response, the IRS simplified the bifurcation rules by combining the first two approaches into a single, broadly applicable rule. Under the rule, a plan is permitted to explicitly bifurcate the accrued benefit so that the plan provides that the requirements of § 1.417(e)–1(d) apply to a specified portion of a participant’s accrued benefit as if that portion were the participant’s entire accrued benefit. This rule does not impose any requirements with respect to the distribution options for the remaining portion of the accrued benefit.
An alternative rule is roughly the same as the third proposed approach. “Under this alternative rule, the portion of the participant’s accrued benefit, expressed in the normal form of benefit under the plan and commencing at normal retirement age (or at the current date, if later), that is not settled by the single-sum payment must be no less than the excess of: (1) The participant’s total accrued benefit expressed in that form; over (2) the annuity payable in that form that is actuarially equivalent to the single-sum payment, determined using the applicable interest rate and the applicable mortality table. Thus, the portion of the participant’s accrued benefit that is settled by the payment of a specified single-sum amount is implicitly determined as the actuarial equivalent of that single-sum amount.”
The changes under these regulations apply to distributions with annuity starting dates in plan years beginning on or after Jan. 1, 2017. However, taxpayers may apply these rules to earlier periods.
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