A new Internal Revenue Service decision could boost employers and retirement planners but hurt life insurers and the Pension Benefit Guaranty Corp. (PBGC).
The IRS has announced the decision in IRS Notice 2019-18.
The notice will help a pension plan sponsor use the offer of a one-time cash payment to buy out a participant’s pension income stream.
A New Source of Rollover Business?
Today, most U.S. defined benefit pension plan sponsors pay pension insurance premiums to the PBGC. A sponsor’s PBGC premium bill depends on the number of participants in the sponsor’s plan, and the amount of benefits each participant has been promised.
Employers that want to dispose of pension liabilities can transfer pension risk to a life insurer, by buying a group annuity contract.
Under Notice 2019-18, an employer may be able to cut some of its pension liabilities without bothering to buy a group annuity. That shift could cut cases sizes when employers do buy group annuities to shed pension obligations.
The shift could also cut the number of people in U.S. pension plan, and PBGC pension insurance premium revenue.
U.S. workers and retirees already roll many types of lump-sum payments from employer plans into individual annuities, mutual funds held inside individual retirement accounts, and other retirement savings arrangements. Many workers who leave their employers before the normal retirement age cash out their pension plans.
But, if Notice 2019-18 leads to a large number of retirees accepting pension benefits buyout offers, the increase in the number of participants cashing out could increase the amount of rollover cash flowing into IRAs and individual annuities.
Notice 2019-18 History
Years ago, many defined benefit pension plan sponsors used group annuities to fund pension risk transfers.
Since 2000, low interest rates have made group annuities look more expensive.
In 2015, several large employers tried to reduce pension obligations without use of group annuities, by offering pension plan participants temporary “lump-sum windows,” or periods of several months when the participants could exchange monthly benefit streams for one-time payments.
Some critics argued that the lump-sum window arrangements could hurt the participants, by leading participants to trade valuable income streams for relatively low one-time payments.
The IRS cracked down in 2015, in IRS Notice 2015-49, by saying it intended to develop a regulation — interpreting the Internal Revenue Code 401(a)(9) required minimum distribution rules for pension plans — that would block new lump-sum windows. Officials said that, while they were developing the IRC 401(a)(9) regulations, they would block new lump-sum windows by having the IRS refrain from expressing an opinion in private letter rulings, or in determination letters, on the federal tax consequences of a retiree lump-sum window.
In the new notice, IRS officials are retracting what they said in 2015 about developing regulations banning new lump-sum windows.
A Possible Catch
Although the IRS is retracting Notice 2015-49, the IRS and its parent, the U.S. Treasury Department “will continue to study the issue of retiree lump-sum windows,” officials say in the Notice 2019-18.
IRS officials are still deciding whether lump-sum windows might not violate parts of the Internal Revenue Code other than IRC 401(a)(9), officials warn.
While officials are thinking, “the IRS will not issue private letter rulings with regard to retiree lump-sum windows,” officials say. “However, if a taxpayer is eligible to apply for and receive a determination letter, the IRS will no longer include a caveat expressing no opinion regarding the tax consequences of such a window in the letter.”
A copy of IRS Notice 2019-18 is available here.
— Read Insurers Are Competition for the PBGC: GAO Chief, on ThinkAdvisor.