Clarity Needed for IRS Partial Annuity Rules

However, Michael L. Hadley, partner in the law firm of Davis & Harman, testifying on the Council’s behalf, urged the Treasury and the Internal Revenue Service (IRS) to apply the proposals prospectively only and to state that no inference should be drawn regarding current law. “[W]e disagree with Treasury and IRS’ position in the guidance that, under current law, when one portion of a retirement benefit distribution subject to Section 417(e) is a ‘decreasing’ benefit, both portions of the distribution are subject to the minimum present value requirements of Section 417(e)(3). The Council believes instead the current regulation does not clearly require that, and can be reasonably interpreted to reach the opposite result,” Hadley said. (See “Treasury Proposals Pave Way for Offering Lifetime Income Options”)  

Hadley explained: “Generally lump sums and certain other distributions paid from defined benefit pension plans must be no less than the amount calculated using the interest and mortality assumptions provided under Section 417(e). The regulations apply the 417(e) valuation requirement to all payment forms not explicitly exempted.” Hadley asked for clarity about an exemption such as one relating to non-decreasing annuities.  

The current Section 417(e) present value requirement “does not apply to an amount of a distribution paid in the form of an annual benefit that does not decrease during the life of the participant,” said Hadley. “If the requirement applies to the whole benefit if any portion of the benefit decreases, then saying it does not apply to ‘an amount’ of a distribution is unnecessary. Rather, the regulation would have just said 417(e) does not apply to ‘a distribution’ or to ‘an optional form’ that does not decrease during the life of the participant.” 

Hadley also requested that Treasury and IRS officials ensure that the final regulation’s discussion of its “three-bucket” approach to plan designs that offer bifurcated benefits (separately determined benefits with separate elections made by the participant) does not result in a retirement plan program being inadvertently excluded from the relief because the design does not fit into an allowed category under the proposed rule.   

“The Council appreciates Treasury and the IRS’ efforts to clarify the treatment of optional forms of benefits paid out under the Section 417(e) regulations,” Hadley concluded. “Retirement plan participants are better served by having a choice on how they receive those benefits. But reasonable minds might differ on the meaning of the proposed regulation, which is exactly why we support a clarification.”  

Hadley’s testimony is available here.  

In addition, Jay Haines, an employee benefits lawyer in the Legal Department of FMR LLC (the parent company of Fidelity Investments), testifying on behalf of the Council, identified three specific recommendations that would address certain practical considerations.  

Create a correction program: Plan sponsors need a correction program ­— similar to the Employee Plans Compliance Resolution System (EPCRS) — through which inadvertent errors can be quickly and easily fixed without any loss of benefits. Such a program should also enable participants to avoid disqualifying the entire annuity contract from Qualified Longevity Annuity Contract (QLAC) status under appropriate circumstances.   

Facilitate the purchase of QLACs outside of a plan without leakage:  Under the proposed regulations, the 25% limit applies separately to employer-sponsored retirement plans and IRAs.  The Council believes it is likely that more plans will facilitate the purchase of a QLAC through IRA rollovers than directly through the plan itself.  The Council urges Treasury and the Service to apply the 25% limit to the plan balance so long as it is a direct rollover used to purchase the QLAC individual retirement annuity.  Clarifying this point will give plans more flexibility to assist participants in purchasing QLACs without having to contract with a single provider.  

Accommodate changing QLAC options within plans over time:  Once this guidance is finalized, some employers may begin to offer QLACs in their plans. Over time, employers will also naturally decide to change QLAC providers as markets, products and circumstances change. Final regulations should clarify that such changes would not constitute an impermissible forfeiture under Code Section 411 or a violation of the anti-cutback rules of Code Section 411(d)(6). Additionally, we recommend that the proposal be enhanced to include guidance that would allow the participant to keep the QLAC that he or she had purchased prior to its becoming unavailable under the plan.  

Haines testimony is available here.