IRS Issues Final Rule About Partial Annuities in DB Plans

The Internal Revenue Service (IRS) has issued a final rule modifying minimum present value requirements for partial annuity distribution options under defined benefit (DB) plans.

In its regulation, the IRS says that in the case of a DB plan that offers a single-sum distribution or other form of accelerated distribution as an optional form of benefit in addition to the required qualified joint and survivor annuity (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. 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 Treasury Department and the IRS believe 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.

In order to facilitate the payment of benefits partly in the form of an annuity and partly as a single sum (or other accelerated form), the final rule amends the regulations under section 417(e) to permit plans to simplify the treatment of certain optional forms of benefit that are paid to a participant partly in the form of an annuity that is excepted from the minimum present value requirements of section 417(e)(3) pursuant to sections 1.417(e)–1(d)(6) and partly in a more accelerated form. The final regulation provides rules under which the participant’s accrued benefit can be bifurcated so that the minimum present value requirements of section 417(e)(3) and sections 1.417(e)–1(d) apply to only the portion of the participant’s accrued benefit that is paid in an accelerated form.

In addition to rules provided in proposed regulations, an alternative rule is provided in the final regulations under which a plan that distributes a specified single-sum amount to a participant satisfies the requirements of sections 1.417(e)-1(d) with respect to that payment, provided the remaining portion of the participant’s accrued benefit satisfies a minimum requirement. 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: The participant’s total accrued benefit expressed in that form; over 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 final rule also includes a number of examples to illustrate the bifurcation rules and rules of operation.

The rule is effective September 9, 2016, and applies to distributions with annuity starting dates in plan years beginning on or after January 1, 2017.