Individual Discusses Risks of Lump Sum Payouts Under RMD Regs

May 25, 2022

Internal Revenue Service
Attn: CC:PA:LPD:PR (REG-105954-20)
Room 5203, Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Comments on Proposed Regulations Regarding Required Minimum Distributions (REG-105954-20)

Dear Sir or Madam:

Please consider the following comments on the proposed regulations on Required Minimum Distributions, issued by the U.S. Department of the Treasury (Treasury) and Internal Revenue Service (IRS or the Service). My comments, as set forth below, are made solely in my individual capacity and accordingly are not made on behalf of, and are not intended to represent the views of, any organization or any other person.

I appreciate, as do other stakeholders, the thought and care invested by Treasury and the Service in the preparation of these extensive proposed rules. My comments and recommendations relate only to a few specific issues.

Retiree lump sum buybacks of DB pensions in pay status

Recommendations: While finalizing the regulations, propose an amendment to section 1.401(a)(9)-6(n) and (o) making clear that the regulations' existing prohibition on changes to the period of payment once retirement payments have begun (in section 1.401(a)(9)-6(a)(1)) means that DB plans cannot offer participants a lump sum commutation or cashout of their ongoing DB pensions. The amendment would provide that such cashouts do not qualify as increases in benefits pursuant to plan amendments under -6(o) and do not come within any of the other specific exceptions to the regulations' general rule prohibiting changes to the period of payment. An example could be added to illustrate the point.

Background and Comments: The regulations under section 401(a)(9) are not wholly and exclusively about limiting deferrals of tax-favored distributions. Consistent with the statute, the -6 regulations governing DB plans also include several provisions implementing other retirement policies reflected in other Code provisions, which the regulations coordinate with the central 401(a)(9) policy of limiting deferral of retirement benefits and preventing their use in estate planning. Examples of such other policies and statutory provisions include

• the requirement for actuarial increases in benefits for those who retire after the year in which they attain age 70 ½ (in -6(g)) and

• the rules coordinating with the section 436 restrictions on lump sums and other accelerated distributions (in -6(j)).

Another example of such other policies in the section 401(a)(9) regulations — and the one at issue here — is the longstanding prohibition on changes in the period over which retirement benefits are paid once payments over a period have commenced:

“Once payments have commenced over a period, the period may only be changed in accordance with paragraph (n) of this section.”

Section 1.401(a)(9)-6(a)(1). This prohibition on any changes in the payment period once periodic payments have commenced is separate and distinct from the requirement (also in -6(a)(1)) that payments be nonincreasing.

Section 1.401(a)(9)-6(n) and (o) enumerate a discrete and limited list of exceptions to the no-change rule and the nonincreasing rule (such as retirement, plan termination, marriage, and certain benefit payment increases pursuant to plan amendments). Retiree lump sum offers to cash out pay status DB pensions are not among the exceptions. (In particular, the proposed amendments should make clear that the exception for amendments that increase benefits was not intended to include a plan amendment offering to accelerate and cash out ongoing annuity payments to which a retiree was entitled before the amendment, even if the amendment also increases annuity payments.)

In fact, such corporate buyouts of ongoing lifetime pensions fly in the face of years of retirement income policy designed to preserve the favorable attributes of DB plans by promoting lifetime income and providing longevity risk protection. Especially since 2010, the Treasury and Labor Departments, Congress, and the pension community have gone to considerable lengths to promote lifetime income in qualified plans, including

• Introducing QLACs,

• permission to embed annuities in DC plan target date funds,

• facilitating partial annuitization as a QDOA to replace total lump sum cashouts in DB plans,

• facilitating self-annuitization by rolling DC lump sums into DB plans to provide retirement income,

• promoting lifetime income estimates in DC plans,

• enacting a fiduciary safe harbor for selection of annuity providers,

• encouraging annuity portability provisions, and others.

It is obviously too late to attempt to prohibit lump sums in DB plans; many such plans have offered and paid them for years, and many participants rely on their availability. But many other DB plans do not offer lump sums, and it is not too late to limit lump sums where they are not already a well established option that participants rely upon. It appears, for example, that practitioners had long believed that offering to buy back a retiree's ongoing pension for cash was prohibited or, at the very least, highly questionable. However, starting about ten years ago, several private letter rulings reached the somewhat surprising result that such lump sum offers to pay status DB retirees were permissible, until Treasury and the Service undertook a policy process and announced their conclusion to the contrary in 2015.

DB pensions, like other life annuities, protect retirees against running out of assets in retirement. This protects against both longevity risk and the uncertainty and need for guidance as to how much retirees may prudently or optimally withdraw each year without running an undue risk of burning through their savings too quickly or, on the other hand, hoarding and unnecessarily denying themselves a better standard of living.

Offering retirees who have been receiving a lifetime pension the option of cashing out presents a temptation to act against their best interest. The prospect of cash-on-the-barrel can be seductive, especially to less sophisticated retirees who may be particularly susceptible to “wealth illusion” (the tendency to overvalue a lump sum compared to a steady, reliable, and lifelong stream of income). In particular, DB lifetime pensions apply to decumulation the same operative principle that drives automatic accumulation: the power of inertia that automatically continues a steady pattern of saving in a 401(k)-type plan is at work in DB pension decumulation as well. Unless a participant exercises initiative and affirmatively acts to change the status quo, the status quo (whether accumulating or drawing down) continues uninterrupted. Accordingly, a lump sum offer to a retiree receiving a lifetime pension threatens to interrupt the constructive inertia that provides retirement security for millions of households.

In this regard, it is useful, by way of further background, to recall Section II (Background) of IRS Notice 2015-49, which provided, in pertinent part:

“Section 1.401(a)(9)-6, A-1(a) provides that absent an applicable exception, in order to satisfy § 401(a)(9), distributions of an employee's entire interest must be paid in the form of periodic annuity payments for the employee's or beneficiary's life (or the joint lives of the employee and beneficiary) or over a period certain that is no longer than a period permitted under § 1.401(a)(9)-6, A-3 or A-10, as applicable (which is approximately equal to the joint and last survivor life expectancy of the employee and an assumed beneficiary who is 10 years younger than the employee, with a longer period if the sole beneficiary is the employee's spouse and the spouse is more than 10 years younger). The regulations prohibit any change in the period or form of the distribution after it has commenced, except in accordance with § 1.401(a)(9)-6, A-13. If certain conditions are met, § 1.401(a)(9)-6, A-13(a) permits changes to the payment period after payments have commenced in association with an annuity payment increase described in § 1.401(a)(9)-6, A-14.” [emphasis added]

“Section 1.401(a)(9)-6, A-1(a) also provides that the payments must be nonincreasing or may increase only as otherwise provided, such as permitted increases described in § 1.401(a)(9)-6, A-14. Section 1.401(a)(9)-6, A-14(a)(4) permits annuity payments to increase “[t]o pay increased benefits that result from a plan amendment.” In addition, § 1.401(a)(9)-6, A-14(a)(5) permits annuity payments to increase “to allow a beneficiary to convert the survivor portion of a joint and survivor annuity into a lump sum upon the employee's death,” but no similar rule is provided with respect to conversion of an employee's annuity benefit during an employee's life or conversion of a beneficiary's annuity other than upon the employee's death.”

“The § 401(a)(9) provisions and related regulations regarding pension plan annuities were crafted to provide an administrable way to ensure that a distribution of the employee's benefit will not be unduly tax-deferred. For example, a pension plan cannot permit an employee who has passed the required beginning date to defer distribution of the bulk of the employee's benefit (and thus defer the tax) until later in life, while taking relatively small periodic benefits in the interim. In addition, under the regulations, a defined benefit pension plan cannot permit a current annuitant to commute annuity payments to a lump sum or otherwise accelerate those payments, except in a narrow set of circumstances specified in the regulations, such as in the case of retirement, death, or plan termination. See § 1.401(a)(9)-6, A-13(a) and (b). If a participant has the ability to accelerate distributions at any time, then the actuarial cost associated with that acceleration right would result in smaller initial benefits, which contravenes the purpose of § 401(a)(9).”

“A number of sponsors of defined benefit plans have amended their plans to provide a limited period during which certain retirees who are currently receiving joint and survivor, single life, or other life annuity payments from those plans may elect to convert that annuity into a lump sum that is payable immediately.¹ These arrangements are sometimes referred to as lump sum risk-transferring programs because longevity risk and investment risk are transferred from the plan to the retirees. For purposes of compliance with the requirements of § 401(a)(9), the addition of such a right to convert a current annuity into an immediate lump sum payment has been treated in some instances as an increase in benefits that is described in § 1.401(a)(9)-6, A-14(a)(4) (with the result that the annuity payment period would be permitted to change under § 1.401(a)(9)-6, A-13(a)).”

Notice 2015-49 then included the following paragraph in section III (Anticipated amendments to the Regulations Under Section 401(a)(9)):

“The Treasury Department and the IRS intend to amend the regulations under § 401(a)(9) that address the distribution of an employee's interest after the required beginning date. Those regulations reflect an intent, among other things, to prohibit, in most cases, changes to the annuity payment period for ongoing annuity payments from a defined benefit plan, including changes accelerating (or providing an option to accelerate) ongoing annuity payments. The Treasury Department and the IRS have concluded that a broad exception for increased benefits in § 1.401(a)(9)-6, A-14(a)(4) that would permit lump sum payments to replace rights to ongoing annuity payments would undermine that intent. Accordingly, the Treasury Department and the IRS intend to propose amendments to § 1.401(a)(9)-6, A-14(a)(4) to provide that the types of permitted benefit increases described in that paragraph include only those that increase the ongoing annuity payments, and do not include those that accelerate the annuity payments. The exception for changes to the annuity payment period provided in § 1.401(a)(9)-6, A-13 (as intended to be amended) would not permit acceleration of annuity payments to which an individual receiving annuity payments was entitled before the amendment, even if the plan amendment also increases annuity payments.”

Later, IRS Notice 2019-18 provided that Treasury and the Service “no longer intend to propose the amendments to the regulations under section 401(a)(9) that were described in Notice 2015-49. However, the Treasury Department and the IRS will continue to study the issue of retiree lump-sum windows.” [emphasis added] The Notice went on to state that, “[u]ntil further guidance is issued [emphasis added], the IRS will not assert that a plan amendment providing for a retiree lump-sum window program causes the plan to violate section 401(a)(9), . . .” but added that “[d]uring this period, the IRS will not issue private letter rulings with regard to retiree lump-sum windows.”²

It has been about three years since Treasury and the Service stated (in Notice 2019-18) that they would continue to study the issue of retiree lump-sum windows and alluded to the possibility of further guidance (referring to actions they were taking “until further guidance is issued”). Accordingly, nothing in Notice 2019-18 precludes or is inconsistent with proposing further guidance at this point, based on further experience and attention to these issues. In fact, proposing guidance at this point would be natural and appropriate, as it has become evident with the additional passage of time that this issue shows no signs of going away. DB plan sponsors have continued to consider and implement risk transfer transactions, often with a view to reducing DB plan liabilities on corporate balance sheets.

At the time the 2015 and 2019 Notices were issued, it was unclear whether and, if so, when there would be other reasons to open up and rework the extensive section 401(a)(9) regulations. It was not yet clear whether and, if so, when Congress would enact the substantial section 401(a)(9) changes (ultimately enacted in the December 2019 SECURE Act) that gave rise to the need to amend the associated regulations.

Then, once the SECURE Act was signed into law and the section 401(a)(9) proposed regulation amendment project was initiated, there was time pressure to issue guidance interpreting and giving effect to the major section 401(a)(9) statutory changes in a timely fashion, given their effective date. Moreover, considering the magnitude of the project of amending various portions of these extensive and complex regulations while restating the entire regulation to convert from Q&A to standard regulation format, there might have been some hesitation to take on the risk transfer retiree lump sum issue as well.

Now, however, is an appropriate time to fold in the limited retiree lump sum provision and example suggested here. These proposed regulatory amendments, as well as the QLAC amendments also suggested in this comment, need not “catch up” with or complicate finalization of the whole section 401(a)(9) regulation; they can be proposed, with notice and request for public comment, while the rest of the regulation is finalized.

QLACs

Recommendations: Consider the following additional amendments to the QLAC rules.

First, the 25% limit should be applied so as to permit a rollover from a qualified plan to an IRA of an amount that is used to purchase a QLAC under the IRA without any requirement to apply the 25% limit again, after rollover, to the amount rolled over.

Background and Comments: This would reduce potential outflows from plans to IRAs that are forced by the 25% rule, which can cause participants purchasing QLACs from IRAs to roll over from the qualified plan four times as much as they need. There is no need to wait for Congress to make this change; the 25% rule, like the dollar limit and the entire QLAC construct, is a creature of regulation. Treasury and the Service have the authority to modify the 25% rule and allow it to be applied in the manner suggested. It is suggested also that Treasury and the Service revisit the question when to measure the account balance for purposes of applying the 25% limit (for example, should it be based on the account balance immediately before the purchase rather than at the prior year end).

For example, a participant whose qualified plan account balance is $500,000 could use up to $125,000 of that balance to purchase a QLAC under the plan. If the participant's goal is to purchase a QLAC for $125,000 but prefers to do so under an IRA instead (or if the plan sponsor prefers that QLACs be purchased under an IRA using rollover funds instead of under the plan, the participant should be permitted to roll the $125,000 to the IRA and simultaneously use that full amount rolled over to purchase a QLAC held by the IRA without being required to apply the 25% limit again at the IRA level, thereby being forced to roll over $500,000 from the plan in order to buy a $125,000 QLAC.

In other words, the 25% limit should not be required to apply twice, both before and after the rollover from a plan to an IRA, provided that the purchase of the QLAC under the IRA occurs upon or immediately after the rollover, without taking into account any growth in the amount rolled over to the IRA (whether because of post-rollover earnings or contributions to the IRA, any and all of which would independently be subject to the 25% limit). This simplification would further the policies underlying the QLAC rules, including the 25% limit, without impeding the use of QLACs in cases where qualified plan sponsors prefer that participants buy their QLACs not as a qualified plan investment but instead from IRAs or as individual retirement annuities.

Second, this comment relates to the proposed QLAC amendment that would apply, only after the required beginning date, the prohibition on commutation benefits, cash surrender values, and similar features. Please consider whether this amendment could be usefully revised to achieve the same objective in a more targeted fashion. For example, insofar as the objective is preserving the ability to transfer out of the investment before the required beginning date in order to obtain the relief under Notice 2014-66, might the exception be framed more narrowly? Might it be framed as permission to transfer out of the QLAC investment to another investment alternative under the plan without allowing more complex product features such as commutation benefits, cash surrender values or other investment-related features?

If you have any questions about these comments or would like to discuss them further, please contact me at 301-526-8028 or at jmarkiwry@gmail.com

Yours sincerely,

J. Mark Iwry
J. Mark Iwry, PLLC
Washington, DC

cc:
Rachel Leiser Levy
Laura B. Warshawsky
Brandon M. Ford
Linda Marshall

Carol Weiser
Helen Morrison
Harlan Weller
William Evans