Individual Comments on Proposed Minimum Present Value Rules

Re: IRS REG-107424-12

I agree with the interpretations in the proposed regulations, as described below. These regulations would provide needed guidance on the interworking of actuarial adjustments for distributions commencing before (and after) normal retirement age, including both annuities and lump sum payments.¹

1. Mortality Adjustment. Death benefits are "ancillary benefits" except when part of a form of payment of the accrued benefit.

• For example, assume a 'vanilla' defined benefit plan provides a free 50% j/s CLARDEFINE death benefit for any vested participant who dies before the annuity starting date and that the accrued benefit under the plan is a straight life annuity commencing at age 65 (NRA), with various optional forms of benefit, including a 50% j/s and a lump sum payment that is calculated using the section 417(e) assumptions. Assume further that, under the plan, a participant who terminates early with vested rights can commence payments at any time thereafter and the benefits that commence before 65 are actuarially reduced using reasonable actuarial assumptions specified in the plan. However, there is no actuarial reduction for early commencement if the participant retires after age 55 with 20 years of service, assuming the participant elects one of the plan's annuity forms of payment. Thus, a participant who retires at age 55 with 20 or more years of service can elect (i) an unreduced straight life annuity, (ii) any of the annuity forms of payment which are actuarially adjusted to have the same value as the immediate (unreduced) straight life annuity, or (iii) a lump sum which is actuarially equivalent to the age 65 straight life annuity using the applicable section 417(e) assumptions.

This is consistent with my belief that an actuarial reduction for early commencement at say age 55 includes three basic elements: (a) an interest discount to reflect that the age 65 life annuity income stream is commencing 10 years early; (b) a longevity reduction to reflect that the participant's life expectancy at age 55 is longer than at age 65 so that the annuity income stream will be payable for a greater number of years; and (c) a mortality reduction to reflect that the participant might have died between age 55 and age 65 and thus not become entitled to the age 65 life annuity. The key point being that the mortality adjustment is applied without regard to the plan's free 50% j/s because that benefit is an ancillary benefit.

Note that these same actuarial adjustments also apply for purposes of an actuarial increase for commencement after normal retirement age, so that an annuity commencing at say age 70 includes not only any accruals from normal retirement age to age 70, but also an interest increase, a longevity increase, and a mortality increase.

2. Application of Section 417(e). (a) Social Security Leveling. The proposal to clarify the application of section 417(e) to social security leveling options seems reasonable to me.

I find the statutory language on the application of section 417(e) to be unclear overall. I recollect that when it was enacted under the Retirement Equity Act of 1983, it was intended to prevent an abuse used by some plans under which lump sum payments were offered to participants which were calculated using very high rates of interest, such as a 10%, 12%, or even 15% rate of interest, which were above-market rates in the early 1980s and had the effect of making the lump sum less valuable than the normal retirement benefit (and thus an economic forfeiture). Further, the context of the 1983 addition of section 417(e) was as a development out of the original small sum cash out rule enacted under ERISA ($1,750 in 1974), so that the 1983 statutory change was intended to apply to lump sums. However, the language of section 417(e) is vague ("immediately distribute the present value") and I am not aware of any helpful history in the published committee reports other than the following language from the report for the General Agreement on Trade and Tariffs of 1994 (GATT 1994):

"Problem

Congress adopted the interest rate cap to prevent plans from using unreasonably high interest rates to determine the present value of participants' benefits. If plans could use high interest rates, plans could lower the single sum paid to participants. The PBGC interest rates were adopted as the standard because the rates were presumed to duplicate group annuity rates. However, the PBGC interest rates reflect annuity rates only if considered in combination with the specified PBGC mortality tables and the law does not require that the specified PBGC mortality tables be used." [Emphasis added.]

My reaction is that section 417(e) is intended to apply to lump sum payments partly because that form of payment is tempting to participants,³ but also because a plan can have a short-term actuarial gain where a form of payment is accelerated. Given this background, it seems reasonable to clarify that, under the current rules (which apply section 417(e) to all forms of payment other than those excepted in section 1.417(e)-1(d)(6)), section 417(e) applies to social security leveling options,⁴ given that social security options decline and a social security leveling option could in some cases consist of only a few years of payments (somewhat akin to a lump sum payment).

(b) Post-NRA Benefits. In the case of retirement after normal retirement age, I have always understood statutory and regulatory references to the "accrued benefit" to include post-normal retirement age accruals and⁵ any actuarial increase for deferral past normal retirement age. You may wish to add another example to make that clear.

(c) Application to Life Annuities. The preamble requests comments on interpreting section 417(e) to apply to all of the plan's forms of payment, including an immediate straight life annuity and an immediate statutory j/s annuity, not merely to the accrued benefit.

I would recommend against this change. The legislative history reflects a concern with an economic forfeiture of the accrued benefit (the benefit payable at normal retirement age), not with a forfeiture of any early retirement subsidy. The vesting protections added by ERISA only apply to the accrued benefit, not to an early retirement subsidy, and accordingly the section 417(e) protections should not apply beyond the accrued benefit. The 1988 Treasury Regulations (at section 1.411d-(4), Q&A-2(a)(2)(i)) are clear and a close to contemporaneous interpretation of the statute. I first learned about this rule while I was in private practice in 1990 via De Nobel v. Vitro Retirement Plan 885 F.2d 1180 (4th Cir.1989).

Note that a plan decision to base lump sum payments on only the accrued benefit might rationally be made as a method to constrain costs relating to so-called death-bed elections. Thus, under the existing regulations, if the plan is so written, an employee whose death is immanent can choose between the plan's pre-retirement j/s death benefit and the various death benefits under the plan's other optional annuity forms of payment -- calculated in either case taking the plan's early retirement subsidy into account -- or a lump sum payment calculated without taking that subsidy into account. There is no good statutory, legislative intent, or policy reason to require a plan to choose between either having no lump sums or having lump sums that expose the plan to the actuarial risk of a death-bed election.⁶

3. Transition Rules.

I recommend that you consider coordinating the transition rules for these final regulations to coordinate with the effective date for the proposed new mortality table rules when they are finalized (and very much hope those rules go into effect for plan years beginning on or after January 1, 2018).

Very truly yours,

² Similarly, the plan could be amended to make the 50% j/s death benefit elective with a charge for the coverage. Likewise, if the plan's death benefit were a free 75% j/s death benefit, that ancillary benefit could be reduced to 50% without regard to section 411(d)(6) or amended to make the 50% j/s death benefit elective with a charge for the coverage (but a 50% j/s death benefit would have to be provided assuming the plan's statutory j/s is a 50% j/s).

³ We do not know our life expectancy, tend to overstate our health risks, and tend to have short-range vision (in fact, my father bought a new car with his lump sum pension payout). Thus, the lump sum looks more valuable than the annuity, sometimes referred to as the "wealth illusion."

⁴ This comment letter of course does not include social security supplements within the meaning of a social security leveling option.

⁵ And any combination thereof, such "greater of," and "sum of."

⁶ A plan could also use other conditions for election of a lump sum (such as a 90-day or 180-day advance election requirement), but such conditions would needlessly burden plans and participants.