Consultants Weigh In on Proposed Minimum Present Value Rules

This letter provides Willis Towers Watson's comments with respect to the changes the Internal Revenue Service and Treasury are considering to the Internal Revenue Code (IRC) § 417(e) regulations.

Willis Towers Watson is a leading global advisory, broking and solutions company that employs 39,000 associates worldwide. Our approximately 600 Enrolled Actuaries provide actuarial and consulting services to more than 1,700 defined benefit plans in the U.S.

Following are our comments.

Lump Sum Values of Subsidized Annuities

First we will address IRS's request for comment on whether, in the case of a plan that provides a subsidized annuity payable upon early retirement, and determines a lump sum distribution as the present value of that early retirement annuity, the minimum lump sum should be required to be calculated as the greater of (i) the § 417(e) present value of the immediate annuity and (ii) the § 417(e) present value of the deferred to normal retirement date (NRD) annuity, rather than solely as (ii). If the minimum can be calculated solely as (ii), a plan could optionally provide a lump sum equal to the immediate annuity converted at a different interest rate (e.g., a fixed or variable rate, including § 417(e) ), with a minimum lump sum (ii) without also having to provide (i).

Note that while informal guidance (2006 Gray Book Q&A 33) had indicated that the IRS believes that the regulations currently require the greater of (i) and (ii) when any lump sum based on the immediate annuity is provided, many plan sponsors interpreted the current regulations as requiring only (ii). The regulation provides the following (bold and bold italics added):

1.417(e)-1(d) Present Value Requirement --

We believe that basing the minimum present value solely on the normal retirement age accrued benefit provides the level of protection required by § 417(e)(3). Furthermore, from a policy standpoint our view is that additional requirements should not be placed on a plan sponsor who wishes to provide a second potentially greater benefit under a § 417(e) option than if the AIR and AMT were used. Requiring a third potentially greater still benefit -- the present value of the immediate annuity using the AIR and AMT -- would represent just such an approach for a plan sponsor that wishes to provide a § 417(e) option based on the greater of the AIR and AMT applied to the accrued benefit and different assumptions applied to the immediate benefit. We believe that such a requirement would reduce the likelihood that plans will provide anything greater than the § 417(e) present value of the deferred to NRD benefit. Therefore, we oppose this interpretation of the regulations and support any change that would make it clear that it doesn't apply. Furthermore, if the regulations are finalized to require this third calculation if the plan sponsor had voluntarily chosen to include the second, we request that § 411(d)(6) relief be granted to permit a sponsor to eliminate the second calculation since many sponsors would never have added this calculation had they known that the third calculation would be required.

Many plan sponsors that provide a lump sum or Social Security level income option based on the immediate annuity did not follow the interpretation in 2006 Gray Book Q&A 33, in reliance on their determination letters and on their own interpretation of the regulatory language. Others added a minimum benefit of the § 417(e) present value of the immediate annuity, solely because they believed they were required to under the IRS position expressed in the 2006 Gray Book. When the IRS clarifies the requirements either (i) some plan sponsors will be forced to amend their plan to provide an additional minimum benefit or (ii) other plan sponsors will have a minimum benefit in their plan that was added solely in reliance on the 2006 Gray Book that is not required and was never wanted by the plan sponsor. This situation is analogous to the situation that existed due to the lack of clarity surrounding the application of § 417(e) to the whole benefit when part of the benefit is paid in a § 417(e) form. We ask that IRS provide similarly flexible transition rules so that plan sponsors who complied with the Gray Book Q&A are not disadvantaged (i.e., § 411(d)(6) relief to eliminate the additional minimum calculation if it is no longer required), and that no plan sponsors are forced to retroactively recalculate benefits (i.e., if the additional minimum calculation is required).

Additional Comments

Mortality Increments Post-NRD

We appreciate and support the proposed clarification that preretirement mortality discounts can be used in determining lump sums for non-contributory benefits, irrespective of whether benefits are forfeited on death. However, we are concerned that the proposed regulation could be interpreted to require mortality increments in post-NRD benefits for plans (e.g., cash balance plans) under which there is no forfeiture on death, and no mortality discount in calculating pre-NRD lump sums. Specifically, we are concerned about this wording:

Stability Periods and Look-Back Months

Given that the proposed regulations would modify the sections of the § 417(e) regulations that deal with stability periods and look-back months used for the AIR and AMT, and changes in stability periods and look-back months with § 411(d)(6) relief, we ask that IRS take this opportunity to clarify the circumstances in which the stability period and/or look-back month can be changed with § 411(d)(6) relief (i.e., by providing a one-year period during which the greater of the benefit payable using the old and the new bases is provided). Informal guidance (2008 Gray Book Q&A 41) first indicated that this relief is only available for § 417(e) options, and then 2012 Gray Book Q&A 39 indicated it was available for all optional forms of benefit, but not for other uses of the AIR and AMT (e.g., converting cash balance accounts to annuities). Since then, in the hybrid regulations, IRS provided similar (and very welcome) relief for changes in the stability period or look-back month used to set a plan's interest crediting rate.

We ask that the regulation be revised to make clear when the § 411(d)(6) relief applies for changes in stability periods and look-back months. In addition, we ask that the relief be provided for all such changes, irrespective of the use of the interest rate or mortality table that is set with reference to the stability period and look-back month. Most plan sponsors, for administrative convenience, strongly prefer to use a single stability period and look-back month, and need the flexibility to change if circumstances warrant (e.g., if they find that the look-back period is not adequate for efficient benefit election processing). For example, the inability to change the basis for converting cash balance accounts to annuities (for which many plans use the AIR and AMT) with § 411(d)(6) relief prevents plan sponsors from fixing administrative problems caused by the timing of availability of rates by changing the stability period and look-back period, since the change cannot apply to a crucial element of the calculation (without onerous calculations required by § 411(d)(6) protection, which still cannot be performed on a timely basis).

Specifically we ask that § 411(d)(6) relief (with the 12 month "greater of" period) apply for all purposes for which a plan uses an interest rate or mortality table determined based on a stability period and look-back month that are permitted under the § 417(e) regulations (whether or not the interest rate is actually the AIR, as opposed to another variable basis like a Treasury rate). There are many administrative reasons why plan sponsors want to change these stability periods and look-backs, or are required to (e.g., when plans are merged and a single AIR and AMT must be used for the merged plan). Running multiple stability periods and look-back months for different purposes is cumbersome and inhibits administrative efficiency, and there is no reason to believe that benefits will be higher or lower over time using any particular stability period or lookback month.

In addition, because the Gray Book is not official guidance, and the current regulation is not clear with regard to the scope of this § 411(d)(6) relief, we ask that any clarification be applied prospectively (i.e., only for changes in stability periods or look-back months that are made after the effective date of the final regulations), with either the guidance in the final regulations, or reasonable interpretations of the guidance in the current regulations, permitted to be followed for earlier periods.

Contributory Plans

The proposed regulations would apply to benefits paid beginning on annuity starting dates (ASDs) that fall after the regulations are finalized. In addition, the change to bar reflection of mortality between the date contributions are refunded and NRD is defined in terms of how the accrued benefit derived from employee contributions (ABDEC) is determined, not in terms of how the residual accrued benefit is determined. Thus in the very common case where a participant elects a refund of employee contributions at termination of employment, and defers the remaining benefit until later, we believe the proposed regulations would not require redetermining the employer provided benefit (because the proposed regulations govern the ABDEC, the ASD for the ABDEC fell before the final regulations' effective date, and there are no longer employee contributions at the effective date of the final regulations). We ask that the final regulations indicate explicitly that this is the intent. We note that it would be extremely difficult for many plans to redetermine the remaining employer provided benefit if an ABDEC paid out many years ago needed to be recalculated.

Conclusion

We appreciate the IRS and Treasury Department giving consideration to these comments. Please contact either of the undersigned if you have any questions or would like to discuss our comments in more detail.

Maria M. Sarli, FSA, EA

This letter provides additional comments of Willis Towers Watson with respect to the changes the Internal Revenue Service and Treasury are considering to the Internal Revenue Code (IRC) § 417(e) regulations. We previously submitted comments on February 14.

Willis Towers Watson is a leading global advisory, broking and solutions company that employs 39,000 associates worldwide. Our approximately 600 Enrolled Actuaries provide actuarial and consulting services to more than 1,700 defined benefit plans in the U.S.

Employee Contributions and Bifurcated Benefits

We believe that the combination of (i) the requirement in the proposed regulations to disregard preretirement mortality in determining the present value of the employee provided benefit, and (ii) the final § 417(e) regulations issued in September 2016 ("2016 regulations") relating to bifurcated benefits, produce an illogical result that we suspect was not intended. Specifically, a contributory plan whose only available lump sum is a refund of contributions with interest will provide a higher residual employer benefit if that lump sum is taken than if the same lump sum is taken from a plan that is identical except that it also provides a full lump sum option. The reason for this is that the plan providing the full lump sum is required to use the explicit bifurcation rules under the 2016 regulations, which require proportional treatment for the lump sum and accrued benefit settled for the bifurcated pieces. However, the proposed regulations require a different conversion factor for the employee provided benefit than would typically be used for the employer provided benefit thereby bringing into question the appropriateness of requiring proportional treatment.

To illustrate we will use information from Examples 2 and 3 of the 2016 regulations. Example 2 states that the employee provided monthly benefit at age 65 to Participant T is $261.21, based on $32,000 of contributions with interest and a 10.209 deferred annuity factor that does not reflect mortality prior to 65. Since the contributions with interest is the only lump sum available, the plan does not use the explicit bifurcation rules and instead must meet the requirement that the residual benefit is at least the total accrued benefit of $1,500 less $261.21, or $1,238.79.

Moving on to Example 3, a full lump sum is also offered causing the explicit bifurcation rules to apply. Imagine that this full lump sum is based only on the accrued benefit, reflects preretirement mortality for the employer provided piece, and that the factor reflecting preretirement mortality is 10. The total lump sum under the proposed regulations would be $32,000 + $1,238.79 x 12 x 10 = $180,654.80. If the same $32,000 refund of contributions is elected then the explicit bifurcation rules seem to require that the accrued benefit settled equal ($32,000 / $180,654.80) x $1,500 = $265.70. This results in a residual accrued benefit of $1,234.30 which is less than the amount from Example 2.

We see no reason for this disparity, which is caused solely by the availability of a full lump sum. Furthermore, if the plan in Example 2 were amended to provide for a full lump sum, the resulting lower residual benefit might be viewed as violating § 411(d)(6), while preserving the residual benefit could be viewed as violating the requirements of the 2016 regulations. Our recommendation to address this issue would be to modify the 2016 regulations to state that the benefit settled by the lump sum payment be no greater than (or the residual benefit no less than) the proportional amount currently called for (i.e., as opposed to precisely equal to such proportional amount). Alternatively, refunds of employee contributions with interest could be carved out from the proportional calculations, although this would require plans to specify an ordering of when employer versus employee benefits are settled in the event that there are broad partial lump sum options available. We note that such a requirement would be similar to the existing requirement to specify which benefits are settled when different factors apply to different portions of the benefit.

We appreciate the IRS and Treasury Department giving consideration to these comments. Please contact either of the undersigned if you have any questions or would like to discuss our comments in more detail.

Maria M. Sarli, FSA, EA