IRS No Longer Prohibits Retiree Lump Sum Windows In Defined Benefit Pension Plans

Defined benefit (DB) plan sponsors can once again offer retirees and beneficiaries receiving annuity payments a limited opportunity to convert their benefits into a lump sum. IRS Notice 2019-18, issued on March 6, ends a de facto ban on retiree lump sum windows, which had become a popular DB plan de-risking strategy until the IRS essentially outlawed it in Notice 2015-49, issued July 9, 2015.

IRS’s Surprising Change of View

The 2015 Notice said that the IRS would propose regulations under Section 401(a)(9) retroactively effective to July 9, 2015, forbidding the acceleration of in-pay status benefits into lump sum cash outs. But the 2019 Notice says that the IRS will not issue those regulations after all. The 2019 Notice also confirms that the IRS will:

  • Not challenge plan amendments adding retiree lump sum windows as possible Section 401(a)(9) violations of the required minimum distribution rules.

  • No longer issue private letter rulings on retiree lump sum windows.

  • No longer caveat determination letters for plans that include retiree lump sum window provisions.

Senior citizen groups had pushed hard for the 2015 ban out of concern that retirees would outlive their income if they could convert lifetime income streams into lump sums. Even though the 2019 Notice says that the IRS will continue studying the issue, no rationale was given for the sudden (and somewhat surprising) change.

Pros and cons of retiree lump sum windows

The table below shows some pros and cons of a retiree lump sum window.

Pros Cons
  • Reduction in plan administrative expenses, including Pension Benefit Guaranty Corporation premiums

  • “Adverse selection,” meaning that retirees most attracted to the lump sum option may be those in poor health, and paying a lump sum to these participants may be more expensive than continuing to pay their annuity

  • Removes longevity and investment risk from balance sheet

  • Retirees may need to be given the opportunity to re-elect all optional forms of payment, so retirees with spouses that have died since retirement could increase their annuities to higher amounts

  • May provide positive balance sheet impact if the accounting obligations booked are more than the lump sums actually paid

  • Settlement accounting rules could trigger a one-time non-operational expense in the year that lump sums are paid 

  • Reduction in headcount could exempt plan from onerous IRS funding and Pension Benefit Guaranty Corporation filing requirements, and could even exempt plan from audit if headcount falls to less than 100 participants as of the first day of the plan year

  • Up-front administrative costs of offering a temporary lump sum program for retirees 

BDO Insights

Notice 2019-18 introduces new considerations for DB plans. An actuary or ERISA counsel can help plan sponsors make informed decisions about whether retiree lump sums make sense for their plans.
Your BDO representative can help explain the various choices related to DB plans and the outcomes they can provide for your organization.