Many pension plan sponsors are offering or have already offered terminated participants a one-time opportunity, during a short “window” period, to take a lump-sum payment equal to the value of their pension, in lieu of future retirement payments. A cash-out window is attractive to pension plan sponsors because it removes the participants from the PBGC premium rolls and reduces risk by settling a substantial portion of their pension liability. An expected change in the mortality tables, which will further increase pension costs, has pushed sponsors to accelerate window programs.
The IRS and the DOL have been grumbling about cash-out windows over the last year, concerned that windows undermine U.S. retirement policy and retirement security. While the federal government struggles to promote the transformation of defined contribution plans into lifetime income security for participants, it does not want lifetime pension benefits turning into lump-sum payouts. The IRS and DOL have been considering what authority they have to limit the practice, or at least require expanded disclosure to participants considering a lump-sum offer.
On July 9, the IRS took its first swing at cash-out windows in Notice 2015-49, which states that the IRS will amend the required minimum distribution (RMD) regulations soon to address lump-sum windows. These regulations will provide that the RMD rules are violated if participants currently in pay status cash out future pension payments, because payouts do not comply with the RMD rules if the form changes after payments have begun.
Most cash-out windows do not offer lump sums to participants in pay status, so this Notice will not directly affect those windows. Yet the Notice shows the IRS is actively looking for ways to limit cash-out windows and will act quickly when it sees a way to do so.
The good news is that the IRS said this treatment would apply only from the date of the Notice—the Notice was issued to give advance warning to employers considering windows. The new rules will not apply to employers with formal decisions to offer a window already in place by July 9. If any future rules are similarly prospective only, employers can offer windows without worrying that future IRS rules will undo their efforts.
The bad news is that the IRS Notice gave no transition period. If a week ago an employer was contemplating a window offering cash-outs to participants in pay status, today that option is no longer available. Future changes may be similarly abrupt. Employers considering a window for participants who are not yet in pay status may want to finalize and formalize their decisions soon.
If you have any questions, please contact Mary Jo Larson at firstname.lastname@example.org or 248.784.5183, or any member of our Employee Benefits & Executive Compensation Practice Group.