IRS Reverses Course on Lump Sum Windows for Retirees in Pay Status

Plan sponsors of defined benefit plans frequently entertain options for “de-risking” their plans due to the increasing and accruing pension liabilities. Many plan sponsors have frozen their defined benefit plans but are still finding that pension liabilities are increasing. We are frequently asked to consult on lump sum window projects as an option to mitigate the increasing liabilities.

Until March 6, 2019, one possibility that was not available to plan sponsors was the ability to offer lump sum windows to retirees who were already in “pay status.” This had been the case since 2015, when the Internal Revenue Service (“IRS”) indicated in Notice 2015-49 that it intended to adopt regulations prohibiting retirees in pay status from being eligible for such lump sum windows. Why? The IRS had taken the position that it was a violation of the required minimum distribution (“RMD”) regulations to replace any annuity form of benefit in pay status with a lump sum payment or any other accelerated form of distribution.

In IRS Notice 2019-18 (“Notice”), the IRS reversed course from its 2015 position. The Notice indicates that the IRS will NOT be amending the RMD regulations to prohibit offering a lump sum window to retirees currently receiving annuity payments. However, the IRS did indicate that it intends to continue to study the issue of retiree lump sum windows, and to review lump sum windows for compliance with other provisions of the Internal Revenue Code.

So what does this mean to sponsors of defined benefit plans? For now, plan sponsors can again utilize the lump sum window to retirees in pay status as a strategy for “de-risking” defined benefit plans. Plan sponsors should pay special attention when utilizing this option and work carefully on the design of the lump sum window with ERISA counsel to ensure compliance, given the implication in the Notice that plan sponsors can expect increased scrutiny when offering lump sum windows to retirees in pay status.