New IRS Rules Allow for Annuity, Lump-Sum Payout Split in Defined Benefit Plans


New rules issued by the IRS are intended to facilitate the payment of benefits under a defined benefit plan in the form of an annuity and partly as a single sum or other accelerated form, giving participants more options for how to take their pension distribution.

Under the rules issued on Sept. 8, participants will better able to get financial protection against the risk of outliving their savings while also increasing liquidity during retirement, the IRS said.

The operation of the tax code minimum present value rules for defined benefit plans makes it difficult for many plan participants to achieve both objectives, it said.

As currently constructed, the rules leave many participants no practical choice but to accept an accelerated distribution such as a lump sum, when they would be better served if they could elect to receive a portion of their benefit in annuity form and the remainder in accelerated payments so that they don’t outlive their savings, the IRS said.

In general, the minimum present value of an optional form of benefit cannot be less than the present value of the accrued benefit calculated by using a specified applicable interest rate and specified applicable mortality table.

Under the new rules, rather than apply the minimum value requirements to the entire benefit distribution, the plan may explicitly bifurcate the benefit so that the minimum value requirements “apply to a specified portion of a participant’s accrued benefit as if that portion were the participant’s entire accrued benefit,” the IRS said.

There are no requirements imposed on the distribution options for the remaining portion of the accrued benefit, the IRS said.

In the alternative, a plan that distributes a specified single amount to a participant satisfies the minimum present value requirement as to that payment, “provided the remaining portion of the participant’s accrued benefit satisfies a minimum requirement,” the IRS said.

Under this computation, “the portion of the participant’s accrued benefit that is settled by the payment of a specified single-sum amount is implicitly determined as the actuarial equivalent of that single-sum amount,” the IRS said.

However, this process, which the rule calls “implicit bifurcation,” is not available in all circumstances, the IRS said. It is not available, for example, when a plan has been amended to eliminate an optional form of benefit, while retaining the optional form of benefit for benefits accrued as of the amendment date.

“The implicit bifurcation rule is also not available in a situation in which a single-sum distribution is available to settle a participant’s entire accrued benefit and the plan permits a portion of the benefit to be paid as a lump sum,” the IRS said.

Explicit bifurcation would have to be used to split the benefit distribution in those situations, the IRS said.

The new rules were part of a regulatory package unveiled by the Treasury Department in 2012 to help individuals save for retirement and provide retirees with expanded options for managing their savings. This included a proposal, finalized in 2014, allowing employees to convert part of their defined contribution plan account balances into a longevity contract at an advanced age without triggering the tax code’s age 70½ minimum distribution requirements.

The new rules went into effect Sept. 9 and apply to distributions with annuity starting dates in plan years beginning on or after Jan. 1, 2017. Plans must be amended to provide the bifurcated distributions.

See related story, Lump Sum or Annuity? Treasury Rules Don’t Make You Choose.

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