IRS May Permit Elimination of Annuities for 401(k) and Profit Sharing Plans

By C. Frederick Reish

The IRS recently announced, in Notice 98-29, that Treasury regulations may be proposed to permit defined contribution plans to eliminate annuities (and other optional forms of benefit).

If this relief is granted, it would protect plans from inadvertent disqualification where, for example, a third party administrator (TPA) amends a takeover plan into the TPA's prototype document—but the new document does not preserve all the payment forms contained in the prior document.

Background
IRC §411(d)(6) prohibits plan amendments that eliminate distribution options for benefits already accrued (i.e., "protected benefits"). However, §411(d)(6)(B) permits exceptions to that rule to be created by Treasury regulations.

The Notice states that the IRS and the Treasury Department recognize that the cost and complexity of plan administration is increased by the "accumulation" of a variety of payment choices. The Notice gives two examples. The first example is an employer who adopted a prototype plan document with one set of distribution options (e.g., including annuities), but which subsequently amends into another prototype sponsor's plan document which provides for different forms of distributions (e.g., without an annuity option). Since a plan amendment which eliminates protected benefits violates the qualification rules, the plan, if audited by the IRS, will be disqualified or, alternatively, the employer will be forced to pay a sanction under the IRS' Closing Agreement Program (CAP).

The second example is one in which employers merge with or acquire other businesses, and both businesses sponsor qualified plans. If the employer chooses to merge the plans, the resulting plan will ordinarily need to provide for a wide array of payment forms, in order to include the protected forms in both of the prior plans, increasing the complexity and cost of administration, as well as, the possibility of an inadvertent disqualifying mistake.

The IRS also points out that it has become easier for individuals to substantially duplicate the distribution options under defined contribution plans through, for example, the use of IRAs. Further, UCA '92 has expedited the process by requiring that direct rollovers be a distribution option.

Possible Relief for Defined Contribution Plans
In the Notice, the IRS tells us that it has been considering the following relief: A plan amendment to a defined contribution plan which eliminates alternative forms of payment would not violate §411(d)(6) if, after the amendment, each affected participant could elect between a lump sum payment and at least one form of extended payments. Acceptable extended payment alternatives would be: (1) a single and joint life annuity; (2) installments over a single and joint life expectancy; or (3) if the plan did not previously offer (1) or (2), installment payments over the longest installment period offered under the prior document.

The Notice asks for comments on this approach and on possible variations, such as installments over a fixed period (e.g., five, 10 or 20 years), or permitting participants to withdraw any amount from their accounts at any time, or not requiring any extended payment form. Comments are also sought on other possible approaches.

The Notice points out that the new regulation will only give relief from §411(d)(6) for defined contribution plans and will not eliminate the annuity requirements of §401(a)(11) and §417 or the direct rollover rules under §401(a)(31). Thus, a profit sharing plan would need to comply with the §401(a)(11) rules on spousal death benefits in order to eliminate the annuity option for benefit distributions.

Analysis
Based on discussions with IRS officials, the IRS has been considering this relief for a period of time and is prepared to propose regulatory relief. However, prior to issuing proposed regulations, they want to get private sector input to ensure that they have considered all the issues. Hopefully, proposed regulations will be issued before the end of this year. If so, then your 1999 restatements can be drafted to take the new rules into account by, e.g., eliminating the annuity option from 401(k) and profit sharing plans.

This relief offers two significant benefits to TPAs. First, it would protect plans from being disqualified for the inadvertent elimination of a protected form of payment when the plan documents are restated. Second, if annuity options are removed from 401(k) and profit sharing documents, it would eliminate the administrative work involved in complying with the QJSA participant election and spousal consent rules.

The impetus for this change has come from the financial institutions which sponsor 401(k) prototype documents and which are concerned about possible §411(d)(6) violations in takeover cases. The change will benefit everyone in the benefits community who prepares plan documents. It will eliminate a level of complexity which has offered little, if any, benefit to participants and their spouses.

Comments
Comments must be submitted to the IRS by August 31st. The ASPA Government Affairs Committee will be filing comments on behalf of ASPA.

© 1998 from the American Society of Pension Actuaries. Article originally appeared in the ASPA ASAP, No. 98-15, June 10, 1998.

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