IRS Issues Final Regs On Retirement Plan Payout Options

Gregory E. Matthews


Employers are permitted to revise provisions of their plans through a formal amendment. This year many employers will be revising their plans and possibly a whole series of changes without their knowledge when they restate their plans for the required GUST amendments. What employers can do directly or inadvertently is eliminate a benefit option, unless permitted by the Code. The IRS has just made this process a little less challenging by permitting certain options to be omitted when specific criteria are met.

Basically, Code Section 411(d) prohibits any plan amendment that has the effect of eliminating an optional form of benefit. As a result, a defined benefit retirement plan can wind up with a variety of payout options. Thus, when an employer switches from one provider’s prototype plan to another prototype, the employer will frequently be offering different payment options. Unless the new plan document continues to offer the payment choices that were available under the prior plan, this requirement is violated. Similarly, problems arise when an employer merges plans after a corporate change. When plans are merged, the new plan must generally offer all of the payment choices available to employees covered by the prior plans to those employees — even if benefit options differ in only insignificant ways.

*The newly-released final regulations allow defined contribution plans to basically eliminate all optional benefit forms and offer only lump-sum distributions.

The final rules expand the application of certain exemptions under 411(d) in the proposed regulations. The proposed regulations would have allowed plans to eliminate most optional benefits as long as the remaining options included a lump-sum option and at least one extended payment option. However, the final rules drop the extended payment option requirement.

The IRS says that it made the change in response to input from employers who argued that requiring plans to offer extended payments creates administrative burdens without providing any real advantages for plan participants. For example, employers noted that plans would have to include lengthy explanations of the extended payment option in plan materials and maintain a system to administer the extended payments, even though few, if any, participants choose the extended payment option. Moreover, employers noted that plan participants always have the option of rolling a lump-sum distribution into an IRA, which will commonly offer a variety of alternative payment forms.

Ground Rules

The final rules provide that a defined contribution plan can eliminate any and all alternative benefit forms as long as the amended plan offers a lump-sum option that is otherwise identical to the options being eliminated. A lump-sum distribution option will be considered identical to an eliminated benefit if it is identical in all respects except the timing of the payments. That is, when benefits are available, cannot change. For example, a lump-sum option will not be considered identical to an installment payment option if it is not available on the date the installment payments would have begun and in the same medium of distribution, or if the lump sum imposes any eligibility conditions that did not apply to the installment form.

*Transition Rule The final regulations include a transition rule to protect participants who may have been anticipating the availability of a particular payout option. A plan amendment that eliminates or restricts the ability of a participant to receive a particular optional benefit form cannot apply to any distribution that has a starting date earlier than the ninetieth day after the date the participant has received a summary plan description reflecting the elimination of the benefit option. However, an amendment can apply as of the second plan year following the plan year in which the amendment is adopted, if that’s earlier.

Addressing Plan-to-Plan Transfers

The problem of a lost payout option can also arise in other circumstances, for example, when an employee transfers from one company division to another that has a different retirement plan without the same benefit options. In the past, it was often impossible to transfer an employee’s funds to the new plan because the transfer would effectively eliminate an optional form of benefit.

Under old rules, optional benefit forms could be eliminated when a plan-to-plan transfer was made with the participant’s consent——but only if the benefit was fully vested and eligible for an immediate distribution. In most cases, such a transfer was impractical because of the administrative requirements.

The final regulations address this problem by permitting “transaction or employment change” transfers between the same type of plan when a participant’s benefit is not fully vested or is not currently available for distribution. Similar rules apply to transfers following certain corporate transactions, such as mergers and acquisitions.

And where benefits are fully vested and available for distributions, the final regulations permit a transfer between different types of plans. That is, funds may be transferred from a defined benefit plan to a defined contribution plan, or vice versa. A transfer between two 401(k) plans or two money purchase pension plans is treated as a transfer between the same types of plans. However, a transfer from a 401(k) plan to a regular profit-sharing plan is not permitted.

These plan-to-plan transfers are permitted only when the participant has made a voluntary, fully-informed election to transfer his or her entire benefit to the new plan. Thus, the participant must be permitted to leave his or her benefits in the current plan——or, if that plan is terminating, receiving any available optional form of benefit from the plan. Otherwise, the existing 411(d) protection continues.

Note that the final regulations state that the right to distributions in cash, employer securities, or property other than marketable securities under the plan generally cannot be eliminated. However, a defined contribution plan can be amended to limit in-kind distributions to the types of property in which a participant’s account is invested at the time of the amendment. In addition, a plan can provide that a participant will be permitted to receive a distribution in the form of a particular type of property only if the participant’s account includes that type of property at the time of the distribution.

Gregory E. Matthews, CPA, Matthews Benefit Group, Inc., St. Petersburg, Florida, gmat@ERISA.com