After a four-year rule-making process, the U.S. Department ofTreasury and IRS have released final regulations intended toencourage participants in defined benefit pension plans to takepart of their savings in an annuitized payment stream, as opposedto electing to take the entire benefit in a lump sum.

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In the final rule published in the Federal Register on Sept. 9,regulators note that the Treasury Department and IRS “believe thatmany participants are better served by having the opportunity toreceive a portion of their retirement benefits in annuity form while receivingaccelerated payments for the remainder of their benefits to provideincreased liquidity during retirement.”

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Cathy Weatherford, CEO of the Washington,D.C.-based Insured Retirement Institute, which had lobbied forclarified rules that would expand participants choice indetermining how they receive their benefits while still protectingthe value of a lifetime income guarantee, issued astatement in support of the final rule.

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“This rule will provide pension plan participants with moreflexibility when given the option of a lump sum or an annuity,”said Weatherford. “It removes the all-or-nothing choice that theseworkers must make when given the option, and in doing so, it willhopefully encourage more Americans to take their benefit, at leastin part, in the form of a lifetime income stream.”

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Under existing regulatory requirements, plan sponsors wererequired to apply minimum present value requirements, or interestrate and mortality assumptions set by Congress, to both theannuitized and lump-sum portions of the benefits if a participantchose to split the forms of payment.

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Those rules, first established in 1988, encouraged manyparticipants to forgo a monthly, annuitized stream of distribution,opting instead for a lump-sum distribution to free up liquidity inretirement.

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In doing so, those participants invite greater investment risk,and potentially expose themselves to longevity risk — or a scenarioin which they outlive their savings, Treasury and the IRS noted intheir final rule.

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How it would work

The final rule allows plan sponsors to apply the minimum presentvalue requirements under IRS rules only to the portion of the totalbenefit that is paid in a lump sum.

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The reminder of the total benefit that is distributed inannuitized form can be valued using typical “annuity equivalencefactors,” according to analysis on practicallaw.com, an editorialservice written by attorneys to help the legal industry interpretlaws and regulations.

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Going forward, sponsors can take two approaches to so-calledbifurcated pension benefit distributions for plan years beginningJan. 1, 2017, when the new rule takes effect:

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In order for the minimum present value requirements to apply toonly the lump-sum portion of the distribution, a plan can apply the“explicit” bifurcation rule, under which the minimum valuerequirements are applied to the lump sum as if the lump sum werethe entire benefit.

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Or, a sponsor can apply the minimum present value requirementsto the lump sum if the remainder of the total benefit to beannuitized satisfies a minimum requirement.

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The annuitized portion of the total benefit must be no less thanthe greater of the participant’s total accrued benefit inannuitized form, or the annuity payment is actuarially equivalentof the lump sum payment.

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The final rule, which was simplified from its proposed formsubsequent to stakeholders’ comments, offers seven specificexamples of how the new rule is applied to determining bifurcateddistributions.

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Those examples, and the entire rule, can be viewed here.

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