The Internal Revenue Service (IRS) issued updated regulations on the minimum present value requirements for defined benefit plan distributions. While we believe that the majority of plans require no amendment on account of the new regulations, some plans will be impacted. This alert will highlight notable new provisions that were not in the proposed regulations. The updated regulations can be found at Updated Regulations.

Applicability Date: The updated minimum present value rules apply to distributions with annuity starting dates that occur on or after October 1, 2024. However, as described below, the regulations under section 411 allow amendments adopted on or after January 19, 2024, to change the lookback month or stability period.

Background

In general, Internal Revenue Code (IRC) section 417(e) requires that distributions payable in lump sums or certain other forms satisfy the minimum present value requirements. Under the regulations, the distribution payable as a lump sum (or other forms subject to the rules) must not be less than the amount determined using a prescribed mortality table (the “applicable mortality table”) and the prescribed interest rates (the “applicable interest rates”).

Under the regulations, other forms of benefits are subject to the minimum present value requirements unless the distribution is paid in a form that (A) does not decrease during the life of the participant, or in the case of a Qualified Pre-Retirement Survivor Annuity (QPSA), the life of the participant’s spouse, or (B) decreases during the life of the participant merely because of the death of the survivor annuitant or the cessation or reduction of a Social Security supplement or qualified disability benefit.

The Pension Protection Act of 2006 (PPA ’06) changed section 417(e) so that the applicable interest rates were the “segment rates” specified by IRC section 430 instead of the 30-year Treasury rate that had been used. Similarly, the applicable mortality table was changed by PPA ’06 so that it was based upon the mortality tables specified by section 430. The changes made by PPA ’06 were first applicable in 2008.

While the IRS has been publishing the applicable interest rates and the applicable mortality table to be used under section 417(e) regularly since the change in law, the actual regulations under the section had not been modified. In November 2016, the IRS proposed an update to the regulations, which have now been finalized taking into account comments that were received.

Highlights of the Updated Regulations

In general, the updated regulations retain the structure of the prior regulations. Accordingly, the applicable interest rates may be specified by a plan as the segment rates for a lookback month and apply the rates for a stability period. The lookback month may be the first, second, third, fourth, or fifth full calendar month preceding the first day of the stability period. The stability period may be one calendar month, one plan quarter, one calendar quarter, one plan year or one calendar year. The applicable mortality table is the mortality table for the calendar year during which the stability period containing the annuity starting date begins.

Changes in Lookback Month and Stability Period

The updated regulations amended the regulations under IRC section 411, to broadly permit changes in the lookback month and stability period. New section 1.411(d)-3(a)(4) permits a defined benefit plan to be amended to change the stability period or the lookback month provided that any distribution for which the annuity starting date occurs on or after the effective date of the amendment and before the end of the one-year period commencing on the amendment date is the greater of (i) the amount determined using the pre-amendment stability period and lookback month; and (ii) the amount determined using the post-amendment stability and lookback month.

New section 1.411(d)-3(a)(4) applies to amendments adopted on or after January 19, 2024, which is the date the updated regulation was published in the Federal Register.

Cheiron Observation: The updated regulations make it easier for a plan to change the lookback month or stability period as needed. The one-year transition rule means that the prior lookback month or stability period can be ignored for distributions in later years.

Clarification of Use of Pre-Retirement Mortality

The updated regulations follow the proposed regulations and generally provide that the probability of death is taken into account for purposes of determining the minimum present value without regard to the death benefits provided under the plan. However, if any portion of a participant’s accrued benefit is derived from employee contributions, the probability of death during a deferral period is not taken into account for purposes of determining the present value of the benefit derived from employee contributions. Therefore, a plan with employee contributions will generally have to make separate calculations for the part of the benefit provided by the employee contributions and the part of the benefit provided by employer contributions.

In response to comments, the updated regulations provide that an optional form of benefit that is subject to the minimum present value requirements is not treated as failing the requirement under section 1.401(a)(20) (Q&A-16) of the regulations that no optional form of benefit be more valuable than the Qualified Joint and Survivor Annuity (QJSA) if the amount calculated under the optional form (i) takes into account the probability of death before retirement and any death benefit provided under the plan, or (ii) uses a present value factor for the employee-derived accrued benefit as the factor applicable to the employer-derived accrued benefit. This provision effectively allows a plan to ignore the probability of death before retirement in determining the present value of the entire benefit rather than make separate calculations for the part of the benefit provided by the employee contributions and the part of the benefit provided by employer contributions.

Cheiron Observation: If a plan has employee contributions, an amendment will likely be needed to satisfy the requirement that no mortality be taken into account for the employee-derived portion of the accrued benefit. Alternatively, the plan amendment could provide that no pre-retirement mortality be used to determine the minimum present value of a lump sum or other form subject to the rules of section 417(e).

Social Security Level Income Options

A social security level income option is an optional form of benefit that provides additional temporary annuity payments in earlier years before an assumed social security commencement age and lower benefits in later years after social security benefits are assumed to commence so that the sum of plan benefit plus the social security benefit provides approximately level income to the participant. The updated regulations make it clear that a social security level income option is subject to the minimum present value requirements. The regulations include an example showing a social security level income option that fails the minimum present value requirements.

Bifurcation of SS Level Income Option

The existing regulations permit a plan to bifurcate the accrued benefit and specify a portion of the benefit that can be payable in an optional form subject to section 417(e) with the remainder payable in an optional form not subject to section 417(e).  In response to comments, the updated final regulations provide a new implicit bifurcation rule applicable to a social security level income option. 

Under the new implicit bifurcation rule, a plan satisfies the minimum present value requirements with respect to the temporary annuity portion of a social security level income option if two requirements are satisfied. The two requirements require a bit of calculation, but effectively limit the amount of the accrued benefit that is reduced to provide for the temporary annuity payments prior to the age of commencement of social security benefits. The remaining annuity payments that are not temporary are not subject to the minimum present value requirements.

Cheiron Observations: If a plan has a social security level income option that does not already satisfy the minimum present value requirements, then the plan will need to be amended so that either the entire option satisfies the present value requirements or the plan provisions satisfy the implicit bifurcation rule. Unless a plan has employee contributions or a social security level income option, the updated regulations should not require any plan changes. Plan amendments required by these final regulations are generally effective for annuity starting dates on or after October 1, 2024.

Cheiron pension consultants can assist you in reviewing a plan to see if changes are needed on account of the updated regulations.

Cheiron is an actuarial consulting firm that provides actuarial and consulting advice. However, we are neither attorneys nor accountants. Accordingly, we do not provide legal services or tax advice.