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Guest Article

Deloitte logo

(From the October 14, 2002 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits. Hyperlinks within the article have been added by BenefitsLink.)

IRS, Treasury Issue Proposed Regulations on Disclosing Relative Values of Optional Benefit Forms


The IRS and Treasury have issued proposed regulations on disclosing relative values of optional benefit forms to defined benefit plan participants preparing to take distributions. These disclosures would compare the relative values of optional benefit forms with that of the plan's qualified joint and survivor annuity. The proposed regulations were published in the October 7 edition of the Federal Register (67 FR 62417). IRS and Treasury currently plan to finalize the proposed regulations and make them effective for distributions with annuity starting dates on or after January 1, 2004.

Background

In general, IRC section 401(a)(11) requires tax-qualified pension plans to make a Qualified Joint and Survivor Annuity (QJSA) the default distribution option for vested participants. In the case of a vested participant that predeceases his annuity starting date, the surviving spouse's default distribution option must be a Qualified Preretirement Survivor Annuity (QPSA). These rules apply to defined benefit plans, money purchase pension plans, and to certain defined contribution plans.

Under IRC section 417(a), participants generally must be permitted to waive these default distribution options, and to revoke such waivers, within the "applicable election period." (In the case of a QJSA, the "applicable election period" is the 90-day period ending on the annuity starting date; for QPSAs, the "applicable election period" begins in the year the participant attains age 35 and ends with the participant's death.) Married participants must have their spouses' consent before waiving a QJSA or QPSA.

Within a "reasonable period of time" before participants' annuity starting dates, IRC section 417(a)(3) requires pension plans to provide them a written explanation of the terms and conditions of the QJSA and QPSA, their rights to waive the QJSA or QPSA with spousal consent, the effect of such a waiver, and their rights to revoke such a waiver. This is sometimes referred to as the "section 417(a)(3) explanation."

Current Treasury regulations relating to the section 417(a)(3) explanation provide, "participants must be furnished a general description of the eligibility conditions and other material features of the optional forms of benefit and sufficient additional information to explain the relative values of the optional forms of benefit available under the plan (e.g., the extent to which optional forms are subsidized relative to the normal form of benefit or the interest rates used to calculate the optional forms)." Treas. Reg. Sec. 1.401(a)-20, Q/A 36. Among other things, the regulations also require a "general explanation of the relative financial effect on a participant's annuity" of electing to waive the QJSA and/or the QPSA. The current regulations do not provide plan sponsors with any meaningful detail regarding what they need to do to comply with these requirements.

Summary of Proposed Content Requirements for QJSA Explanations

The proposed regulations would require pension plans to provide the following information in the section 417(a)(3) QJSA explanation with respect to each of the plan's optional benefit forms:

  • A description of the optional form of benefit;

  • A description of the eligibility conditions for the optional form of benefit;

  • A description of the financial effect of electing the optional form of benefit (i.e., the amount payable under the form of benefit);

  • In the case of a defined benefit plan, a description of the relative value of the optional form of benefit compared to the value of the QJSA; and

  • A description of any other material features of the optional form of benefit.

The proposed regulations would give plans the option either to (1) automatically provide participant-specific information regarding the optional benefit forms available to the participant, or (2) to provide more general information about the plan's optional benefit forms and allow participants to request more specific information. These rules would be set out in a new Treas. Reg. Sec. 1.417(a)(3)-1.

Participant-Specific Information Option

Plans that elect this option would automatically provide the required information for each of the optional benefit forms available to the participant receiving the QJSA explanation. The information generally would have to be participant-specific, but plans could use reasonable estimates (e.g., estimates based on data as of an earlier date than the annuity starting date or an estimate of the spouse's age) to provide relative values of optional benefit forms compared to the value of the QJSA, and to compare the financial effect of distribution forms available to a participant. Plans would have to provide more precise calculations upon request.

In comparing the relative value of an optional form of benefit with the value of the QJSA, the proposed regulations specify "the benefits under one or both optional forms of benefit must be converted, taking into account the time value of money and life expectancies, so that the values of both optional forms of benefit are expressed in the same form." The plan sponsor could accomplish this in any one of three ways:

  • Expressing the actuarial present value of the optional form of benefit as a percentage or factor of the actuarial present value of the QJSA;

  • Stating the amount of the annuity that is the actuarial equivalent of the optional form of benefit and that is payable at the same time and under the same conditions as the QJSA; or

  • Stating the actuarial present value of both the optional form of benefit and the QJSA.

The proposed regulations provide guidance on selecting the interest and mortality assumptions to be used for determining relative values.

Because the volume of information could easily become confusing to participants-- particularly if they have numerous benefit options-- the proposed regulations would allow plans to group any two or more optional forms of benefit that have approximately the same value. On the QJSA explanation, the plan could then disclose the relative value of only one of the optional forms in each group compared to the value of the QJSA. (If a single sum option is included in a group, it must be used for the comparison.) Alternately, the QJSA explanation could include a representative relative value for each group as long as the representative relative value is within the range of all the relative values of the benefit forms in the group.

In order to determine if two or more optional forms of benefit have approximately the same value, the relative value comparison would have to be made by expressing the actuarial present value of each of those optional forms of benefit as a percentage of the actuarial present value of the QJSA. Those optional benefit forms that vary in relative value in comparison to the QJSA by 5 percentage points or less could be treated as having approximately the same value. For example, if three optional forms have relative values of 87.5 percent, 89 percent, and 91 percent of the QJSA, all three could be treated as having approximately the same value. Additionally, any optional forms that have relative values of at least 95 percent of the QJSA could be treated as having approximately the same value as the QJSA.

Generally Applicable Information Option More Flexible

Instead of automatically providing the required information about the QJSA and all optional benefit forms available to the participant, the second option would permit plans to provide participants with a QJSA explanation that discusses only the QJSA and the optional benefit forms generally available under the plan. Additionally, the plan's QJSA explanation could include a chart showing the financial effect and relative value of the plan's optional benefit forms in a series of hypothetical examples instead of the participant-specific statement of financial effect and relative value comparisons required under the first option.

Plans that use this general information option must give participants the right to request and receive the required information about the optional benefit forms available to that participant, as well as participant-specific statements of financial effect and comparisons of relative values of available optional benefit forms with the QJSA.

Additional Information to Be Provided in QJSA Explanation

Regardless of the option used, the proposed regulations also would require QJSA explanations to include an explanation of the relative value concept. Additionally, QJSA explanations would have to include a general statement that all comparisons provided are based on average life expectancies, and that the relative value of annuity payments ultimately will depend on actual longevity.

Summary of Proposed Content Requirements for QPSA Explanations

In general, the proposed regulations would require a QPSA explanation to include:

  • A general description of the QPSA;

  • The circumstances under which it will be paid if elected;

  • The availability of the election of the QPSA; and

  • A description of the financial effect of a QPSA election on the participant's benefits (i.e., an estimate of the reduction to the participant's estimated normal retirement benefit that would result from a QPSA election).

Instead of a specific description of the financial effect of a QPSA election, the QPSA explanation could provide a general description of the financial effect of the election. For example, the general description could be in the form of a chart showing the reduction to a hypothetical participant's normal retirement benefit at a representative range of participant ages as a result of the QPSA election. If a chart or other general description is used, the plan must provide participant-specific information upon request.

Method for Providing Section 417(a)(3) Explanation

The proposed regulations also clarify that the section 417(a)(3) explanation must be in writing, and that acceptable delivery methods include first class mail to the participant's last known address and hand delivery. Simply posting section 417(a)(3) explanations at a worksite, etc., is not an acceptable delivery method. The preamble states the proposed regulations do not address using electronic media to provide section 417(a)(3) explanations. IRS and Treasury anticipate issuing future guidance on this issue.

Impact on Plan Sponsors

The IRS's and Treasury Department's stated intention is to "propose disclosure requirements that would enable participants to compare the relative values of the available distribution forms using more readily understandable information." The preamble indicates that the proposed regulations are designed to address concerns-- which have been raised by participant advocacy groups and various Members of Congress-- about whether defined benefit plan sponsors give participants enough information to make an informed choice among their various distribution options. For example, in some cases pension plan sponsors have been accused of not making it clear to participants who accept an early retirement offer that one or more annuity options include early retirement subsidies, whereas the lump sum distribution option does not.

However, it appears the proposed regulations would impose substantial new burdens on pension plan sponsors that would increase the cost and complexity of plan administration. Furthermore, it is not clear whether the resulting information would be helpful or merely confusing to participants.

The IRS is accepting written comments on the proposed regulations, and is planning a public hearing January 14, 2003. Comments and/or requests to speak at the hearing must be submitted to IRS by January 2, 2003.

If you have any questions about the proposed regulations, please contact your Deloitte advisor.


Deloitte logoThe information in this Washington Bulletin is general information only and not intended to provide advice or guidance for specific situations. Contact your Deloitte advisor for information regarding your specific circumstances.

If you have questions or need additional information about this article and you do not have a Deloitte advisor, please contact Martha Priddy Patterson (202.879.5634) or Robert B. Davis (202.879.3094).

Human Capital Advisory Services, Deloitte LLP, 555 12th Street NW, Suite 500, Washington, DC 20004-1207.

Copyright 2002, Deloitte.


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