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Guest Article

Deloitte logo

(From the March 29, 2004 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Issues Proposed Anticutback Regulations


The IRS this week issued comprehensive proposed regulations that would define the scope of the anticutback rule and provide exceptions for eliminating early retirement benefits, retirement-type subsidies, and optional forms of benefit from defined benefit plans. 69 FR 13769 (March 24, 2004). Plan sponsors may not rely on these proposed regulations until they are adopted in final form.

The deadline for submitting comments to IRS on the proposed regulations is June 22, 2004. Following is a summary of some of the proposed regulations' key provisions.

Background

In general, IRC section 411(d)(6)(A) prohibits plan amendments that have the effect of reducing participants' accrued benefits. This so-called "anticutback rule" clearly prohibits, for example, retroactive changes to a defined benefit plan's benefit accrual formula if the change would cause any participant's accrued benefit to be reduced. The anticutback rule does not prevent plan sponsors from changing their plans to reduce future benefit accruals.

Additionally, IRC section 411(d)(6)(B) specifies plan amendments that eliminate or reduce an early retirement benefit or retirement-type subsidy, or eliminate optional forms of benefit, with respect to benefits attributable to service before the amendment are treated as reducing accrued benefits. However, the statute also gives Treasury authority to issue regulations permitting plan sponsors to amend their plans to reduce or eliminate benefits or subsidies that create significant burdens or complexities for the plan and its participants, so long as the amendment does not adversely affect the rights of any participant in a more than de minimis manner. The statute also gives Treasury authority to issue regulations permitting plan sponsors to eliminate other optional forms of benefit.

The proposed regulations represent an ambitious attempt by IRS to, among other things, update existing regulations under IRC section 411(d)(6); clarify several issues raised in litigation involving the anticutback rule; define the terms "early retirement benefit" and "retirement-type subsidy"; and provide exceptions for eliminating optional forms of benefit, and reducing or eliminating early retirement benefits and retirement-type subsidies, with respect to previously accrued benefits. They also would provide guidance on complying with ERISA section 204(h) notice requirements in certain circumstances.

Definitions

Under the proposed regulations, an early retirement benefit would be defined as "the right, under the terms of a plan, to commence distribution of a retirement-type benefit at a particular date after severance from employment with the employer and before normal retirement age." As the definition implies, early retirement benefits with different terms relating to timing would be treated as different early retirement benefits.

A retirement-type subsidy would be defined as "the excess, if any, of the actuarial present value of a retirement-type benefit, over the actuarial present value of the accrued benefit commencing at normal retirement age or at actual commencement date, if later, with both such actuarial present values determined as of the date the retirement-type benefit commences." The proposed regulations would define a "retirement-type benefit" as the "payment of a distribution alternative with respect to an accrued benefit or the payment of any other benefit that continues after retirement that is not an ancillary benefit." (Ancillary benefits, which are not protected by the anticutback rule, would be defined to include social security supplements, certain disability benefits, and ancillary life insurance or health insurance benefits, among other things.)

A frequently litigated issue is whether benefits contingent on the occurrence of an unpredictable event-- such as a plant shutdown-- are retirement-type subsidies protected by the anticutback rule. Although most courts have ruled such benefits are not protected, one court has ruled they are protected. Bellas v. CBS, Inc., 221 F.3d 517 (3rd Cir. 2000), cert. denied, 531 U.S. 1104 (2001). The IRS apparently has concluded the Third Circuit is right.

According to the preamble to the proposed regulations, a plant shutdown or other contingent event type benefit is protected by the anticutback rule if it is a retirement-type subsidy. This means the benefit cannot be reduced or eliminated with respect to service prior to the applicable amendment date, even if the contingency has not yet occurred. The proposed regulations would provide if the contingent-event benefit continues beyond retirement (and is not an ancillary benefit), it would be a retirement-type benefit, and if the present value of the retirement-type benefit is greater than the present value of the accrued benefit, it would be a retirement-type subsidy.

Redundancy Exception

The proposed regulations would provide two exceptions to the general rule that a plan sponsor generally may not amend its plan to eliminate optional forms of benefit with respect to previously accrued benefits. Both exceptions generally are designed to ensure participants continue to have certain options available if a plan eliminates one or more optional forms of benefit, and both require delayed effective dates.

Under the first exception, known as the "redundancy rule," such an amendment generally would not violate the anticutback rule if--

  • the optional form of benefit being eliminated is redundant with respect to a retained optional form of benefit; and

  • the amendment does not apply to an optional form of benefit with an annuity starting date that is earlier than 90 days after the date the amendment is adopted.

In order for an optional form of benefit to be redundant with respect to a retained optional form of benefit, the latter would have to be available to the participant and in the same "family" of optional forms as the form of benefit being eliminated. Also, a participant's rights with respect to the retained optional form of benefit could not be subject to materially greater restrictions-- such as eligibility conditions or right to designate a beneficiary, et al.-- than the optional form being eliminated.

The proposed regulations outline 6 different families of optional forms of benefit.

  1. Joint and contingent options with continuation percentages of 50 percent to 100 percent. An optional form of benefit would be within this family if it provides a life annuity to the participant and at least a 50 percent survivor annuity.

  2. Joint and contingent options with continuation percentages less than 50 percent. An optional form of benefit would be within this family if it provides a life annuity to the participant and a survivor annuity that is no more than 50 percent of the participant's annuity.

  3. Term certain and life annuity options with a term of 10 years or less. An optional form of benefit would be within this family if it is a life annuity with a payment guarantee of no more than 10 years.

  4. Term certain and life annuity options with a term in excess of 10 years. An optional form of benefit would be within this family if it is a life annuity with a payment guarantee of more than 10 years.

  5. Level installment payment options over a period of 10 years or less. An optional form of benefit would be within this family if it provides for substantially level payments to the participant for a fixed period of at least 2 years and a payment guarantee of no more than 10 years if the participant dies before the end of the fixed period.

  6. Level installment payment options over a period of more than 10 years. An optional form of benefit would be within this family if it provides for substantially level payments to the participant for a fixed period with a payment guarantee in excess of 10 years if the participant dies before the end of the fixed period.

For purposes of determining if two or more forms of benefit would be treated as members of the same family, the proposed regulations would allow plan sponsors to disregard differences with respect to social security leveling features, refund of employee contribution features, or retroactive annuity starting date features. But if the eliminated optional form includes a social security leveling feature, then so must the retained optional form of benefit. The same rule would apply if the eliminated optional form includes a refund of employee contribution feature. Similarly, if the eliminated optional form does not include a retroactive starting annuity date feature, the retained optional form could not include that feature.

Note that single sum distribution options do not fit within any of these 6 families. As a result, according to the preamble, plan sponsors would not be able to use the redundancy rule to eliminate a single sum distribution option.

Additional requirements would apply if the amendment would eliminate an early retirement benefit or reduce a retirement-type subsidy. (Specifically, the additional l requirements would apply if the optional form to be retained either has a different annuity starting date than the optional form to be eliminated or, as of the "applicable amendment date," the actuarial present value of the optional form to be retained is less than the actuarial present value of the optional form to be eliminated.) In these cases the amendment would be permitted only if the other requirements for the redundancy exception were satisfied, and if--

  • the optional form to be eliminated creates significant burdens and complexities for the plan and plan participants; and

  • the elimination does not adversely affect the rights of any participant in more than a de minimis manner.

Whether the optional form creates significant burdens and complexities for the plan and participants would be determined based on all the facts and circumstances. Some relevant factors would include whether the annuity starting dates under the plan considered in the aggregate are burdensome or complex, and whether the effect of the plan amendment is to reduce the number of categories of early retirement benefit.

The de minimis requirement would be satisfied if the retained optional form's annuity starting date is within 6 months of the annuity starting date for the eliminated optional form, and the actuarial present value of the eliminated optional form does not exceed that of the retained optional form by more than a de minimis amount. Under the proposed regulations, a reduction in actuarial present value would be of no more than a de minimis amount if the reduction does not exceed the greater of 2 percent of the present value of eliminated optional form's retirement-type subsidy (if any) prior to the amendment or 1 percent of the participant's compensation for the prior plan year.

Core Option Exception

The second exception generally would permit plans to eliminate optional forms of benefit if, after the amendment, each of 4 specific "core" options remain available, and if the eliminated optional form remains available for at least 4 years after the amendment is adopted. The core options identified in the proposed regulations are--

  • a straight life annuity with level payments during the participant's life and no death benefit;

  • a joint and contingent annuity with a life annuity for the participant and a 75 percent survivor annuity for the participant's beneficiary;

  • a 10-year certain life annuity with guaranteed payments for 10 years even if the participant dies before the end of that period; and

  • the most valuable option for a participant with a short life expectancy, meaning the optional form of benefit for each annuity starting date that is reasonably expected to result in payments having the largest actuarial present value in the case of a participant who dies shortly after the annuity starting date.

The proposed regulations would provide a "safe harbor hierarchy" for satisfying the most valuable option for a participant with a short life expectancy requirement. If the plan has a single-sum distribution option with an actuarial present value at least as great as that of any eliminated optional form of benefit, the plan could treat that option as the most valuable for each annuity starting date if it is available at all annuity starting dates, even if it was not available before the amendment.

If the plan does not have a single-sum distribution option that satisfies these requirements, it could use a joint and contingent annuity if the continuation percentage is at least 75 percent and at least as great as the highest continuation percentage available before the amendment. Finally, if the plan cannot use either the single-sum or joint and contingent annuity safe harbor, it could treat a term certain and life annuity with a term certain of at least 15 years as the most valuable option.

This exception would not apply to amendments eliminating an optional form including a single sum distribution option unless it applies to less than 25 percent of the participant's accrued benefit as of the date the optional form is eliminated. Also, if the form being eliminated is the most valuable option for a participant with a short life expectancy, the exception would apply only if an identical optional form is being retained. For purposes of determining if a retained form is identical, the plan could disregard actuarial factors used to determine distribution amounts, annuity starting dates, social security leveling features, refund of employee contribution features, and retroactive annuity starting date features.

Furthermore, as with the redundancy exception, additional rules would apply if the amendment would eliminate an early retirement benefit or retirement-type subsidy.

204(h) Notice Requirements

Under IRC section 4980F(e) and ERISA section 204(h), defined benefit plan sponsors must give plan participants advance notice of any amendments providing for a significant reduction in the rate of future benefit accrual or eliminating or reducing any early retirement benefits or retirement-type subsidies. The proposed regulations would amend existing Treasury regulations (Sec. 54.4980F-1) to clarify how those rules would apply to changes permitted by the proposed regulations.

Other Matters

As noted, the proposed regulations stake out the IRS's position on several controversial court decisions involving the anticutback rule. The Fourth Circuit Court of Appeals last year ruled-- over the IRS's objections-- that a plan sponsor could add a COLA for existing retirees and then take it away without violating the anticutback rule. Board of Trustees of the Sheet Metal Workers' National Pension Fund v. C.I.R., 318 F.3d 599 (4th Cir. 2003). Not surprisingly, the proposed regulations would provide anticutback protection does apply in those circumstances.

In another controversial decision, the Ninth Circuit Court of Appeals in 2001 ruled a plan amendment providing for an actuarial offset of early retirement benefits received by a rehire upon subsequent retirement violates the anticutback rule even though the amendment, combined with a simultaneous change to the plan's benefit formula, caused a net increase to the participant's retirement benefits. Michael v. Riverside Cement, 266 F.3d 1023 (9th Cir. 2001). The proposed regulations would dictate a different result by requiring the amendments to be treated as a single amendment for purposes of the anticutback analysis.

The proposed regulations would not address the issue raised in Heinz v. Central Laborers' Pension Fund, 303 F.3d 802 (7th Cir. 2002), cert. granted, 72 U.S.L.W. 3370 (2003), because that case is now before the Supreme Court. The question in Heinz is whether a pension plan can change its suspension of benefit rules for current retirees without violating the anticutback rule. The federal courts are divided on this issue.


Deloitte logoThe information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.

If you have questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Tom Brisendine 202.879.5365, Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Mike Haberman 202.879.4963, Stephen LaGarde 202.879.5608, J. D. Lutz 202.879.5366, Bart Massey 202.220.2104, Diane McGowan 202.220.2077, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5324, Tom Veal 312.946.2595, or Deborah Walker 202.879.4955.

Copyright 2004, Deloitte.


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