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Guest Article

Deloitte logo

(From the August 21, 2006 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

IRS Issues Final Anti-cutback Regulations for Defined Benefit Plans


The IRS has issued final regulations creating a utilization exception to the IRC § 411(d)(6) anti-cutback rule for eliminating optional forms of benefit from defined benefit plans. 71 FR 45379 (August 9, 2006). The final regulations also codify the Supreme Court's decision in Central Laborers' Pension Fund v. Heinz, 541 U.S. 739 (2004), but apply the reasoning of that decision more broadly.

Background

In general, IRC § 411(d)(6)(A) prohibits plan amendments that have the effect of reducing participants' accrued benefits. This so-called "anti-cutback 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 anti-cutback rule does not prevent plan sponsors from changing their plans to reduce future benefit accruals.

Additionally, IRC § 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 IRC directs Treasury to issue regulations permitting plan sponsors to amend their plans to reduce or eliminate early retirement benefits and retirement-type 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 IRC also gives Treasury authority to issue regulations permitting plan sponsors to eliminate optional forms of benefit.

(IRC § 411(d)(6)(E) generally permits defined contribution plan sponsors to eliminate forms of distribution as long as a single-sum payment is available. The Treasury and IRS issued final regulations pursuant to this provision in 2005.)

Last summer Treasury issued comprehensive final regulations (the "2005 final regulations") that provided two limited exceptions to the general rule that a plan sponsor may not amend its defined benefit plan to eliminate optional forms of benefit with respect to previously accrued benefits. Both the "redundancy" and "core option" exceptions are designed to ensure participants continue to have certain distribution options available after a plan eliminates one or more optional forms of benefit.

At the same time, Treasury issued proposed regulations that would create a third exception (the "utilization" exception) permitting defined benefit plan sponsors to eliminate certain optional forms of benefit that have not been used for two or more years. The proposed regulations also addressed the interaction between the anti-cutback rule and the IRC § 411(a) minimum vesting rules. The 2006 final regulations adopt these proposals with modifications, and also make some changes to the 2005 final regulations.

New Utilization Exception

As noted, the 2006 final regulations create a utilization exception plan sponsors can use to eliminate or reduce all optional forms of benefit that make up a generalized optional form with respect to previously accrued benefits. The utilization exception will apply only if (1) the generalized optional form was available to at least 50 participants during the "look-back period", and (2) no participant has elected any optional form of benefit that is part of the generalized optional form with an annuity start date that is within the look-back period. The utilization exception is not available to eliminate "core" options, which include a straight-life annuity, a 75 percent joint and survivor annuity, a ten-year term certain and life annuity, and the most valuable distribution option for a participant with a short life expectancy.

The look-back period includes the two plan years immediately preceding the year of adoption, plus the period preceding the date of adoption. With respect to the year of adoption, plan sponsors can exclude from the look-back period the month of adoption and the preceding one or two calendar months if within the year of adoption. Also, plan sponsors can extend the look-back period to as many as five years immediately preceding the year of adoption if needed to satisfy the requirement that the generalized optional form of benefit has been available to at least 50 participants during the look-back period. At least one of the plan years in the look-back period must be a 12-month plan year.

A generalized optional form of benefit is available to a participant only if he or she was eligible to elect to begin payment of an optional form of benefit that is part of the generalized optional form being eliminated with an annuity start date within the look-back period. This does not include a participant who --

  • did not elect any optional form benefit with an annuity start date within the look-back period;
  • elected an optional form of benefit that included a lump-sum representing at least 25 percent of the participant's accrued benefit;
  • elected an optional form of benefit that was available only for a limited period of time and that contained a retirement-type subsidy where the subsidy that is part of the generalized optional form being eliminated was not extended to any optional form of benefit with the same annuity start date; or
  • elected any optional form of benefit with an annuity start date that was more than 10 years before normal retirement age.

Plan sponsors may count participants who elected a lump sum that represented at least 25 percent of their accrued benefits, but if they do the utilization exception will be available only if the generalized optional form of benefit being eliminated was available to 1,000 participants -- instead of 50 -- during the look-back period.

The utilization exception is effective for amendments adopted after December 31, 2006.

Interaction Between Anti-cutback and Vesting Rules

In Heinz, the Supreme Court ruled a multiemployer plan amendment that expanded the scope of a suspension of benefit requirement for current and future early retirees violated the anti-cutback rule to the extent it applied to benefits accrued before the amendment's effective date. The amendment, which expanded the definition of "covered employment" that would trigger a suspension of benefits, was not prohibited by the minimum vesting requirements. However, the Supreme Court concluded the amendment violated the anti-cutback rule because it placed greater restrictions or conditions on participants' rights to previously accrued protected benefits.

The 2006 final regulations take this rule a step further by applying it to any amendment that adds a restriction or condition that is otherwise permitted under the vesting rules pursuant to IRC § 411(a)(3) through (11), and not just to amendments relating to suspensions of benefits. However, the final regulations clarify that the anti-cutback rule does not prohibit amendments changing a plan's vesting computation period in accordance with DOL Reg. § 2530.203-2(c). The final regulations illustrate the scope of these rules with a series of examples, including the following:

Example 3. (i) Facts. Employer N maintains Plan C, a qualified defined benefit plan under which an employee becomes a participant upon completion of 1 year of service and is vested in 100% of the employer-derived accrued benefit upon completion of 5 years of service. Plan C provides that a former employee's years of service prior to a break in service will be reinstated upon completion of 1 year of service after being rehired. Plan C has participants who have fewer than 5 years of service and who are accordingly 0% vested in their employer-derived accrued benefits. On December 31, 2007, effective January 1, 2008, Plan C is amended, in accordance with section 411(a)(6)(D), to provide that any nonvested participant who has at least 5 consecutive 1-year breaks in service and whose number of consecutive 1-year breaks in service exceeds his or her number of years of service before the breaks will have his or her pre-break service disregarded in determining vesting under the plan.

(ii) Conclusion. Under paragraph (a)(3) of this section, the plan amendment does not satisfy the requirements of this paragraph (a), and thus violates section 411(d)(6), because the amendment places greater restrictions or conditions on the rights to section 411(d)(6) protected benefits, as of January 1, 2008, for participants who have fewer than 5 years of service, by restricting the ability of those participants to receive further vesting protections on benefits accrued as of that date.

Of course, the final regulations confirm that this rule applies only to the extent the amendment affects previously accrued benefits. The anti-cutback rule does not prohibit amendments that apply only with respect to future benefit accruals.

The rule relating to changes to suspension of benefit provisions is effective for periods beginning on or after June 27, 2004 -- the date of the Supreme Court's decision in Heinz. Soon after Heinz the IRS issued Rev. Proc. 2005-23 to provide guidance on correcting offending amendments to suspension of benefits provisions adopted before June 27, 2004. The preamble to the final regulations clarifies that, with respect to offending amendments adopted before January 1, 1989, the requirements of Rev. Proc. 2005-23 do not apply.

The rule relating to other plan amendments making changes permitted by the vesting rules, but not by the anti-cutback rule, is effective for amendments adopted after August 9, 2006.


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 any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Laura Edwards 202.879.4981, Mike Haberman 202.879.4963, Stephen LaGarde 202.879-5608, Bart Massey 202.220.2104, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5314, Carlisle Toppin 202.220.2067, Tom Veal 312.946.2595, Deborah Walker 202.879.4955.

Copyright 2006, Deloitte.


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