MPPP - Expenses for Purchase of Annuities

[J. Bringhurst]

We have a client who is terminating a money purchase pension plan (prototype) that has one remaining participant with an account balance in excess of $5,000. The client knows that they will have difficulty getting the sole participant to return the benefit distribution form (they would also like to discourage him from electing what could be a pretty expensive annuity given the small participant population)and are wondering if they can state in their cover letter and/or 204(h) notice that (1) an annuity will be purchased for him if he does not respond with an election by the deadline and (2) any expenses associated with the purchase of the annuity will be assessed against his account. Can a plan even be amended for this and, if so, what fiduciary issues arise? The basic plan document is pretty general with its plan expense language...

[david rigby]

Purchase of an annuity is usually an option. However, it is the participant's option most often. Your situation seems like a good solution on a practical level.

However, if the plan sponsor already has another DC plan, you might consider the alternative of merging the MPP plan into the other.

[RTK]

I am not sure what plan expenses you are considering. What comes to mind is the DOL op ltr to the effect that QDRO expenses could not be charged to an individual account. Basically, access to the statutory QDRO rights could not be encumbered by imposing separate fees or charges not provided for in ERISA.

Regarding the annuity purchase, it would be required upon plan termination unless participant elected otherwise, and if married, with spouse consents (assuming the plan is not a govt or non-electing church plan). Don't forget that there are fiduciary issues with respect to the purchase of the annuity contract. Good luck wtih that.

[mwyatt]

I'm not following your expense comments on the annuity (unless you are referencing time in selecting an annuity). You state that this is a money purchase, not a defined benefit plan. If he has a $10,000 account balance, then this is your cost of the annuity. If you are referencing the cost to the participant as to value received for a small purchase, this I can understand, but I don't think there is really any way around the situation (assuming your participant doesn't want the money for creditor reasons - just a guess).

[AndyH]

But, to avoid a 411(d)(6) cutback, wouldn't you have to preserve the lump sum option, at least at retirement age? So it will cost more than $10,000 to get an annuity with a surrender value of $10,000, so there is an expense component to this. I'd guess you could charge the "expense" as a general expense rather than an earmarked expense, allocated to all participants, which happens to be 1. So I guess you end up having to look for an annuity with the lowest possible surrender charge.

Kind of like a cat chasing it's tail.

[RTK]

I had not thought of expenses in the context of the amount of premium above $10,000 that would be required to buy an annuity with a $10,000 surrender value. I would view that amount as part of the cost of the annuity, and not as an expense of the plan. In this regard, while I agree that you have to preserve a lump sum option, I do not believe you have to preserve the $10,000 lump sum amount. I think the plan can just buy the best annuity it can with $10,000.

BTW, to avoid the ugly issues that arise from trying to buy a deferred annuity that protects 411(d)(6) benefits, provides for spousal benefits, etc. when the plan may be purchasing one annuity every decade or so, I have long written my plan documents to provide that only immediate annuities are available as a form of distribution.

[mbozek]

RTK: My reading of reg 1.417(e)-1(B)(1) indicates that a plan must offer both an immediate as well as a deferred annuity to a participant as well as a lump sum option. Isnt limiting distribution option to an immediate annuity create a disqualfiying provision in all of your plans?

[AndyH]

Right. RTK, please explain that last statement.

[J. Bringhurst]

I think that AndyH has gotten to the heart of my question. Really, we would like to encourage the participant to (1) respond in a timely manner to our benefit distribution materials and (2)select a lump sum. Since it might be very costly to purchase a deferred annuity for one person, can we inform him of this and that the expense will affect his accrued benefit (if it does indeed affect his accrued benefit)? Who may be required to pay for this expense? I really need to know if the expense can, in effect, be passed along to the one remaining participant or, assuming the plan is overfunded, must it come from other assets? If it can be passed along, must the plan be specifically amended for this or is the plan's general expense language (i.e., expenses associated with administering the plan, to pay benefits, etc.) sufficient?

[MGB]

Why do you keep refering to a separate expense? If you buy an annuity for 10,000, that's it. There isn't any expense being paid by anyone. All costs are buried in the annuity contract itself.

And why would a money purchase plan be overfunded?

[mbozek]

Since each participant in a mppp must have an individual account under IRC 414(i) and benefits can be paid only from such account, I do not understand what this thread is about. Under ERISA 206 the normal form of benefit for a participant is a J & S annuity. The annuity is purchased from the participants account. The cost of the annuity is part of the overall amount paid to the ins co and is not paid separately. If the participant has an account balance of $100,000 then the amount used to purchase the will be $100,000 and the mo annuity benefit will be the amount provided in the annuity table which is part of the annuity contract. I dont understand what the cost of an annuity for one person has to do with the obligation to puchase an annuity benefit under ERISA. The cost is built in to the amount of the purchase price -- it is not a separate expense. If the Particpant does not want to incure a hefty load charge then he/she can elect to receive a lump sum distribution and rollover the proceeds to an IRA.

[J. Bringhurst]

You're right about the overfunding issue. I just wasn't thinking. But, I'm a bit confused on the expense issue. Assuming that the lump sum present value is $10,000 - how is the expense wrapped into the determination of the annuity "price"?

Sorry to be so daft, I don't have that much experience with this topic.

[J. Bringhurst]

As to the "cost" for purchasing an annuity for one individual, I've just heard that it is "expensive" and not really understood what that means. I've also heard that it is difficult to even get annuity providers to write an annuity for one participant.

Obviously, I'm not getting this......just be patient with me......I thought that the purpose of these message boards was to get information from people with greater experience/knowledge in a particular area. Not particularly helpful if one is made to feel like an ass.

[AndyH]

J. Bringhurst, what they are saying is probably true, that the $10,000 account value is not protected. I was thinking that you'd have to protect that value, but perhaps not.

I guess the annuity under this approach would provide whatever the annuity provides, with nothing protected except the availability of payments at times allowed under the terms of the plan, and under all forms allowed under the terms of the plan.

It's just that there is no way the participant could surrender it on day 1 and receive $10,000, so I'd be pretty hot if it was me who was annuitized. I'd urge caution. It's common to threaten or allude to such a forced annuity purchase, but I'd be real careful if your bluff is called. Exhaust all other avenues first IMO.

[J. Bringhurst]

Yes, basically I'd assumed that there was an "expense," "cost," or some kind of sales load for the purchase of an annuity contract (how else would the annuity provider make a profit?). I'd also assumed that this amount (if separated from the value of the annuity) would be greater, per annuity, for a smaller population.

I'm going fishing.....this is too complicated for me.

[RTK]

mbozek: My comment was directed towards ongoing defined contribution plans. I was trying to avoid having to purchase a deferred annuity for a terminated 47 year old with a $10,000 account. As you know, the annuity must provide for 411(d)(6) protected benefits, spouse benefits, election procedures, etc. Based on some experience with annuity purchases for terminating defined benefit plans, I was concerned that such an annuity would be difficult to purchase. On the other hand, it should be fairly easy to buy an immediate single life annuity or immediate joint and survivor annuity for the odd participant who wants one.

I obviously thought this would not be a disqualifying provision (but ignorance is bliss). The disqualification of all of my plans can't be good. Actually, from a qualification perspective, I was more concerned that a deferred annuity would not have all of the required provsions in it, which would raise its own set of qualification issues for the plan.

In any case, I do not see anything in the Code or Regs. that requires an ongoing defined contribution plan to offer a deferred annuity option to participants in a defined contribution plan. In fact, 1.417(e)-1(B)(1) states that a qualified joint and survivor annuity is an annuity that commences immediately.

Termination is a different matter for money purchase pension plans, but because of 411 consent requirements. In that case, 1.411(a)-11 could force the purchase of a deferred annuity for a participant who does not consent to a distribution and is younger than the normal retirement age (or age 62 if later). Note that this would not be an issue for an ongoing plan, since the participant can defer by not applying for the distribution.

J.Bringhurst: It is also my understanding that a one participant annuity with all of the required provisions in it can be expensive and difficult to buy. You are right that the annuity provider will take a piece of the pie. However, I view this as part of the cost of the annuity. Thus, the key here is what annuity will the $10,000 buy. I reiterate that I do not believe that the $10,000 value must be protected. Thus, if you have to buy an annuity, you would take the participant's account balance and buy the best annuity you can.

As far as the participant, I do not see any problems with notifying the participant of the terms of the annuity that would be purchased as the required default, including the cost of the annuity and the benefits that would be provided by the annuity. You are already required to notify the participant of the material features and relative values. I would go the extra mile and give the participant the specific cost and benefit information as well. Arguably, it would make for a more informed (affirmative or default) participant election (which could be useful when the participant later complains).

[mbozek]

RTK: Maybe I am not looking in the right place but my reading of the 417 reg you cite states that a plan cannot just offer a choice only between a lump sum and a deferred annuity but but also must offer an immediate annuity. I think the plan can satisfy this requirement by offerring the participant the option of either an immediate annuity or a deferred annuity in addition to cash.

[david rigby]

I would go further than RTK and suggest that it is very unlikely that an insurer will sell you a deferred annuity on one participant unless the premium amount is high, and maybe only a short deferral period. Thus you can't buy the annuity, and you can't complete the plan termination until you buy the annuity.

The practical result is to buy an immediate annuity, a J&S if the participant is married. I don't know if this causes any problems in the regulatory arena.

[RTK]

I know that offering just an immediate annuity (and not a deferred annuity) does not seem right. And you are right that the 417 regs prohibit a choice between an immediate lump sum and a deferred annuity, but also require an immediate annuity to be offered. I just don't (or don't want to) read that as requiring a deferred annuity for an ongoing dc plan (so long as the plan offers an immediate lump sum and an immediate annuity). I find administration and communication issues easier without the deferred annuity option. And since I was unable to find any specific requirement for a deferred annuity, I made the immediate annuity the standard approach for my plans.

[J. Bringhurst]

Not quite sure if there has been any consensus on the approach to take with a terminating money purchse pension plan. Some have indicated that it is permissible to inform the participant that an immediate annuity will be purchased in his name if he does not return the distribution materials by the required date. This would seem to take care of any difficulty in actually purchasing a deferred annuity for anly one participant. How do I get around protected benefit issues as to other forms of benefit offered under the plan when using a default approach such as this, however? A couple of the responses seem to indicate that a deferred annuity must be offered...though I'm not sure if the focus was on a terminating MPPP...

[RTK]

I think derailed the train.

There are two code issues.

First is the joint and survivor annuity requirements under code section 417. I don't believe that a deferred annuity is required under 417 (for a terminating or ongoing plan).

Second is the required consent for a distribution under code section 411. Under code section 411 regs, IRS takes postion that the consent regulations apply on and after plan termination. Accordingly, the IRS's position is that cannot distribute upon plan termination without consent. Since a plan is not considered terminated until the plan assets are distributed, that leaves two choices: purchase of a deferred annuity with all of the required provisions in it; or transfer of account to another defined contribution plan.

Here are steps to consider.

If the participant has attained the normal retirement age (or age 62 if later), code section 417 does not apply. If you are that lucky, it would be permissible to offer the participant the choice between an immediate annuity (in the plan's normal form) or lump sum payment, with the annuity being the default option.

If the participant is younger than the normal retirement age (or age 62, if later), then a deferred annuity would be required to be offered to satisfy the 411 consent rules, in addition to an immediate annuity and lump sum payment. Also, the deferred annuity would be required to be the default option. The deferred annuity would have to include all of the forms of distribution provided under the terminated plan, the pre-retirement spouse death beneft provisions of the terminated plan, permit the participant to elect payment at the times provided for by the terminated plan and permit the participant to defer payment until the plan's normal retirement age (or age 62 if later).

The problem is trying to buy a deferred annuity with all of the required provisions. As noted, it could be very difficult to find an insurance company willing to sell a deferred annuity, or willing to sell at a reasonable rate. Nonetheless, you should check with a number of insurance companies.

If you find a decent insurance company willing to sell a deferred annuity, this should be communicated as the default option to the participant, along with a clear explanation of the costs and benefits of the annuity.

If no such deferred annuity is available, there is no good option. Fortunately (for me), I have never had this problem, and I do not recall anything specifically addressing the issues. I suppose the best that can be done is to offer the participant the choice between the immediate annuity and lump sum payment. This would get the assets out of the plan, but leave the plan administrator/fiduciary with some exposure. I would try to get some "informal" guidance from the IRS before proceeding this way.

[J. Bringhurst]

Thank you RTK.

I think that we have pretty much decided to take the route you've outlined since our participant is, indeed, younger than the plan's normal retirement age. We will offer him all of the distribution forms under the plan and provide that a deferred annuity (with all applicable bells and whistles) will be the default. What kept messing me up was the "cost" of this option. And, it's rare that I've seen benefits communications materials describing this issue to participants - materials usually describe the actuarial adjustments that are made to various forms of benefit (re relative value of different forms) but rarely the hidden "cost" involved.