optional forms, anti-cutback rule and plan termination

[Guest Salvador A Mander]

Plan specifies that participants with 20 years of service may receive benefits in the form of a lump sum. Plan terminates this year in a standard termination at a time when participant X has 15 years of service.

Instead of giving all participants the option to receive a termination lump sum, the plan purchases deferred annuity contracts (with the same options available under the plan) for participants not otherwise eligible to receive a distribution.

Participant X continues to work for an additional 5 years. Must the lump sum feature be preserved in the deferred annuity contract, or can the plan avoid a cutback problem based on the fact that the participant had not satisfied the condition for receiving a lump sum when the plan terminated?

[Andy the Actuary]

My favorite question. In a standard plan termination, not only must all rights and features be preserved but also (assuming the employer is ongoing), the annuity contract must continue the same plan provisions (i.e., allow for lump sum) or if a lump sum is offered, it must assume that participant will grow into any subsidies or rights he would have had if the plan had continued. Thus, the cost of plan termination may surprisingly be much greater than the FT as the lump sum would assume the subsidy whereby the participant might otherwise leave before satisfying the conditions for the subsidy.

See rev rule 85-6, which while it addresses early retirement subsidies, the line of thinking would be believed to apply to your situation.

IRS_Rev._Rul._85_6_Early_Retirement_Subsidy_Termination.PDF

[Guest Salvador A Mander]

My favorite question. In a standard plan termination, not only must all rights and features be preserved but also (assuming the employer is ongoing), the annuity contract must continue the same plan provisions (i.e., allow for lump sum) or if a lump sum is offered, it must assume that participant will grow into any subsidies or rights he would have had if the plan had continued. Thus, the cost of plan termination may surprisingly be much greater than the FT as the lump sum would assume the subsidy whereby the participant might otherwise leave before satisfying the conditions for the subsidy.

See rev rule 85-6, which while it addresses early retirement subsidies, the line of thinking would be believed to apply to your situation.

Thanks! That was my instinct - that the annuity contract would have to specify that the participant could take the lump sum if he later satisfied the terminated plan's criteria, but I wasn't aware of any specific guidance. This is the logical conclusion, I believe, given that a "plan amendment" under 1.411(d)-3(a) includes a plan termination.