On September 8, 2016, the Internal Revenue Service (IRS) issued final regulations providing guidance on the minimum present value requirements for defined benefit plan distributions to simplify the treatment of certain optional forms of benefit that are paid to a participant partly in annuity form and partly in lump sum (81 Fed. Reg. 62359 (Sep. 9, 2016)). The final regulations adopt proposed regulations issued in February 2012 with certain modifications and clarifications (see Legal Update, IRS Proposes Guidance Simplifying Use of Annuities in Retirement Plans: Partial Annuity Distribution Options for Defined Benefit Plans).

Under the current regulations, if a participant in a defined benefit plan elects both a lump sum and annuity distribution, both portions are subject to the minimum present value requirements of Internal Revenue Code (Code) Section 417(e)(3), which are statutorily prescribed actuarial assumptions (interest rates and mortality assumptions) for both portions elected.

In the preamble, the IRS explains that many participants have been reluctant to elect an annuity distribution and are choosing instead to take an accelerated distribution to maximize their liquidity in retirement. However, choosing a single sum or other accelerated form of distribution can cause participants to risk outliving their savings. According to the IRS, participants often benefit from having the opportunity to elect to have a portion of their retirement benefits in the form of an annuity and the remainder in the form of accelerated payments.

To simplify the treatment of certain optional forms of benefit that are paid partly in annuity form and partly in lump sum, the IRS issued proposed regulations that would have modified the current regulations regarding the minimum present value requirements for defined benefit plan distributions (see Legal Update, IRS Proposes Guidance Simplifying Use of Annuities in Retirement Plans: Partial Annuity Distribution Options for Defined Benefit Plans). In response to comments, the IRS issued these final regulations adopting the proposed regulations with certain modifications and clarifications.

Like the proposed regulations, the final regulations provide that if a participant chooses two different distribution options for separate portions of a bifurcated accrued benefit, the two options would be treated as two separate optional forms of benefit for purposes of Code Section 417(e)(3) (26 U.S.C. § 417(e)(3)). This means that a participant's accrued benefit can be bifurcated so that the minimum present value requirements of Code Section 417(e)(3) apply only to the portion of the participant's accrued benefit that is paid in a lump sum (rather than to the entire benefit) and the plan could use its usual annuity equivalence factors for the annuity portion (rather than being required to make a special calculation for the annuity portion using the Code Section 417(e)(3) assumptions).

The final regulations provide two approaches to bifurcating the accrued benefit so that the minimum present value requirements apply only to the portion of the participant's accrued benefit that is paid in the form of a lump sum:

The final regulations also provide certain rules that apply to the bifurcation rules, including situations in which each bifurcation rule must be used.

Additionally, the final regulations:

The final regulations promote the IRS's goal of providing participants with greater flexibility to elect both a lump sum distribution and an annuity, which may assist participants with lifetime income in potentially reducing the risk of outliving their savings. Plan administrators should familiarize themselves with the simplified rules and consider ways to make plan participants aware of the change.