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Lump Sum Pension Buyouts: What the IRS Stance Means

The IRS and Treasury have taken steps that curb lump sum pension buyout offers by pension plans to those receiving ongoing payments. In a recent post on his “Nerd’s Eye View” blog, Michael Kitces offers his take on their recent actions and what they mean.

Kitces notes that lump sum buyout offers by pension plans and employers that want to de-risk have become more common when pension recipients who are receiving ongoing payments have the chance the convert future payments to a one-time lump sum that can be rolled into an IRA. This practice can result in lump sum offers that are very modest, Kitces writes, and the Government Accountability Office has raised concern that pension plan participants may not be given enough information concerning such buyouts.

The Treasury plans to update Treas. Reg. §1.401(a)(9) in a way that would limit such buyout offers. Not only that, the IRS on July 9 issued Notice 2015-49, which provides that qualified defined benefit plans generally may not replace any joint and survivor, single life or other annuity currently being paid in a lump sum or through other accelerated distributions. Under the notice, plan sponsors that want to “de-risk” their pension plans will no longer be able to give participants who are receiving monthly annuity benefits the option to convert that benefit to a lump sum. The IRS action will not prevent opting to receive a lump sum at retirement, however. The provisions of the notice went into effect immediately on July 9.

“For most, that’s probably good news, given ‘questionable’ buyout offers (and Congress beginning to scrutinize various ‘pension advance’ schemes), and concerns about the ability of some retirees to manage the investment and longevity risk that they take on with a lump sum,” writes Kitces.

But the new stance may not be a panacea for everyone. Kitces points out, for instance, that people who are ill or whose pension plan is underfunded and fear that it may default may miss an opportunity to obtain a buyout while they are experiencing circumstances that could make one advantageous to them.

Not only that, the new IRS position could have long-term ill effects, Kitces argues. He writes, “Ironically, while the purpose of the new rules was to shore up protections for pensioners, the elimination of yet another means by which plan sponsors can ‘de-risk’ their pension exposures may only serve to further accelerate the slow-motion demise of the defined benefit plan altogether.”