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IRS regulation will allow employers in bankruptcy to remove lump-sum benefit options

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IRS regulation will allow employers in bankruptcy to remove lump-sum benefit options

A final Internal Revenue Service regulation will allow employers in bankruptcy to remove lump-sum options as a way for plan participants to receive their accrued benefits.

While accrued benefits normally cannot be reduced or eliminated, the final rule will allow “a debtor in a bankruptcy proceeding to amend its single-employer defined benefit plan to eliminate a single-sum distribution option” as long as certain conditions are satisfied. Those conditions include a determination by the judge overseeing the employer's bankruptcy that the elimination of the lump-sum option is necessary to avoid termination of the employer's pension plan.

The IRS rule, which the agency first proposed in June, is of particular relevance to American Airlines Inc., whose AMR Corp. parent filed for Chapter 11 bankruptcy nearly a year ago.

American had said that while it wanted to freeze the plan, the lump-sum benefit issue first had to be resolved. The airline was concerned that a high number of pilots would retire early to collect their lump-sum payouts if it froze the plan.

“The departure of a significant number of pilots in a short period of time, incentivized by the availability of lump-sum payouts, would have a severe detrimental impact on our operations and is a risk that the company simply cannot afford to take,” Jeff Brundage, senior vice president-human resources, wrote in a letter to airline employees.

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Referring at the time to the proposed IRS regulation, “This news puts us in a position to make major progress in that effort” to freeze rather than terminate the plan, AMR Chairman and CEO Tom Horton said in a statement. America froze the pilots' plan Nov. 1, along with three other plans that do not offer lump sums.

The final rule, published in Thursday's Federal Register and effective Nov. 8, moves the airline “one step closer” to maintaining the freeze, an American Airlines spokesman said Friday.

American Airlines pilots and the federal Pension Benefit Guaranty Corp. reap big benefits from a plan freeze compared with a plan termination.

If the PBGC took over the plan, many pilots would see a big reduction in their pension benefits. That is because the maximum annual benefit — $54,000 — that would be guaranteed by the PBGC is significantly less than the benefits many pilots have earned.

For the PBGC, a plan freeze would mean the agency, which last year reported a $26 billion deficit, would be spared another multibillion-dollar loss.

The PBGC has not disclosed the funded status of the pilots' plans. But it said in a preliminary estimate that the pilots' plan, along with three other plans, have about $8.3 billion in assets and about $18.5 billion in promised benefits. The PBGC said if the plans were to fold, the agency would be liable for about $17 billion in benefits, resulting in an $8.7 billion loss to the agency.

The three other frozen plans cover members of the Transport Workers Union, the Association of Professional Flights Attendants and other nonunion employees.