Pension annuity conversion to lump-sum benefit for current retirees OK: IRS rulings

WASHINGTON—Giving retirees the ability to convert the monthly pension benefit they receive into a lump-sum benefit does not violate federal pension law or regulations, the Internal Revenue Service says.

In two private letter rulings that became public Friday, the IRS said a proposed lump-sum payment option that would be available during a limited time period is a “permitted benefit increase.” One of the private letter rulings involves a situation in which retirees would have between 60 and 90 days to decide whether to take the lump-sum option, while in the other, the retirees would have between 30 and 60 days to decide.

The IRS does not identify those requesting private letter rulings. The letters are made public about three months after they received by the parties requested them.

However, those letters follow the previous announcements—as part of their pension “de-risking” strategies by—Ford Motor Co. and General Motors Co. to give certain salaried retirees a one-time right to convert their annuities to lump sums.

Such an approach has drawn increased interest from employers as they look to reduce risks and costs associated with defined benefit plans. To the extent that employers are able to reduce the number of participants in their pension plans, factors such as fluctuating interest rates used to value plan liabilities become less important.

In addition, by reducing the number of participants in their plans, employers will save on such costs as premium payments—which under a new law are set to jump again—to the Pension Benefit Guaranty Corp., while plan administration costs will decline.

While the IRS private letter rulings cannot be cited as precedent, they could spark increased employer interest in the lump-sum benefit option approach.

Prior to the IRS private letter rulings, “there was not complete clarity” on this approach for individuals already receiving benefits. It will be helpful to have this clarity,” said Jason Richards, a Towers Watson & Co. senior consultant in St. Louis and a member of the consultant's retirement risk management group.

With the release of the private letter rulings, “others may have more confidence in following a similar route” of the applicants, he said.

“As major market shifts are often driven by the actions of the largest corporate plan sponsors, other companies seeking to reduce their pension risks—including sponsors of active ongoing plans—are likely watching and considering whether the new direction might be right for them, too,” Towers Watson said in a newsletter published Friday.