The Internal Revenue Service Issues a Second Set of Final Regulations Regarding the Disclosure of Relative Values of Optional Forms of Benefit
The Internal Revenue Service (the “IRS”)has issued final regulations (the “final regulations”) on the disclosure of relative values of optional forms of benefit distribution offered under defined benefit plans, money purchase pension plans, and certain other defined contribution plans subject to Section 401(a)(11) of the Internal Revenue Code (the “Code”). The final regulations generally retain the effective dates and requirements provided in prior IRS guidance, while clarifying and modifying several requirements based on comments received by the IRS. The highlights of the final regulations are described in this article.
In December 2003, the IRS issued regulations regarding the content of qualified joint and survivor annuity (“QJSA”) and qualified pre-retirement survivor annuity (“QPSA”) notices (the “2003 regulations”). The 2003 regulations specify how the relative value of optional forms of distribution must be expressed. These regulations are intended to require plans to provide participants with enough information to enable them to compare the values of the distribution forms available to them. (Please see our June 2004 Special Alert for complete details regarding the requirements for disclosing relative value information to participants.) The 2003 regulations were applicable to QJSA distributions with annuity starting dates on or after October 1, 2004 and to QPSA explanations provided on or after July 1, 2004.
Subsequently, in Announcement 2004–58 and in proposed regulations issued in January 2005 (the “proposed regulations”), the IRS provided that the 2003 regulations are generally effective for QJSA explanations with annuity starting dates beginning on or after February 1, 2006. This extension, however, does not apply to the explanations required for a QPSA or any optional distribution form subject to Section 417(e)(3) of the Code with an actuarial present value that is less than the actuarial present value of the QJSA offered by the Plan. The original effective date requirements in the 2003 regulations (July 1, 2004 for QPSA explanations and October 1, 2004 for QJSA explanations) continue to apply to these forms of benefit payments. Optional forms of distribution subject to Section 417(e)(3) of the Code include single sums, distributions in the form of partial single sums in combination with annuities, installment payments, and social security leveling options. (Please see our September 2005 edition for complete details regarding the proposed regulations.)
Provisions Relating to Effective Date
As in the proposed regulations, the final regulations retain the October 1, 2004 effective date for any optional form of benefit that is subject to the requirements of Section 417(e)(3) of the Code if the actuarial present value of that optional form is less than the actuarial present value of the QJSA. For all other optional forms of benefit subject to the QJSA explanation requirements, the final regulations retain the effective date of February 1, 2006.
The proposed regulations listed social security leveling options as optional forms of benefit subject to Section 417(e)(3) of the Code and thus not eligible for the February 1, 2006 extension. In response to comments that social security leveling options are not subject to Section 417(e)(3) of the Code, the IRS decided not include in the final regulations a list of examples of optional forms of benefit that are subject to Section 417(e)(3) of the Code. The IRS states that its decision to omit the list of examples reflects its agreement that these regulations are not the appropriate place for guidance on minimum present value requirements of Section 417(e)(3) of the Code.
In the final regulations, as in the proposed regulations, a plan may use the delayed effective date rule, even if there are minor differences between the value of an optional form and the value of a QJSA for a married participant that are caused by the calculation of the value of the optional form of benefit based on a life annuity, rather than on the QJSA. Solely for purposes of the effective date provisions, the actuarial present value of an optional form is treated as not being less than the actuarial present value of the QJSA if:
- using the applicable interest rate and applicable mortality table under Treasury Regulation sections 1.417(e)–1(d)(2) and 1.417(e)–1(d)(3), the actuarial present value of that optional form is not less than the actuarial present value of the QJSA for an unmarried participant; and
- using reasonable actuarial assumptions, the actuarial present value of the QJSA for an unmarried participant is not less than the actuarial present value of the QJSA for a married participant.
Provisions of the Proposed Regulations Retained
The final regulations retain modifications of the 2003 regulations that appeared in the proposed regulations. For example, for purposes of disclosing the plan’s normal form of benefit, reasonable estimates such as those used to disclose participant-specific information may be used, but only if the plan follows the requirements applicable to the use of reasonable estimates in disclosing participant-specific information. Further, the final regulations retain the rule that the inclusion of participant- specific information does not cause an explanation to fail to satisfy the rules permitting reliance on generally applicable information.
The final regulations also retain a change to Treasury Regulation section 1.401(a)–20, Q&A–16, originally set forth in the proposed regulations, which clarifies the interaction between:
- the rule prohibiting a plan from providing an option to a married individual that is worth more than the QJSA; and
- the requirement that certain optional forms of benefit be calculated using specified actuarial assumptions.
Under that clarification, a plan would not fail to satisfy the requirements of Treasury Regulation section 1.401(a)–20, Q&A–16, merely because the amount payable under an optional form of benefit that is subject to Section 417(e)(3) of the Code is calculated using the applicable interest rate and applicable mortality table required by Section 417(e)(3) of the Code.
Provisions Added or Modified by the Final Regulations
The final regulations adopt other modifications of the 2003 regulations suggested by commentators that were not addressed in the proposed regulations. For example, the final regulations identify the optional forms of benefit available with retroactive annuity starting dates that are required to be covered in a QJSA explanation. Under these regulations, required information must be provided for optional forms of benefit with retroactive annuity starting dates that are available with payments commencing at the time the QJSA notice is provided.
The IRS clarifies in the final regulations that the disclosure of the financial effect of an optional form of benefit (including a benefit with an annuity starting date) must describe the amounts and timing of payments to the participant under the form of benefit during the participant’s lifetime, and the amounts and timing of payments after the participant’s death.
Another modification in the final regulations that was not included in the proposed regulations limits the optional forms that may be described as being approximately equal in value to the QJSA to those optional forms that are within a range of 95% to 105% of the actuarial present value of the QJSA. This limitation applies whether the comparison is made to the QJSA for married participants or unmarried participants. In order to give employers sufficient time to perform the additional calculations required to implement this rule, this change to the regulations need not be applied for disclosures made before 2007.
The final regulations also clarify that, for purposes of comparing the value of an optional form of benefit to the value of the QJSA, if an optional form of benefit is not subject to Section 417(e)(3) of the Code, the reasonableness of interest and mortality assumptions is determined without regard to the circumstances of the individual participant. The applicable mortality table and the applicable interest rate, as defined in Treasury Regulation sections 1.417(e)–1(d)(2) and 1.417(e)– 1(d)(3) are considered reasonable actuarial assumptions for this purpose and may be used.
Finally, in order to avoid providing a level of detail that would overwhelm participants, the final regulations provide that simplified presentations of financial effect and relative value are permitted for disclosure of a significant number of substantially similar optional forms. For example, a plan that provides joint and survivor annuities with survivor payments available at any whole number percentage between 50% and 100% would be permitted to only disclose the financial effect and relative value of the joint and 50% survivor annuity, the joint and 75% survivor annuity and the joint and 100% survivor annuity.
Good Faith Compliance Provided
As noted above, the 2003 regulations, as amended by the new final regulations, generally apply to a QJSA explanation with respect to any distribution with an annuity starting date that is on or after February 1, 2006. The final regulations provide that a reasonable, good faith effort to comply with the new regulations will generally be deemed to satisfy the requirements for QJSA explanations provided before January 1, 2007. For QJSA explanations provided before January 1, 2007, however, the change to Treasury Regulation section 1.417(a)(3)–1(c)(2)(iii)(C), relating to disclosures of optional forms of benefit that are approximately equal in value to the QJSA, is not required to be applied.
If you have any questions regarding the final regulations and how these new rules impact your benefit plans, please contact us.