IRS to Eliminate Common ERISA Pension Plan De-risking Strategy

August 7, 2015
« Next Previous »

Last week, the Internal Revenue Service issued a notice to announce that it will prohibit a cash-out window for Employee Retirement Income Security Act pension plans. The amendment to the ERISA pension plan de-risking strategy will prevent lump sum payments in lieu of remaining annuity payments.

The new ERISA de-risking strategy

The IRS announced in Notice 2015-49 that it will no longer allow lump sum cash-outs, a practice it previously permitted under several rulings. However, the IRS’s new position will place limits on lump sum offers from employers’ plans for participants who are not yet receiving distributions from pension plans covered by ERISA. In the notice, the IRS stated that lump sum cash-outs “undermine the intent” of the minimum required distribution regulations that prohibit accelerated annuity payments for pre-existing ERISA pension plans. This notice represents a significant shift for the IRS, as it recently permitted lump sum cash-outs in private letter rulings for large sponsors, including Ford and General Motors.

A common de-risking strategy

Employers often provide voluntary lump sum cash-out options for current employees and retirees as a cost-effective method of reducing pension risk and reducing administrative costs. The buyout strategy is typically offered to pensioners during a company’s financial restructuring period to avoid future funding risks arising from underperforming pension assets. A pension plan must have an assumed rate of return on plan assets and when performance falls below the assumed rate of return, the sponsor must increase its contribution to the plan. With the volatility and potential financial burden of tax-qualified defined benefit obligations for sponsors, employers look to de-risking strategies as a means of financial stability.

Opponents of the ERISA de-risking strategy

The IRS’s new requirements follow a General Accounting Office report that found a significant number of de-risking disclosures for ERISA pension plan participants were deficient. This prompted criticism from the American Association of Retired Persons to limit ERISA de-risking strategies. The AARP noted that de-risking strategies may cause pensioners to lose their PBGC insurance protection and a significant amount of their retirement wealth. According to Norman Stein, Senior Policy Advisor to the Pension Rights Center, these de-risking strategies eliminate federal private pension protections for ERISA. “The offer of a lump sum can create considerable confusion and anxiety for older Americans, who are often not in a position to appreciate the risks they face and the losses they might suffer,” Stein noted.


Following the amendment, the IRS now requires employers seeking to settle liabilities for retirees in ERISA pension plans to transfer the liabilities to a third-party insurance company. However, the amendment will permit other risk transfer strategies, including lump sum cash-outs already in progress. Senator Ron Wyden noted that the new amendment is significant because lump sum cash-outs can jeopardize the ERISA pension plans for more than 44 million workers and retirees. The irony is that businesses are criticized when they take too much risk, but when business attempts to reduce its risk, rule changes such as this one, prevent it.  Remember, General Motors and the City of Detroit went bankrupt because of legacy costs and I wonder if any retirees whose benefits were curtailed as a result wish they had taken a lump sum.