Under some defined benefit plans, participants receive a portion of the benefit as an annuity and a portion as a lump sum. Sponsors of such plans should review the method used for calculating these benefits, particularly annuity benefits, to determine whether the combined value of both portions meets the minimum present value requirements for lump sums. Recent proposed IRS regulations include an interpretation of current law that may differ from the way some plans have been administered.
On February 2, 2012, the Internal Revenue Service (IRS) issued proposed regulations addressing the minimum present value requirements under Internal Revenue Code (Code) section 417(e) for defined benefit pension plans under which participants receive divided payments, typically a lump sum together with an annuity. If a participant can receive both a lump sum and an annuity, these proposed regulations aim to simplify and encourage the participant’s choice of annuity benefits.
Notably, the preamble summary of current law concludes both parts of a divided pension benefit are treated as a single benefit subject to the same minimum present value requirements as lump sums. The proposal would create a limited exception, which becomes available only after the regulations take effect. If a plan satisfies the limited exception, the minimum present value requirements for lump sums would not apply to annuity benefits.
At this time, because of the proposal’s key conclusion that both parts of a divided pension benefit are subject to minimum present value requirements, defined benefit plans offering divided benefits should be reviewed and compared with this interpretation of current law.
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