Final regulations effective August 15, 2005 describe circumstances under which plan sponsors can amend their defined benefit plans to eliminate early retirement benefits and subsidies and optional forms of benefits. These final regulations attempt to clarify Internal Revenue Code Section 411(d)(6) (a.k.a. the “anti-cutback” rule). The purpose of Section 411(d)(6) is to prevent employees from losing benefits they have already accrued. Although the concept appears straightforward, the rules and regulations implementing the concept can be confusing and are highly dependent on definitions and interpretations of the rules, including court opinions.
Among the attempts at clarity of the new provisions are definitions of “early retirement benefits,” “early retirement subsidies,” and “retirement-type benefits.” The regulations also list ancillary benefits which are not protected by the anti-cutback rules, which include:
- Social Security supplements
- Disability benefits to the extent the disability benefit exceeds the benefit otherwise payable
- Life insurance benefits
- Medical benefits under IRC Section 401(h)
- Death benefits other than a death benefit that is part of an optional form of benefit
Plant shutdown benefits permitted under qualified pension plans that do not continue past retirement age and do not affect accrued benefits are not protected by the anti-cutback rule. However, benefits contingent on certain events, such as a plant shutdown or involuntary separation, that continue after retirement are considered retirement subsidies and are protected under the anti-cutback rule. This rule applies to amendments adopted after December 31, 2005.
Optional Forms of Benefits
Optional forms of benefits can be eliminated if they are “redundant” or the amendment applies to a benefit with an annuity commencement date earlier than 90 days after the amendment is adopted. Plan amendments to defined benefit plans will not violate the anti-cutback rule if the optional form of benefit being eliminated is in the same category or “family” as other such benefits available and under no greater restrictions to participants. Examples of “families” for optional forms of benefits include joint and contingent options with continuation percentages of 50% and more (survivor annuities) as well as 50% and less.
Optional benefits may also be eliminated by plan amendment if four “core” options will remain and if the optional form of benefit eliminated will remain available for at least four years after the amendment adoption. Core benefits are:
- Straight-life annuities with level payments and no death benefit
- Joint and contingent annuities with a participant life annuity and 75% survivor annuity
- 10-year certain life annuity with guaranteed payments for 10 years (even if the participant dies before the 10-year period is up)
- The most valuable life option for a participant with a short life expectancy (i.e., optional form of benefit for each annuity starting date reasonably expected to result in payments with the largest actuarial present value for the participant who dies soon after the annuity starting date)
Proposed regulations also issued last month would establish a “utilization test” that plan sponsors could apply to reduce or eliminate retirement benefits, retirement subsidies, or optional forms of benefits if the benefit to be eliminated was available to at least 100 participants during a two-year look-back period (which can be expanded up to five years) but was not elected by any participant. The utilization test could not be used to eliminate or reduce “core benefits” (listed above).
The proposed regulations would also provide guidance on the interaction between the anti-cutback rule and vesting requirements. The proposed regulations follow a 2004 Supreme Court opinion that suspension of early retirement benefits accrued prior to a plan amendment cutting back the availability of these early retirement benefits post-retirement violated the anti-cutback rule.
The utilization test rules are proposed to be effective for amendments after December 31, 2006, while the regulations proposed in regard to cutback of accrued benefits would be effective June 7, 2004, the date of the Supreme Court opinion. Comments on the proposed regulations are due by November 15, 2005.PROPOSED IRS CODE SECTION 415 REGULATIONS, THE DEFINITION OF COMPENSATION, AND ITS EFFECT ON DEFFERALS POST-SEVERANCE
Background: On May 31, 2005, the government issued proposed rules under Internal Revenue Code Section 415, which describes the limitations on benefits and contributions for qualified plans, including the definition of “compensation” to be used when determining those limitations. This definition has major significance and affects other sections of the Code, for example, the provisions that determine who are “highly compensated” employees and the performance of nondiscrimination testing. The proposed regulations incorporate guidance on other subjects from the IRS and Treasury over the past two decades (and several years) since a major overhaul of Code Section 415 regulations was last issued. Questions remain about the regulations’ meaning and implications.
However, we bring to your attention one of the proposed provisions that can be relied upon even in proposed form and about which there has been no guidance from the IRS in the past, which is the definition of compensation and 401(k) deferrals from severance pay.
Under the proposed regulations:
- An employee can continue to make deferrals from certain types of compensation for up to two months after termination from employment. The types of compensation are limited to:
- regular compensation, including commissions and bonuses, that the employee would have earned if he or she had not terminated employment;
- accrued sick leave, vacation or other leave that the employee could have used if he or she had not terminated;
- payments while the employee is on military duty.
We will alert you to the other provisions of the Code Section 415 regulations when final.
PENSION REFORM LEGISLATION
For news and continuing updates on Pension Reform Legislation, please visit our website at www.constangy.com. For further information on any benefits and ERISA topics, you are encouraged to phone Dana Thrasher or Rebecca Amthor at 205-252-9321, Mike Malfitano at 813-223-7166, or your Constangy attorney.
For more information on the Act or any other benefit matters, please contact Ira Friedrich, Carl Cannon or Andrea Bailey at (404) 525-8622 or Dana Thrasher at (205) 252-9321.