Surprise! IRS issues final regulations on minimum present values 

February 20, 2024

Final regulations under Internal Revenue Code (IRC) Section 417(e) update procedures for defined benefit (DB) plans to calculate minimum values for lump sums and other accelerated forms of payment. The regulations — issued without fanfare more than seven years after IRS first proposed the rules in late 2016 — have a few changes from the proposal. Notably, the final rules include new and welcome flexibility for DB plan sponsors to change Section 417(e) rates used for other purposes. The changes are generally optional and unlikely to have a significant effect on participant benefits. Accordingly, many plan sponsors may simply decide to leave plan administration unchanged. However, certain contributory plans and plans that haven’t been treating Social Security level-income options (SSLIOs) as subject to Section 417(e) may need to change procedures. Sponsors may immediately rely on the regulations, which will generally apply to distributions starting Oct. 1.

When a DB plan pays a participant’s benefit in a lump sum or other accelerated form — such as a SSLIO or installments over a fixed number of years — Section 417(e) minimum present value rules generally apply. (Special rules cover most cash balance and other hybrid plans, but those rules are beyond the scope of this article.) The minimum present value rules require the distributions to be at least the actuarial equivalent of the accrued benefit payable at normal retirement age (NRA), calculated using prescribed interest and mortality assumptions. However, until now, the regulations haven’t specified whether the prescribed mortality applies only after NRA or also between the participant’s age on the annuity starting date and NRA. Using preretirement mortality produces a smaller present value, since it accounts for the probability that the benefit will not be paid.

Like the proposal, the final regulations require using preretirement mortality to calculate the minimum present value — regardless of whether the plan pays the full value of the participant’s benefit on death. This is because IRS views the death benefit not as part of the accrued benefit but instead as an ancillary benefit that employers can eliminate. Of course, plans may provide a larger benefit by using a more generous basis than Section 417(e) requires. Many plans currently disregard preretirement mortality when determining the lump sum value of the benefit (resulting in a lump sum larger than the minimum present value) and can continue to do so after the regulations take effect.

Some DB plans require participants to pay contributions to fund part of the benefit. The employee-provided benefit may not be forfeited on the participant’s death and are considered part of the accrued benefit. Therefore, plans can’t use preretirement mortality when determining the present value of these amounts. Under the final rule, contributory plans will determine the minimum present value as:

• The present value of the employee-provided accrued benefit, ignoring preretirement mortality, plus
• The present value of the employer-provided accrued benefit, reflecting preretirement mortality

Change for some contributory plans relying on older guidance. IRS guidance issued in 1989 let plans pay the greater of (i) the present value of the employee-derived benefit, ignoring preretirement mortality, or (ii) the present value of the total accrued benefit, reflecting preretirement mortality. This approach is no longer acceptable under the final regulations, so some plan sponsors will have to change their calculations to reflect the new rules going forward.

Previously calculated benefits unaffected. The regulations clarify that plans needn’t revise benefits for calculations performed before the regulation’s applicability date. This will be welcome news for contributory plans that allow terminating employees to take a partial distribution (most commonly, a lump sum equal to the amount of the employee’s contributions with interest), with a residual annuity payable at a later retirement date. Some commenters on the proposal were concerned that these residual annuities would have to be recalculated under the new rules.

The regulations include a special provision for certain plans that ignore preretirement mortality when calculating lump sums, including plans that reflect the death benefit in the present value and contributory plans that for administrative ease, ignore preretirement mortality on both the employee- and employer-derived benefits. Under the new methodology, lump sums calculated in this manner exceed the minimum benefit payable under Section 417(e). Although paying larger amounts is permissible, commenters expressed concerns that doing so would violate the requirement in Treas. Reg. Sec. 1.401(a)-20, Q&A-16, which says the plan’s qualified joint-and-survivor annuity (QSJA) must be at least as valuable as any other optional form of benefit payable at the same time, with one exception: optional benefit forms subject to Section 417(e) that are calculated using both the prescribed interest rate and mortality. In response to these comments, the final regulation expands the Q&A-16 exception for benefits in these two specific situations.

The final regulations don’t include the earlier proposal’s language about benefits paid after NRA that had raised concerns among practitioners. The proposal said that the present value of any Section 417(e) payment form “cannot be less than the present value of the accrued benefit payable at normal retirement age except to the extent that, for an optional form of benefit payable after normal retirement age, the requirements for suspension of benefits under section 411(a)(3) are satisfied.” Commenters worried that because the proposal required plans to always reflect mortality on employer-provided benefits, plans might also have to reflect mortality — often called “survivorship” in this context — when calculating actuarial increases for late retirement. Reflecting survivorship would have increased the benefit for plans that didn’t already do the calculations this way and might have had other consequences beyond the minimum present value rules.

In response to those concerns, the final regulations explicitly distinguish between benefits paid before and after NRA. The new language says that the present value of any optional form paid after NRA “may not be less than the present value of the immediate annuity (payable in the same form as the accrued benefit is expressed).” Although this formulation doesn’t raise the same concerns as the proposal, the provision neatly avoids altogether the question of how to calculate the immediate annuity at the late-retirement age. In the preamble to the final regulations, IRS explains that the application of survivorship to the period after NRA arises under the vesting rules of Section 411(a), not Section 417(e). The agency intends to address these issues in a future proposed regulation.

The final regulations include an alternative way for SSLIOs to satisfy Section 417(e). SSLIOs give a participant an approximately constant income stream before and after Social Security benefits start. SSLIOs do this by paying a higher benefit from the plan before Social Security benefits begin, then reducing the benefit thereafter. For example, a participant entitled to a $1,300 per month pension benefit starting at age 60 and a $1,000 per month Social Security benefit starting at age 65 might elect instead a SSLIO from the pension plan that pays $1,900 per month from age 60 to 65 and $900 per month thereafter. In this way, the participant would receive $1,900 from the plan before age 65 and a total of $1,900 in plan plus Social Security benefits from age 65 on.

Because a SSLIO accelerates a portion of a participant’s pension payments, the Section 417(e) minimum present value rules apply. The proposal would have required plans to use the applicable Section 417(e) interest and mortality to calculate minimum benefits. Any lesser benefits would fail to satisfy the minimum present value requirements.

Under the final regulations, as an alternative to using Section 417(e) interest and mortality, plans may instead use “implicit bifurcation” to satisfy the minimum present value rules. Implicit bifurcation treats the benefit as if it consisted of a temporary annuity and a remaining annuity portion. An implicitly bifurcated SSLIO will be deemed to satisfy Section 417(e) as long as two conditions are satisfied. Those conditions require that the remaining annuity benefit in the normal form must be at least as great as the accrued benefit minus the actuarial equivalent (using Section 417(e) assumptions) of the temporary benefit when all amounts are calculated at NRA and the annuity starting date.

Using this method may enable plans to pay somewhat smaller benefits than otherwise would be allowed, but sponsors will have to consider whether the payoff is worth the effort:

• Sponsors will need to amend their plans for the new method, but Section 411(d)(6) anti-cutback relief is not available. So sponsors will have to protect the current conversion basis for benefits accrued as of the date of any change.
• The calculations are complex, making them difficult to implement and explain to participants.

Historically, some plan sponsors didn’t use Section 417(e) assumptions to calculate SSLIOs. In the 2016 proposed regulations, IRS clarified its view that SSLIOs are subject to Section 417(e). Now that the regulations have been finalized, any plans not already using Section 417(e) assumptions to calculate these options will have to start using one of the approaches described in the final regulations.

The new regulations make it easier for plan sponsors to change Section 417(e) interest and mortality rates that a plan uses for other purposes, such as calculating early retirement benefits or optional forms of benefits not subject to Section 417(e). Changes in a plan’s actuarial equivalence bases are generally protected by the anti-cutback rules, meaning those bases can only be changed prospectively, for benefits accrued after the plan is amended. However, the regulations provide explicit anti-cutback relief for changes to the Section 417(e) rates used for minimum present value determinations. Under this exception, plans must pay benefits using the more generous of the old rates or the new rates for a year after the change. After that, the new rates can be applied to all benefits, regardless of when accrued.

This exception didn’t use to apply when sponsors wanted to change their Section 417(e) rates used for other purposes. This meant that even if a sponsor changed its applicable rates for paying lump sums, it couldn’t make the same change to Section 417(e) rates used for other purposes.

The final regulations now extend the exception for changing Section 417(e) rates to optional uses of those rates. Effective immediately, sponsors that use these rates for purposes besides determining minimum present values can now change those rates for all benefits, subject to the same one-year protection period when the more generous basis applies. This relief applies to any permitted change in the time for determining the interest rate (a change in the stability period or lookback month), including an indirect change resulting from a change in the plan year.

The anti-cutback relief for changes to assumptions used for purposes other than minimum present values is available for amendments made on or after Jan. 19. The remainder of the regulations applies to distributions with an annuity starting date of Oct. 1 or later. Earlier distributions are subject to the rules in effect before IRS issued the final regulations. Any benefit calculated before that date won’t change as a result of the new rules. However, employers may optionally choose to apply the final regulations earlier than Oct. 1.

• Final regulations (Federal Register, Jan. 19, 2024)
• Proposed regulations (Federal Register, Nov. 25, 2016)