Comments on optional forms of benefits for defined contribution plans.

August 1, 2000

On August 1, 2000, Tax Executives Institute submitted the following comments to the Internal Revenue Service on the proposed section 411(d)(6) regulations, relating to optional forms of benefits. The comments were prepared under the aegis of TEI's Federal Tax Committee, whose chair is Philip G. Cohen of Unilever United States, Inc. Materially contributing to the preparation of the comments were Michael J. Nesbitt of Paychex, Inc., David E. Sherwood of Microsoft Corporation, and Leslie A. Honig of the Chase Manhattan Bank.

On March 29, 2000, the Internal Revenue Service released proposed regulations (REG-109101-98) that would (i) permit qualified defined contribution plans to be amended to eliminate some alternative forms in which the account balances can be paid under certain circumstances, and (ii) permit certain transfers between defined contribution plans. The proposed regulations were published in the March 28, 2000, issue of the FEDERAL REGISTER (65 F.R. 16546) and in the April 17, 2000, issue of the INTERNAL REVENUE BULLETIN (2000-16 I.R.B. 903). TEI is pleased to submit these comments on the proposed regulations.

Background

Tax Executives Institute is the preeminent association of business tax executives in North America. Our more than 5,200 members represent 2,800 of the leading corporations in the United States, Canada, and Europe. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works -- one that is administrable and with which taxpayers can comply.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by the proposed regulations with special rules regarding optional forms of benefit distributions from qualified plans.

Overview

Section 411 of the Internal Revenue Code sets forth minimum vesting standards for employee pension plans. Section 411(d)(6) provides an anti-cutback rule, i.e., an employer may not decrease an accrued benefit by amending the plan. A plan amendment that retroactively (i) eliminates or reduces an early retirement benefit or a retirement-type subsidy (as defined in regulations), or (ii) eliminates an optional form of benefit is treated as reducing accrued benefits. Thus, once benefits have accrued -- even if they are benefits that the employer was not required to provide -- the employer may not reduce those benefits without imperiling the qualified status of the plan.

Notwithstanding the thrust of section 411(d)(6), the Treasury Department has authority under section 411(d)(6)(B) to provide exceptions to the rule relating to the elimination of optional benefits. Two years ago, the IRS issued Notice 98-29, 1998-1 C.B. 1163, announcing its intent to issue regulations providing such exceptions and asking for comments. On September 11, 1998, the Institute filed comments in response to the Notice. The proposed regulations incorporate the comments received from TEI and others in respect of the elimination of optional forms of benefits.

TEI commends the IRS and Treasury Department for their willingness to consider providing exceptions to the anti-cutback rule in respect of defined contribution plans. The preamble to the proposed regulations notes that the accumulation of a variety of payment choices in a plan may increase the cost and complexity of plan operations. 2000-16 I.R.B. at 903-04. TEI wholeheartedly agrees. Whether a result of mergers, plan redesigns, or other factors, the accumulation of these choices can impose a significant burden and cost to plan sponsors. Participants eligible for these optional benefits must be identified and tracked and regular plan communications must be tailored to these participants. Dealing with these exceptions makes administering the plan more difficult and hinders automation of plan administration.

The inability to eliminate optional forms of benefits can also impose a hardship on participants. Many sponsors have resorted to negotiating the termination of a former plan, prior to an acquisition, to mitigate the complications of the anti-cutback rules. Because termination requires distribution of all plan assets to participants, including the potential cash out of plan investments, such an action may not be in the best interests of participants.

For these reasons, TEI supports the efforts by the IRS and Treasury to provide relief to plan sponsors and participants. Many provisions in the proposed regulations merit support. For example, the provisions that allow transfers between plans in the event of mergers or job transfers by participants are particularly helpful. We suggest, however, that the proposed regulations could go much further in providing relief while not materially reducing benefits to participants. Moreover, published guidance is generally enhanced by the use of examples. For a complex area such as pensions, it is better to err on the side of more, rather than fewer, examples. TEI encourages the IRS to include additional examples highlighting the key points of the regulations, particularly in respect of the proposed changes to Treas. Reg. [sections] 1.411(d)-4, A-3.

The Institute's specific recommendations on the proposed regulations are provided below.

Prop. Reg. [sections] 1.411(d)-4(e): Alternative Forms of Payment

A. Single-Sum Distribution

Prop. Reg. [sections] 1.411(d)-4(e)(1) generally provides that optional forms of benefits can be eliminated if, after the plan amendment, the distribution choices available to the participants include a single-sum distribution option and an extended-distribution option. The preamble to the regulations acknowledges, however, that a strong case can be made that only a single-sum distribution option should be required to be retained, and states that the IRS and Treasury are willing to revisit this issue. 2000-16 I.R.B. at 905. Consistent with our comments on Notice 98-29, TEI strongly supports requiring only a single-sum distribution option. We thus urge the IRS and Treasury to reconsider the requirement for an additional form of extended distribution.

Plan participants who receive a distribution in a lump sum may roll those funds over into an individual retirement account (IRA). These accounts can provide a variety of payment options and investment choices, allowing participants to mirror what may be available in the qualified plan. The availability of this flexibility mitigates the need to retain an extended-distribution option.

The preamble avers that the extended-distribution option should be retained because of the benefit participants can derive from employer involvement in selecting and monitoring investment options. 2000-16 I.R.B. at 905. Given the trend toward more participant-directed investment in qualified plans, however, this benefit may be overestimated. In most cases, plan sponsors make a wide variety of investment options available to participants. While the employer may provide information on the funds (primarily historical performance information) and try to educate the participants on the need for diversification and on how to evaluate risk, the participants ultimately select the combination of investments most suited to their needs or desires. This same process would generally occur when an individual selects an IRA for investment. The investment resources available to the general public are generally more substantial that the information most employers offer.

Ironically, rather than relying on the employer for investment guidance, many participants object to the selection of employer's investment options as too limited. These participants often recommend other funds that should be added to the available choices and obviously do not view the employer's involvement in investment selection as a significant benefit.

TEI reiterates its recommendation that only a single-sum distribution option be required. Given the alternatives available to individuals through IRAs or annuities, retaining an extended-payment option is unnecessary to protect employees. This is particularly true since -- as the preamble acknowledges -- the vast majority of participants who are given a choice elect the single-sum option. Alternatively, the ability to limit the distribution option to a single-sum should at least be applicable to plans with participant-directed investments.

B. Profit-Sharing and Stock-Bonus Plans

At a minimum, the requirement of an extended-payment option should be eliminated for profit-sharing and stock bonus plans because (i) elimination would not actually deprive participants of a right to control the timing of receipt of distributions; (ii) elimination would significantly simplify plan administration; and (iii) an extended-payment option is not a necessary feature of a profit-sharing or stock-bonus plan. In the preamble, the IRS and Treasury acknowledge the first two points, i.e., that participants have great flexibility in controlling the receipt of amounts rolled over to an IRA, including withdrawals over extended periods, and it is costly and complex to administer multiple payment options. Moreover, an extended-payment option has never been required for non-pension plans and is unnecessary in any event.

Savings plans have traditionally played a role as a source of funds for emergency and other extraordinary situations. This is a role they can continue to play during the retirement years through the control of distributions from an IRA (which is not available under an extended-payment option). In addition, IRAs typically allow participants to adjust the amount of withdrawals for regular retirement income, based upon personal knowledge regarding one's life expectancy, the level of investment earnings, etc. Because IRA rollovers offer flexibility to persons of any age, there is no reason to require the retention of such options for persons who have attained a certain age. In sum, the advantages to participants of an extended-payment option under a profit-sharing or stock-bonus plan are dubious and may be outweighed by other factors. The requirement should be eliminated for such plans.

C. Extended-Distribution Option

The preamble requests comments on whether the final regulations should provide specific forms of relief regarding the extended-distribution option. 2000-16 I.R.B. at 905. Assuming this option is retained in the final regulations (and we believe it should not be), TEI offers the following comments on the suggested forms of relief.

1. Should a mandatory extended-distribution form be retained only for participants who have reached a specified age, such as age 55, age 62, or normal retirement age, at the time of distribution?

Any provision that applies only to a segment of the participants -- whether it be an optional form of benefit or some other provision -- adds cost and complexity to plan administration. Accordingly, TEI opposes retaining an extended-distribution option only for participants who have reached a certain age.

One alternative suggested in the preamble is to treat a plan as satisfying the extended-distribution requirement if the plan allows a participant to elect to receive the distribution by transfer of the account to a defined benefit plan. While this may be helpful, the practical effect of the exception would be modest because of the limited number of employers that maintain -- and allow transfers between -- a defined contribution plan and a defined benefit plan.

2. Should there be an exception from the required extended-distribution form if a plan with an extended-distribution form is merged into another plan that does not offer such a form (e.g., if the plan without the extended-distribution form has a larger number of participants) in connection with an asset or stock acquisition, merger, or similar transaction involving a change in employer of the employees of a trade or business?

TEI strongly supports providing such an exception, which would eliminate the need to terminate the prior plan to avoid the anti-cutback provisions (which is often done to the detriment of participants).

The need for this exception is obvious where the number of participants in the prior plan is small in comparison with the successor plan. For example, consider a plan with 20 participants that offers a distribution option of installment payments over 20 years. As the result of a merger, this plan is merged into a plan with 5,000 participants. The successor plan offered only a single-sum distribution option prior to the merger. If the installment option cannot be eliminated, the successor plan would be required to track the 20 participants separately until a distributable event occurs and update its plan procedures and communications to reflect the extended-payment option.

This requirement can impose significant costs on the plan for relatively few participants. Because the small-plan participants are likely to benefit from participation in a larger plan through broader investment options or the ability to make more frequent investment changes, eliminating the optional form of benefit seems a reasonable compromise.

Moreover, if the extended benefit option cannot be eliminated in the above example, it would be a feature of the successor plan. Would this become the "period at least as long as the longest period over which the participant is entitled to receive a distribution under the plan" standard (see Prop. Reg. [sections] 1.411(d)-4(e)(3)(C)) by which all future amendments must be judged? Under current law, the answer is definitely "yes," but we strongly suggest that such a result is not warranted.

3. Should there be an exception from this requirement for small businesses (e.g., employers with fewer than 100 employees or fewer than 25 employees)?

Although the Institute's members do not work for small businesses, TEI would support the establishment of such an exception in the event the extended-distribution option is retained in the final regulations. The cost of plan administration is a concern for all businesses, but for a small business, this cost can act as a bar to implementing a qualified plan. Any provision that minimizes the compliance burden for small businesses should be supported.

D. Elimination of Minor Benefits

According to Notice 98-29, one alternative under consideration was to permit plans to eliminate optional forms of benefits available to no more than a small portion of participants' benefits. TEI endorsed this alternative in our 1998 comments and submitted that taxpayers should also be permitted to eliminate an optional form of benefit that is available to a relatively small percentage of participants. TEI is disappointed that neither alternative is included in the proposed regulations. The Institute believes that the alternatives would reduce plan administration burdens by eliminating options that do not provide a significant benefit to plan participants. We urge the IRS to reconsider these alternatives.

Allowing employers to eliminate minor benefits is wholly consistent with the overall simplifying thrust of the proposed regulations. Relatively minor differences in items, such as designating the time when benefits commence, spawn significant administrative difficulties without producing benefit for the participant -- certainly far less than eliminating an optional form of benefit. Certainly, changing the time of benefit commencement should not be considered a material reduction in benefits if the commencement date is within some set period, say two years, from the original date.

Some plans commence distribution immediately following a triggering event (such as termination of employment), whereas others delay distribution until early in the calendar year following the triggering event. Forcing plan administrators to maintain different commencement dates for benefits paid under two or more merged plans creates an unreasonable administrative burden. Moreover, forcing plan administrators to use the earliest distribution date will often require plans to make dual distributions for each participant -- one after the triggering event and another after the end of the year when a final contribution for the year has been made to the plan and allocated to the participant's account. Similarly, the frequency of installment distributions (monthly, quarterly, or annually) can create unreconcilable administrative burdens for plans wishing to maintain annual installments for the majority of their participants, but forced to provide monthly or quarterly distributions for participants of acquired plans. Similar considerations apply to making minor changes in the timing or frequency of in-service and death-benefit distributions.

TEI submits that requiring rigid adherence to precisely identical timing and frequency of distributions provides relatively little benefit to participants, while impairing potentially significant costs that are typically passed on to participants. By the same token, allowing plan administrators to make minor changes to achieve uniformity (whether distributions are retirement, in-service, or death benefits) would likely lower overall administrative costs and inure to the financial benefit of participants. Thus, TEI believes that the interests of participants would be better served by permitting plans to make minor changes in the commencement date of distributions and in the frequency of installment distributions.

E. Standard For Extended-Distribution Option

Prop. Reg. [sections] 1.411(d)-4(e)(3)(C) includes a special provision for a plan amendment that does not eliminate a life annuity or periodic payments over the participant's life expectancy. For such an amendment, the requirement to provide an extended-distribution option would be met if the plan offered a distribution option of periodic payments over a period "at least as long as the longest period over which the participant is entitled to receive a distribution under the plan." TEI believes that using this standard could impose an added burden to a plan where the longest period relates to an option that is available to only a small percentage of the plan participants.

For example, assume that, as the result of an acquisition, a plan with 25 participants is merged into a larger plan. At the time of the proposed plan amendment, only I participant of the original 25 remains an active participant. Assume further that the acquired plan offered a 30-year installment option, whereas the successor plan, with 5,000 participants, offers a 10-year option. To meet the standard for a plan amendment involving an optional form of benefit, the plan must offer a 30-year installment option to all 5,000 participants merely because a single participant has such an option. TEI believes this is an inappropriate result and recommends the standard not exceed the payment period applicable to the majority of plan participants rather than the longest period.

F. No Prior Extended-Distribution Option

Presumably, if a plan offers only single-sum payment options at the time the amendment to eliminate an optional form of benefit is adopted, there is no requirement under the proposed regulations to provide an extended-payment option. In this case, the longest period over which participants are entitled to receive a distribution is one day. This point should be clarified in the final regulations, perhaps by an example. For this purpose, Example 3 of Q&A-1 of existing Treas. Reg. [sections] 1.411(d)-4 deals with two single-sum payment options and could be used as the basis for an example.

G. Otherwise "Identical" Distribution Form

The proposed regulations provide that the alternative forms of payment must be in an "otherwise identical distribution form" as the form of benefit being eliminated. Prop. Reg. [sections] 1.411(d)-4(e)(2) provides that a distribution form is "otherwise identical" only if it is "identical in all respects" to the eliminated benefit. The proposed regulations provide an example that a single-sum distribution form is not otherwise identical if the single-sum form --

* is not available in the same medium of distribution as the installment form,

* does not apply to the benefit to which the installment form applied,

* imposes any condition of eligibility that did not apply to the installment form, or

* lacks any related election rights that were available in respect of the installment form.

TEI is concerned with the use of the term "otherwise identical" as the standard for determining if a distribution option is comparable to the eliminated one. Although the regulations provide helpful guidance on the meaning of this term, "otherwise identical" implies an absolute standard where even minor differences could be deemed sufficient to preclude relief. This could prompt disagreements on examination concerning whether one benefit option is "identical to another. TEI believes that plan administrators should not be precluded from making minor changes, such as a change of less than two years in the date the benefits would otherwise commence. Such minor changes have little detrimental effect on participants and may allow the plan to achieve significant savings in administrative costs.

TEI recommends that the term be changed to "substantially similar." That language, coupled with the existing examples in the proposed regulations, would more appropriately capture the intent of the provision.

H. Eliminating Little Used Forms of Benefits

Certain optional forms are seldom or never used by participants. See 2000-16 I.R.B. at 903-04. TEI remains concerned that low utilization, as an absolute number, might merely reflect a young participant population with low turnover. An employer, however, could be permitted to eliminate a few benefits. For example, if during the three plan years prior to adoption of an amendment, less than five percent of eligible participants select a 10-year annuity, the plan should be permitted to eliminate this unpopular form of benefit. To prevent anomalous results with small plans, the regulations could also provide that the form of benefit could be eliminated only where there are a minimum number of distributions a year, e.g., 20 per year during a three-year period.

In-Kind Distributions

The preamble requests comments on whether protection for in-kind distributions of employer securities and property that is not marketable securities should be retained. Comments are also requested on protection for other types of in-kind distributions. 2000-16 I.R.B. at 907.

Participants who receive distributions of employer securities are not required to include the net unrealized appreciation of the stock in current income unless they elect to do so. This flexibility in the timing of the taxation of the gain from the appreciation can be a substantial benefit to participants. This is particularly true for participants who have been long-term employees of successful companies and who may have substantial unrealized appreciation in the employer securities they receive. For this reason, TEI supports the continued protection of this distribution option as modified by the proposed regulations

There is no reason, however, to protect in-kind distributions when the underlying securities no longer exist, e.g., when a company is acquired through a cash purchase of shares or when the alternative of investing in employer stock is eliminated. Accordingly, TEI urges that the final regulations clarify that the protection of in-kind distributions is limited to employer securities that carry some minimum period of net unrealized appreciation. The IRS and Treasury may also wish to consider liberalizing the restrictions on 401(k) plan distributions to permit in-service distribution of employer securities with net unrealized appreciation in the event that employer securities are eliminated from the plan.

Prop. Reg. [sections] 1.411(d)-4, A-3: Elective Transfers

A. Sales of Part of a Business

The proposed regulations would substantially revise the circumstances under which elective transfers between qualifying plans may be made. The existing regulations do not permit an elective transfer unless the participant's distribution under the transferring plan is "immediately distributable." The proposed regulations grant broad section 411(d)(6) relief for many types of elective transfers of a participant's entire benefit, without regard to whether the participant's benefit is immediately distributable. The preamble to the proposed regulations strongly implies that the elimination of the "immediately distributable" requirement -- and the substitution of new requirements -- is intended to permit elective transfers in situations in which the section 401(k) "same desk" distribution restriction applies.(1) 2000-16 I.R.B. at 906. In this regard, Prop. Reg. [sections] 1.411(d)-4, A-3(b)(1)(iii) requires, as follows:

The transfer must be made in connection with an asset or stock acquisition, merger, or other similar transaction involving a change in employer of the employees of a trade or business (i.e., an acquisition or disposition within the meaning of section 1.410(b)-2(f)) or in connection with the participant's transfer of employment to a different job for which service does not result in additional allocations under the transferor plan.

The application of the regulation to elective transfers in "same desk" situations is unclear. Under section 401(k)(10), the "same desk" restriction currently does not apply if there is a sale of "substantially all of the assets of a trade or business" or a subsidiary. Based on the preamble, it appears that the proposed regulation's provision for a "change in employer of the employees of a trade or business" is intended to include transactions in which less than all or "substantially all" of a trade or business is acquired. The final regulations should clarify this point by providing that a transaction qualifies if it involves "a change in employer of the employees of all or part of a trade or business." In addition, the parenthetical reference to Treas. Reg. [sections] 1.410(b)-2(f) should be eliminated.

B. Transfers From 401(k) to Non-401 (k) Plans

Prop. Reg. [sections] 1.411(d)-4, A-3(b)(ii) requires that an elective transfer must be between plans of the same type. For example, the proposed regulations require that benefits under a qualified 401(k) arrangement may be transferred only to another qualified 401(k) arrangement. The preamble observes that the proposed rule would ensure that the amounts transferred to the receiving plan would be subject to similar legal restrictions with respect to same in-service distributions. 2000-16 I.R.B. at 906.

TEI recommends that the requirement for "plans of the same type" be eliminated. The participant always retains the right under the elective transfer rules to leave his or her benefit in the existing plan and is thus not deprived of any right by being permitted to transfer to a dissimilar plan. This participant choice is particularly important for 401(k) plan participants whose benefits may not be distributable from a prior employer's plan because of the "same desk" rule. Similarly, once a distribution is immediately available, there is no reason to maintain the prior plan's restrictions on transfer.

In respect of in-service distribution restrictions, we note that in the absence of the "same type" requirement, a transfer could result in various distribution restrictions, depending upon the types and terms of the transferor and transferee plans. The IRS and Treasury's concern about lesser in-service distribution restrictions for some participants in a transferee plan should be weighed against the disadvantages of requiring a participant to leave his or her benefit in a prior employer's plan. These disadvantages include practical investment control limitations in a participant-directed plan and increased costs of plan administration. We submit that the disadvantages of the "plans of the same type" rule outweigh the advantages. At a minimum, the Institute recommends that the "plans of the same type" requirement not apply to elective transfers outside the controlled group from a 401(k) plan, if the reason that benefits are not immediately distributable is the 401(k) "same desk" rule.

Conclusion

Tax Executives Institute appreciates this opportunity to present its views on the proposed regulations issued under section 411(d), relating to optional forms of benefit distributions from qualified plans. The Institute's comments were prepared under the aegis of its Federal Tax Committee, whose chair is Philip G. Cohen. If you have any questions, please do not hesitate to call Mr. Cohen at [phone], or Mary L. Fahey of the Institute's professional staff at [phone].

(1) See P.L. R. 9835040, which holds that when an employee continues on the same job for a different employer as the result of a liquidation, merger, or consolidation of the former employer, there is no "separation from service." This is referred to as the "same desk" rule.