Consequences of failing to provide suspension-of-benefits notice.

A recent court decision takes a different approach from the IRS as to the consequences of failing to provide notice of suspension of benefits under a defined benefit pension plan (Monks v. Keystone Powdered Metal Co., 78 F Supp2d 647 (DC Mich. 2000)). In Monks, the sponsoring employer failed to provide the required suspension-of-benefits notice to an employee who had continued in employment beyond normal retirement age. The Service typically would have viewed this error as a qualification failure and required the employer to correct the situation in a manner that would have awarded Monks his requested relief. However, the court determined that Monks suffered no harm and did not award him any relief. This issue is important to many companies; failing to provide suspension-of-benefits notices is common and the costs of correction can be costly.

Notice Failure

Monks participated in his employer's traditional defined benefit pension plan, which was tax-qualified under Sec. 401(a) and subject to the Employee Retirement Income Security Act of 1974 (ERISA) Title I. Under such a plan, an employee who retires at normal retirement age becomes entitled to begin receiving immediately his pension benefit in the form of a lifetime annuity (i.e., monthly payments for life). Typically, the amount of the monthly payment is a function of years of service and average earnings.

Monks continued to work for his employer for two years past his plan's normal retirement age of 65. During that period, the plan paid no monthly benefits to Monks (i.e., his benefits were suspended), even though his employer violated the plan terms and Department of Labor (DOL) regulations by failing to provide him with a suspension-of-benefits notice once he reached the plan's normal retirement age. Instead, the plan began paying Monks his monthly benefit when he actually retired at age 67. The employer awarded Monks two additional years of credited service under the terms of the plan to reflect his continued employment past normal retirement age, but made no adjustment to the age 65 benefit for its failure to provide a suspension-of-benefits notice.

Monks asserted that the appropriate remedy under ERISA was to elect between (1) his monthly benefit as it continued to accrue under the plan with the two additional years of service (with no actuarial adjustment to reflect the shorter life expectancy and payout period) and (2) the adjusted value of his monthly benefit computed as of his normal retirement date (ignoring the two additional years of service), actuarially adjusted to reflect that the expected payout period would be shorter (due to his shorter life expectancy).

Under ERISA (and the Code), a plan may suspend permanently (i.e., cause employees to forfeit) pension benefit payments to employees who work beyond normal retirement age, without actuarially increasing the monthly benefit when the employee does retire (assuming the employee retires before attaining age 70 1/2), as long as the employer provides the suspension-of-benefits notice required by the DOL regulations when the employee attains normal retirement age. The DOL regulations are based on anti-for-feiture rules found in both ERISA and the Code. A proper notice provides the employee with the specific reasons why the benefit payments are being suspended, a general description and copy of the plan provisions relating to the suspension and other information.

IRS Position and Remedies

When a plan sponsor brings this error to the attention of the Service in its Employee Plans Compliance Resolution System (see Rev. Proc. 2000-16), the IRS typically requires a year-by-year analysis, beginning one year after normal retirement age, in which the employee is awarded the greater of either (1) the pension benefit accrued at the end of the prior year, actuarially adjusted to reflect the shorter payout period based on a shorter life expectancy, or (2) the value of the benefit increased to reflect the additional year of service, with no actuarial adjustment. For corrections involving past failure (e.g., Monks), the Service also requires the employer to pay interest to the employee on missed back payments.

Sometimes, the Service has not permitted the employer to benefit from the "greater-of" rule and, instead, required that the employee be given both elements; this has the effect of dramatically increasing the damages. At other times, the IRS has allowed the employer to mike a one-time adjustment (as of the date of actual retirement) rather than a year-by-year analysis; this has the effect of decreasing the damages.

The foregoing correction methodology is based on Prop. Regs. Sec. 1.411(b)-2(b)(4), which addresses a technically different but analogous issue. In some situations in which the greater-of rule is used, the increased benefit resulting from the additional years of service (for which the employer may have already agreed to pay) partially or completely offsets any otherwise required actuarial adjustment. Typically, however, the offset does not completely eliminate damages, and back interest and the required adjustments are costly.

District Court Decision

In a result that may have surprised many practitioners, the district court found that Monks suffered no harm and was entitled to no actuarial adjustment or any other damages. (The court suggested that the DOL's suspension-of-benefits regulations may have been beyond the scope of the agency's implementing authority under the statute, but did not have to rule on that issue, because the plan itself required the suspension notice.) Instead, the court based its finding that Monks was not entitled to damages on (1) case law holding that ERISA does not remedy procedural violations with damage awards, (2) the fact that the proposed Treasury regulations supporting Monks' arguments were never finalized and (3) the theory that Monks forfeited nothing, because his continued accruals for service beyond normal retirement age "overcomes any claimed entitlement to the actuarial equivalent of benefits [he] would have received if he had retired at age 65."

The court also stated that the plan merely required Monks to be notified that his pension benefits would not commence until he actually retired, that Monks was aware of the delay and that it was difficult to see how the notice required by the DOL regulations would have more fully or better advised Monks of the risk of forfeiting a portion of his pension benefits in the actuarial sense. (The cases cited by the court were not strictly on point, as they did not involve failure to provide suspension-of-benefits notices; further, they analyzed issues different from those the court confronted.) Finally, the district court held that Monks had not even stated an ERISA claim for benefits, a surprising conclusion in light of the fact that Monks asked the court to award him an increased monthly pension benefit.

Monks has been appealed to the Sixth Circuit. Pending the appellate decision, similarly situated claimants may want to involve the IRS directly, rather than bringing a benefit claim under ERISA.

FROM ROBERT D. VALER, J.D., LL.M., WASHINGTON, DC

Robert Zarzar, CPA
Partner
Washington National Tax Services
PricewaterhouseCoopers
Washington, DC