Notice 98-29: optional forms of benefits under defined contribution plans.

On September 11, 1998, Tax Executives Institute submitted the following comments to the Internal Revenue Service on Notice 98-28, relating to optional forms of benefits under defined contribution plans. The comments were prepared under the aegis of the Employee Benefits and Payroll Tax Subcommittee of TEI's Federal Tax Committee, whose respective chairs are Mitchell S. Trager of Georgia-Pacific Corporation and Philip G. Cohen of Unilever United States, Inc. Michael J. Nesbitt of Paychex, Inc. contributed materially to the preparation of the comments.

On May 14, 1998, the Internal Revenue Service issued Notice 98-29, announcing its intent to develop exceptions to the plan amendment prohibition outlined in section 411(d)(6) of the Internal Revenue Code. The notice was published in the INTERNAL REVENUE BULLETIN on June 1, 1998 (1998-22 I.R.B. 8).

Background

Tax Executives Institute is the principal association of corporate tax executives in North America. Our approximately 5,000 members represent 2,800 of the leading corporations in the United States and Canada. 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 that taxpayers can comply with in a cost-efficient manner.

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 Notice 98-29, relating to optional forms of benefits under defined contribution plans.

TEI commends the Internal Revenue Service and Treasury Department for undertaking this initiative. In issuing Notice 98-29, the government expressed its belief that any relief "should take into account the interests of participants and the practical needs of employers in effectively and efficiently providing retirement benefits for their employees, including the need to adapt plans to changing circumstances." TEI wholeheartedly agrees. Notice 98-29 represents a positive step in reducing complexity, compliance burdens, and plan operation costs for plan sponsors without disadvantaging plan participants. The Institute urges the IRS to issue the relief as soon as possible.

Notice 98-29: 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. The Treasury Department has authority under section 411(b)(6)(B) to provide exceptions to the rule relating to the elimination of optional benefits. Notice 98-29 announces the government's intent to issue regulations providing such exceptions.

The issue to be addressed in the forthcoming regulations is very real and affects many plans. Corporate mergers and acquisitions may lead to the consolidation of two or more plans, some of which may legitimately offer fewer payment options, perhaps limited to a lump-sum distribution. The sponsor of the survivor plan, however, currently has no choice but to track the protected benefits for the participants of all of the former plans, which can greatly complicate plan administration. The problems may be exacerbated when the number of participants with the protected benefit is relatively small. Indeed, many sponsors have resorted to negotiating the termination of the former plan, prior to an acquisition, in order to mitigate the complications of the anti-cutback rules. Such an approach, however, requires complete distribution of all the former plan's assets -- a result that may not be in the best interests of participants. We are pleased that the IRS and Treasury Department are addressing these issues.

Whatever the alternatives included in the impending regulations, TEI agrees that the thrust should be to offer plan sponsors flexibility in modifying their plans while not materially reducing benefits to the participants. The regulations should not restrict plan sponsors to a single, exclusive payment option. With one exception, the approaches outlined in Notice 98-29 generally accord flexibility to plan sponsors and should be permitted in the proposed regulations. The Institute's specific recommendations on improving the notice are provided below.

Relief Options Under Consideration

A. Lump-Sum Distribution. Notice 98-29 requests comments on whether the IRS and Treasury Department should permit plan sponsors to offer payment of benefits solely in a lump sum. TEI strongly supports this proposal, which would simplify plan administration with little detriment to the participants. Generally, a plan participant who receives a distribution in a lump sum may roll those funds over to an individual retirement account (IRA), which can provide the participant with several payment options. In addition, the participant may arrange for the purchase of an annuity with the proceeds of the distribution. Allowing plan sponsors to restrict payment options solely to a lump sum would be particularly helpful where the plan sponsor has historically not allowed extended payment options, yet a few participants enjoy an extended payment option as a protected benefit from a former plan that was merged into an existing plan.

B. Retention of Single-Sum Distribution and Extended-Payment Option. One approach outlined in Notice 98-29 would permit the elimination of payment methods as long as the plan provides for a lump-sum payment option and at least one extended-payment option. Although the Institute has recommended that plan sponsors be permitted to offer only a lump-sum distribution, this proposal represents a reasonable compromise. It does, however, require further clarification.

Under this approach, if a plan did not previously provide for a sin gle-and-joint-life annuity or installments payable over a single-and-joint-life expectancy, the plan must provide for installment payments over the longest installment period provided under the plan prior to the amendment. TEI submits that the definition of the "plan" for purposes of this requirement should be clarified. Consider the case where a plan with 20 participants is merged into a plan with 5,000 participants following an acquisition. The acquiring plan sponsor may wish to amend the plan simultaneously with the corporate acquisition to eliminate optional benefit forms. Which "plan" provisions are to be examined for purposes of meeting the requirement regarding the longest installment period? The survivor plan (as designated in the plan merger agreement) that offered no installment payments, the former plan that offered an installment option, or both? To simplify administration, the Institute recommends that the provisions of the survivor plan control.

TEI also recommends that plan sponsors be permitted to select from multiple extended-payment options. These options would include the joint-and-survivor life annuity, installment payments over a single-and-joint life expectancy, and installment payments over a specified period of years. Such an approach would permit the sponsor to select a payment method appropriate for its specific circumstances. The more flexibility that the sponsor has in making this choice, the better.

C. Definition of "Small Portion" of Participants' Benefits. Another approach under consideration would permit plan amendments that eliminate optional forms of benefits available to no more that a "small portion" of participants' benefits. TEI supports this alternative. Although the term "small portion" is not defined, we recommend that the regulations confirm that a five-percent rule is reasonable.

D. Low Participant Utilization. Notice 98-29 also outlines an approach that would permit the elimination of optional forms of benefits with respect to which participant utilization is demonstrably very low. The Institute is concerned about the administrability of this approach. For example, what constitutes "very low" utilization? How would this be demonstrated? Over what period of time should utilization be reviewed to determine if it meets the very low criteria?

This provision could also produce unintended results. For example, assume a plan provides a payment option that is available when the participant retires or terminates employment. If the plan sponsor has an employee population that is young with little turnover, the utilization rate for this benefit is likely to be very low for extended periods of time. Nevertheless, this benefit may potentially affect every participant. Is it appropriate to allow the sponsor to eliminate this benefit? We think not. The administrative issues raised by this alternative may well outweigh its benefit to plan sponsors.

E. Small Percentage. Notice 9829 fails to discuss one relief option that TEI believes should be adopted. TEI recommends that the IRS and Treasury Department consider including in the proposed regulations an alternative that would permit plan sponsors to eliminate an optional form of benefit that is available to a relatively small percentage -- which we propose be defined as five percent -- of participants.

For example, assume a plan with 5,000 participants offers only a lump-sum distribution option. As a result of an acquisition, a plan with 20 participants is merged with the existing plan. The smaller plan offers an installment-payment option. In accord with the Notice's simplification objective, the sponsor in this example should be permitted to eliminate the installment-payment option because it applies to less than five percent of all participants.

Transfers Between Plans

Notice 98-29 states that the IRS and Treasury Department are considering whether it would be appropriate to develop additional relief for elective transfers between defined contribution plans. Such relief would apply under certain conditions, for example, where employees are transferred to a new controlled group in connection with an acquisition. Employees would be permitted an election to transfer their benefits between defined contribution plans. The Notice requests comments on this approach, including (i) whether it should be limited to situations in which both plans are of the same type (e.g., profit-sharing plans with qualified cash or deferred arrangements), or (ii) whether the transferee plan should merely be required to retain the distribution restrictions and other relevant characteristics of the transferor plan.

TEI supports the expansion of permissible elective transfers between plans. Such an approach could greatly simplify plan administration for controlled groups, particularly those who engage in significant mergers and acquisitions.

For example, assume an employee works for a corporation that sponsors a defined contribution plan, which provides that distributions will be allowed only when the employee ceases to be actively employed by the corporation or any other member of its controlled group. Assume further that the corporation is then acquired and the employee is transferred to the acquiring company which sponsors its own defined contribution plan. The employee in this example would have his subsequent retirement assets divided between two plans: a portion in the acquired company that no longer employs him, and the balance in the plan of the acquiring company. Both companies would be required to treat this individual as an active participant eligible to make any available investment elections or plan changes, and the employee would have to monitor the status of his interest in both plans. Such fragmentation would increase the compliance burden for the plan sponsors and inconvenience (if not confuse) the employee, even though both plan sponsors are members of the same controlled group.

The Notice would seemingly provide relief in this situation by allowing a transfer of the assets in the acquired company's plan to the plan of the acquiring company, but only if the plans are similar. TEI believes relief should be permitted in any situation involving controlled groups, and therefore recommends against limiting the relief to situations involving similar plans. Whether to permit elective transfers should be the decision of the plan sponsors. Other factors -- such as the need to track vested benefits relating to employee elective deferrals under a cash-or-deferred arrangement existing in the transferor plan but not the transferee plan -- may well prompt sponsors to conclude that a transfer is not appropriate where the plans are dissimilar. The use of the relief provision should be available in any situation where the plan sponsor concludes it is appropriate based on all factors.

Notice 98-29 requests comments on whether transferee plans should be required to retain the distribution restrictions and other relevant characteristics of the transferor plan. TEI believes that the general guidance on when optional forms of benefits can be eliminated should be sufficient to address these situations. No additional restrictions should be necessary. For example, assume that the plan sponsor is permitted to eliminate an optional form of benefit that applies to only a small portion of the participant's benefit. Next assume that an employee is eligible for the optional form of benefit transfers his assets between plans within a controlled group. If the employee had stayed in the original plan, the plan sponsor could have eliminated the optional form of benefit. If the proposed regulations adopt the language of the Notice that the transferee plan should be "required to retain the distribution restrictions" of the transferor plan, would the transferee plan be forbidden to eliminate the optional form of benefit? Presumably, the answer is no. It should not be necessary to impose any conditions on plans involved in these elective transfers that are more restrictive than those that apply to other plans considering the elimination of optional forms of payment. We suggest that the regulations clarify this point.

Conclusion

Tax Executives Institute appreciates this opportunity to present our views on Notice 98-29, relating to optional forms of benefits under defined contribution plans. If you have any questions, please do not hesitate to call Philip G. Cohen, chair of TEI's Federal Tax Committee, at (201) 8715504, Mitchell S. Trager, chair of TEI's Employee Benefits and Payroll Tax Subcommittee, at [phone], or Mary L. Fahey of the Institute's professional staff at [phone].