Several developments in recent months have made settling pension liabilities look more attractive to sponsors of defined benefit plans seeking to de-risk:  First, Ford and GM announced pension settlements of unprecedented size.  Second, Congress passed a pension funding relief bill, known as “MAP-21,” that could encourage pension settlements.  And, third, the IRS issued three private letter rulings providing useful guidance covering lump sum settlements and annuitizations.

Many sponsors of defined benefit plans, especially frozen plans, are considering ways to “de-risk” by reducing or eliminating the volatility associated with their pension obligations for financial accounting and pension funding purposes.  In April, Ford announced that its pension plan would offer lump sums to 90,000 retirees.  In June, GM announced a different pension de-risking approach: GM’s pension plan will offer lump sums to certain retirees but in the context of a plan termination. Under GM’s approach, a retiree will have a choice between: (a) receiving a lump sum distribution equal to the value of his or her remaining annuity payments, and (b) continuing to receive annuity payments from an insurance company rather than from a GM pension plan.  The pensions of some GM retirees will simply transfer from the GM plan to an insurance company without a lump sum option.  GM expects its approach to reduce its U.S. pension obligation by $26 billion.  These recent announcements demonstrate the viability of large settlement strategies.

Later in June, Congress passed pension funding relief. The relief was part of a bill entitled the “Moving Ahead for Progress in the 21st Century Act,” which has become known as “MAP-21.”  MAP-21 could affect a plan sponsor’s analysis of whether to pursue pension settlements.  For example, the funding relief could make it less expensive, after a pension settlement, for the plan sponsor to restore the plan’s funding level with additional contributions to at least 80%; keeping the funding at 80% permits the plan to continue paying lump sums to the plan’s remaining participants.  In addition, although the legislation should reduce minimum required contributions significantly for the next several years, contributions will begin to climb again as plan sponsors make up for the lower contributions in earlier years. These factors might encourage plan sponsors to implement settlement strategies earlier, so that they will benefit from the greater impact of funding relief in the next several years.  Furthermore, MAP-21 increased PBGC premiums.  A settlement strategy relieves the plan of its obligation to pay future PBGC premiums with respect to participants whose liabilities are settled. The substantial increase in future PBGC premiums therefore makes settling liabilities more attractive.

In July, the IRS made public three recent private letter rulings covering pension settlement strategies involving lump sum offers and annuity purchases. In two, the IRS permitted lump sum offers to retirees currently receiving annuities, similar to the offer Ford announced.  In each ruling, the IRS noted that regulations permit a change in annuity payments if the plan is amended to provide increased benefits. The IRS concluded that a one-time offer of a lump sum to retirees would be treated as a benefit increase resulting from a plan amendment. Importantly, the IRS emphasized that its conclusion was based on the fact that the lump sum offer was available only for a limited period of time. In one ruling, the lump sum offer was available during a period that would not exceed 90 days; in the other ruling, the offer period would not exceed 60 days.

A third IRS ruling addressed data corrections following an annuitization.  A plan sponsor transferred plan liabilities to an insurance company, and the insurance company refunded premium amounts after data errors were discovered.  The IRS concluded that the premium refund could be returned to the employer and would not be considered a reversion subject to an excise tax.  The ruling therefore provides helpful guidance for dealing with true-ups on account of data clean-up that occurs after an annuitization.