Relative Value of Optional Form of Benefit
Rev. 05/11/06, E-mail Alert 2006-9

The IRS has released final guidance detailing plan sponsors' obligations with respect to the disclosure of the relative value of optional forms of payment available under their plan documents. The final regulations are generally effective for qualified joint and survivor annuity (QJSA) explanations related to distributions that occur on or after February 1, 2006. However, a transition rule permits "reasonable, good faith" compliance that may be based on substantial compliance with the earlier proposed regulations through December 31, 2006. Full compliance with the final regulations is required as of January 1, 2007. With respect to explanations related to lump sums and optional forms having a lesser value than the QJSA, the new regulations continue to apply to distributions occurring on or after October 1, 2004.

Background
In late 2003, the IRS released complex regulations that require defined benefit plans (and defined contribution plans providing “subsidized” annuities—defined below) to provide participants with detailed information on the “relative value” of the available forms of distribution as compared with the joint and survivor annuity form. Originally, these requirements were to go into effect July 1, 2004, with respect to Qualified Pre-Retirement Survivor Annuity notices (QPSA) and as of October 1, 2004, with respect to the Qualified Joint and Survivor Annuity notices (QJSA). On June 30, 2004, the IRS granted a last minute reprieve that generally applied the updated notice requirements to distributions that commence after the release of additional clarifying regulations. After issuing proposed regulations in 2005, on March 24, 2006, the IRS published its final regulations in the Federal Register that apply to distributions occurring on or after February 1, 2006.

Historical Note: As stated in a previous article, we anticipate that the disclosure requirements will have only a minor impact on defined contribution plan optional forms because in most situations the participant’s account balance is used to purchase a QJSA from a third party insurer and therefore there are no subsidy issues. Subsidy issues usually arise where a defined benefit plan provides both a subsidized annuity benefit and an unsubsidized lump sum benefit. The benefit is subsidized when the plan does not reduce the monthly benefit despite the potential longer payout period under the annuity form. Senator Tom Harkin (D-IA) was concerned that without better disclosure of the values of the benefit forms, a participant would not be aware of or understand that the subsidized annuity has an increased value and would select the less valuable lump sum instead. The IRS proposed regulations went beyond the Senator’s original concerns and imposed additional disclosure requirements. The effective date of the 2003 regulations was delayed to allow for better coordination with the Section 411(d)(6) final regulations, which allow plans to eliminate certain forms of benefits without causing an impermissible cut-backs. However, to address the Senator's concerns, the provisions concerning lump-sum payments went into effect as of October 1, 2004.

The Final Regulations
The final regulations provide guidelines for the determination and comparison of the actuarial present value of the optional form versus the actuarial present value of the QJSA. In addition, the regulations permit the use of reasonable estimates in the disclosure notice to plan participants so long as the plan allows a participant to request personalized and more accurate information regarding the applicable optional forms. The final regulations also set standards that will permit an optional form to be described as approximately equal in value to the QJSA. For example, an optional form that has an present actuarial value that is not less than 95% but not more than 105% of the present actuarial value of the QJSA may be characterized as approximately equal in value. Lastly, the regulations permit a description of optional forms and benefits using a range of representative examples where the "optional forms of benefit are substantially similar if those optional forms are essentially identical except for a particular feature or features…and the feature or features vary linearly." According to the regulations, such a situation would arise where a plan provides a QJSA in whole percentages ranging from 50 to 100%. In this case, a plan could comply with the disclosure requirements by providing information on the relative value of both a 50% and a 100% QJSA and a mid-point QJSA such as a 75% QJSA.

We are currently reviewing the QJSA and QPSA forms that we provide to our defined contribution and defined benefit clients on the 401(k) Portal, and we will release updated forms, as necessary, later this year.