IRS OKs Annuity-Generating Rollover from Employer Defined Contribution Plan to Its Pension Plan

PLR 201527041

In a private letter ruling (PLR), IRS has concluded that retirees may elect to make a plan-to-plan transfer of their account balance in their employer’s defined contribution plan to a defined benefit (pension) plan maintained by the same employer in order to begin receiving an annuity benefit from the transferee plan. The PLR, which dealt with a governmental employer, appears to be the first one issued in the wake of a 2012 initiative that encouraged such transfers.

To read the private letter ruling, please click here.

From Thomson Reuters

Background. Unless one of several exceptions applies, Code Sec. 72(t) provides for an additional tax on any amount received from a qualified retirement plan. The additional tax is 10% of the amount that’s includible in income.

A direct rollover from a qualified defined contribution plan to a qualified defined benefit plan is permitted under Code Sec. 401(a)(31). (Reg. § 1.401(a)(31)-1, Q&A A-2) ) And under Code Sec. 402(c)(1), if any portion of the balance to the credit of an employee in a qualified trust is paid to the employee in an eligible rollover distribution, and the employee transfers any portion of the property received in the distribution to an eligible retirement plan, then the distribution (to the extent so transferred) isn’t includible in gross income for the tax year in which it is paid.

A defined benefit plan is not a qualified plan if it provides for the payment of benefits to a participant which exceed the Code Sec. 415 limitation. Under Reg. § 1.415(b)-1(b)(1)(ii), the annual benefit, for purposes of determining the Code Sec. 415 limitation, does not include the annual benefit attributable to either employee contributions or rollover contributions.

Where rollover contributions are made from a defined contribution plan to a defined benefit plan to provide an annuity distribution, the annual benefit attributable to those rollover contributions, for purposes of Code Sec. 415(b), is determined by applying the rules of Code Sec. 411(c) (relating to determination of accrued benefits). (Reg. § 1.415(b)-1(b)(2)(v)) Accordingly, if the plan uses more favorable factors than those specified in Code Sec. 411(c) to determine the amount of annuity payments arising from rollover contributions, the annual benefit under the plan would reflect the excess of those annuity payments over the amounts that would be payable using the factors specified in Code Sec. 411(c).

Rev Rul 2012-4, 2012-8 IRB 386, involves the direct rollover of an eligible rollover distribution from a qualified defined contribution plan to a qualified defined benefit plan maintained by the same employer. It provides that the recipient qualified defined benefit plan does not violate Code Sec. 411 or Code Sec. 415 if it provides an annuity resulting from the direct rollover that is determined by converting the amount directly rolled over into an actuarially equivalent immediate annuity using the applicable interest rate and applicable mortality table under Code Sec. 417(e) (relating to certain cash-outs).

The ruling further provides a special rule if the qualified defined benefit plan receiving a direct rollover were to use a more favorable actuarial basis for purposes of calculating the annuity resulting from the rollover amount, or otherwise provided for a larger annuity than the annuity derived from employee contributions as determined under Code Sec. 411(c). In such a case, the portion of the benefit under the qualified defined benefit plan resulting from the amount directly rolled over that exceeds the benefit derived from that rolled over amount under the rules of Code Sec. 411(c)(2)(B), is not treated as the benefit derived from the employee’s own contributions, and the excess portion would be included in the annual benefit for purposes of Code Sec. 415(b).

RIA observation: Rev Rul 2012-4, was issued as part of an initiative to help retirees manage their saving by allowing easier access to annuities. The ruling gives participants access to the lower cost annuity purchase rates available to defined benefit plans, and provides a “road map” for allowing employees the option of rolling over 401(k) plan distributions to the defined benefit plan in exchange for an immediate annuity from that plan. See Weekly Alert ¶ 4 02/09/2012 for details.

Facts. County maintains two qualified retirement plans: Plan D, a defined benefit plan for four classes of employees; and Plan C, a defined contribution plan that covers another three classes of employees. Both plans are governmental plans under Code Sec. 414(d) . County intends to permit participants of Plan C who have severed employment with County to make a one-time, irrevocable election to make a plan-to-plan transfer of their account balance under Plan C, the defined contribution plan, to Plan D, the defined benefit plan, in order to receive an annuity benefit from Plan D. The transfer would occur before a participant’s commencement of benefits under Plan C.

After the transfer from Plan C to Plan D, the amount transferred would be immediately annuitized and paid to the participant under Plan D as a single life annuity or a joint and survivor annuity with a spouse, domestic partner, or child as a contingent annuitant. Subsequent to the transfer from Plan C, no other contributions will be made to Plan D by the participant or County.

Favorable ruling. IRS concluded that each employee’s elective plan-to-plan transfer of assets from Plan C to Plan D is a direct rollover within the meaning of Code Sec. 401(a)(31). Under Code Sec. 402(c)(1), the amount transferred from Plan C to Plan D in a direct rollover is not includible in the gross income of the employee for the tax year in which the plan-to-plan transfer occurs. Such amount is taxable to the employee in the tax year in which the amount is distributed from Plan D under Code Sec. 72. As a result, the PLR concludes that the direct rollover of an employee’s account balance under Plan C to Plan D is a permissible plan transfer that won’t result in taxation to the employee under Code Sec. 72(t), Code Sec. 401(k) or Code Sec. 402 at the time of the rollover, and similarly won’t result in constructive receipt of such amounts by an affected employee under Code Sec. 72(t) or Code Sec. 401(k) at the time of the rollover.

IRS also ruled that the transfer of assets from Plan C to Plan D after a participant’s severance from employment won’t be subject to the limitations on benefits under Code Sec. 415(b), to the extent the annual benefit under Plan D derived from the transfer of assets from Plan C is determined using the rules set forth in Code Sec. 411(c).

In addition, under Rev Rul 2012-4, a direct rollover from Plan C to Plan D won’t be subject to the Code Sec. 415(b) limitations if the resulting Plan D benefit is an annuity that is determined by converting the rollover amount into an actuarially equivalent immediate annuity using the applicable interest rate and applicable mortality table under Code Sec. 417(e). If the Plan D benefit attributable to the rollover amount is determined using a more favorable actuarial basis than as provided under Rev Rul 2012-4, then IRS said that the portion of the Plan D benefit resulting from the amount directly rolled over that exceeds the benefit derived from the rolled over amount under Code Sec. 411(c)(2)(B), is not treated as the benefit derived from the employee’s own contributions, and the excess portion would have to be included in the annual benefit for purposes of Code Sec. 415.

References: For participant’s elective transfer of benefits between plans, see FTC 2d/FIN ¶ H-7315 ; United States Tax Reporter ¶ 4014.27 ; TaxDesk ¶ 144,040 ; FTC 2d/FIN ¶ 8061 .

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