United States: IRS-Required Annuity Disclosures: July 1, 2004 Deadline

Late last year, the IRS issued final regulations regarding the information that must be included in the explanation of the qualified joint and survivor annuity (QJSA) and the qualified pre-retirement survivor annuity (QPSA). These regulations are effective with respect to annuity starting dates on or after October 1, 2004, and with respect to QPSA explanations provided on or after July 1, 2004. The regulations mainly affect defined benefit pension plans. However, defined contribution plans subject to the QJSA rules, such as money purchase pension plans, are also required to comply with the new disclosure requirements.

Although the effective date for these new rules is fast approaching, the IRS has informally indicated that it is considering extending the effective date for compliance due to the complicated administrative issues involved. If the IRS does not extend the effective date, these regulations would generally apply to QJSA explanations distributed on or after July 1, 2004, (i.e., within 90 days of October 1, 2004, which is the earliest annuity starting date to which the new rules would apply) as well as QPSA notices distributed on or after July 1, 2004.

These regulations are intended to ensure that plan participants receive sufficient information to determine whether an optional payment form is more or less valuable compared to other payment forms. Plans will have to revise their distribution forms and work with their actuaries to prepare accurate disclosures that comply with the new rules. In addition, now that plans have had a chance to work with these regulations, many plan sponsors are finding other related plan design or qualification issues raised by their current actuarial assumptions and disclosures that require a careful review of plan distribution options.

Under the final regulations, the QPSA explanation must contain a general description of the QPSA, the circumstances under which it will be paid if elected, the availability of the election of the QPSA and a description of the financial effect of the election of the QPSA on the participant’s benefits (i.e., an estimate of the reduction to the participant’s estimated normal retirement benefit that would result from an election of the QPSA). In lieu of the specific disclosure of the financial effect on a participant’s benefits, the QPSA disclosure could provide a general description of the effect of the election, as long as participants are notified of the right to obtain more detailed information on request.

The QPSA explanation must only be provided if the QPSA is not fully subsidized and the plan does not otherwise allow a participant to waive the QPSA or select a nonspouse beneficiary. Although many plans fully subsidize the QPSA, some plans (including many cash balance plans and money purchase pension plans) allow participants to name nonspouse beneficiaries and, such plans must, therefore, provide a QPSA notice.

A QJSA explanation must provide the following information for each of the optional forms of benefit available: a description of the optional form of benefit; a description of the eligibility conditions for the optional form of benefit; a description of the financial effect of electing the optional form of benefit (i.e., the amount payable under the form of benefit to the participant during the participant's lifetime and the amount payable after the death of the participant); for defined benefit plans, a description of the relative value of the optional form of benefit compared to the value of the QJSA; and a description of any other material features of the optional form of benefit.

To comply with the regulations, participant notices must be provided directly to participants (for example, by hand delivery or by first-class mail to the last known address). A general disclosure on a bulletin board or other posting is not acceptable. Also, the notice must be written in a manner to be understood by the "average plan participant."

One of the more complex issues for defined benefit plans is to prepare the disclosure of relative value comparisons. The regulations allow for the relative value disclosure to be made using one of the following methods:

• By expressing the actuarial present value of each optional payment form as a percentage or factor of the actuarial present value of the QJSA (or the single life annuity);

• By providing the amount of an annuity payable at the same time and under the same conditions as the QJSA (or the single life annuity) that is the actuarial equivalent of each optional payment form; or

• By disclosing the actuarial present value of each optional payment form (in addition to the QJSA or the single life annuity).

To simplify relative value disclosures, the regulations permit certain optional payment forms to be grouped together in the explanation if the relative value of each optional form is within five percentage points of each other form in the group. Once grouped, one optional form in the group is specifically disclosed and all others in the group are described as having approximately the same value. If the group includes a lump sum distribution, however, the lump sum must be selected as representative of the group.

Alternatively, all optional payment forms with relative values that are at least 95 percent of the QJSA can be grouped together and described as having a value approximately equal to the QJSA. In addition, all optional payment forms with relative values that are at least 95 percent and no more than 102.5 percent of the single life annuity can be grouped together and described as having a value approximately equal to the single life annuity.

The QJSA explanation must provide an explanation of the concept of relative value and must state that:

• The relative value comparison is intended to allow participants to compare the total value of the distributions paid in different forms;

• The relative value comparison is made by converting the value of the optional payment forms presently available to a common form (such as the QJSA or lump sum distribution); and

• This conversion uses interest and life expectancy assumptions.

The explanation must also include a general statement that "all comparisons are based on average life expectancies, and that the relative value of payments ultimately made under an annuity optional payment form will depend on actual longevity."

A plan can provide reasonable estimates for purposes of providing the financial effect of the optional payment form and for disclosing relative values. If a plan uses estimated amounts for the financial effect or the relative value disclosures, the explanation must identify the estimates and notify the participant of his or her right to request a more precise calculation. If a more precise calculation would materially change the relative values that were disclosed, revised relative values must be provided.

In lieu of providing specific participant information, the QJSA explanation may contain general information for the QJSA and any other payment form that is generally available. If a general explanation is provided, it must provide information on how the participant can obtain information regarding any other optional forms. A general QJSA explanation can provide a chart or other comparison showing the financial effect and relative value of optional payment forms in examples using a hypothetical participant and a representative range of ages.

If a general QJSA explanation is used, the notice must include the amount payable to the participant under the normal form of benefit at either normal retirement or based on immediate commencement. The notice must also state that participants may request specific information based on their personal circumstances.

Plan sponsors have been working with their plan actuaries to develop new disclosures to comply with the regulations. In the course of preparing these notices, some plan sponsors have identified other related plan design or qualification issues that need to be addressed. For example, in calculating the relative values of the optional payment forms, depending on the actuarial assumptions used, there could be cases where the QJSA for married participants might not be the most valuable payment form under the plan, as required under IRS regulations. In addition, some employers have discovered that the actuarial factors applied in calculating decreasing annuities (such as under a social security leveling option) might not satisfy the tax qualification requirements. Other employers have discovered that their plan provides for optional payment forms that have not previously been offered to participants. These issues can present plan qualification issues and should be addressed with legal counsel as soon as possible.

Some employers have expressed a concern that the new relative value disclosures identify that certain optional forms are not, in fact, "worth" as much as the QJSA. From a plan design perspective, these employers have considered changing the factors used to determine optional forms of benefit so they can communicate to participants that the forms of benefit are all equivalent in value. With the deadline approaching for compliance with the relative value regulations, plan sponsors and administrators need to be sure that the proper steps are being taken to prepare participant notices and make any required or desired plan amendments as quickly as possible.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.