The Requirements of Using Pension Maximization

The principal requirement involved in implementing a pension maximization strategy is compliance with the requirements of the Retirement Equity Act of 1984 (REA) for spousal benefits.

The law mandates that a spouse’s interest in the participant’s qualified retirement benefits must be protected and specifies that certain benefits must be paid to the spouse if the participant predeceases the spouse either before or after retirement. If these mandated benefits are not those desired by the participant and spouse, they may elect alternative forms of benefits or designate a beneficiary other than the spouse, but only by following strict compliance rules.1

Required (Default) Spousal Benefits

Unless expressly waived by both spouses in accordance with strict rules, qualified plans must generally automatically provide certain benefits for the participant’s spouse. The first required benefit is a Qualified Preretirement Survivor Annuity (QPSA). The QPSA is the automatic default benefit for the surviving spouse of a participant who dies before retirement, unless the participant and spouse have made a proper election otherwise. The second required benefit is a Qualified Joint and Survivor Annuity (QJSA). The QJSA is the automatic default benefit for the participant and spouse at retirement, unless they have made a proper election otherwise.

Annuity Starting Date

The annuity starting date is a key date for purposes of determining whether benefits are payable as a QPSA, a QJSA, or another selected optional form of benefit payable under the plan. A participant who is alive on the annuity starting date must have benefits payable as a QJSA, unless the participant and the spouse have made a qualifying election otherwise. The surviving spouse of a participant who dies before the annuity starting date must receive a QPSA, unless once again, both the participant and the spouse made a qualifying election to waive the QPSA or to receive some other form of benefit in the event of the participant’s death before the annuity starting date. The annuity starting date is also important for tax purposes, since amounts received as an annuity (periodic payments) and amounts not received as an annuity (nonperiodic payments) are subject to differing tax rules.

As a general rule, the annuity starting date is the first day of the first period for which an amount is paid as an annuity or in any other form as a retirement benefit to the participant under the plan.2 In other words, it is the date at which payments are to commence to the participant under the QJSA or an alternative payout schedule, if properly elected with spousal consent. For most participants this date is the normal retirement age. However, for participants who retire early, it is the earliest date when benefit payments may begin for early retirement or the first date when benefits are payable after retirement, if later. For participants who continue to work beyond normal retirement age, the annuity starting date is generally the date when benefit payments are to begin under the plan once the participant retires.

REA Requirements Apply Generally to All Qualified Pension Plans

Plans that must meet the requirement include defined benefit, money purchase, target benefit, and cash balance plans. They also apply to benefits payable to a participant under a contract purchased by the plan and paid by a third party.

Under a defined benefit plan, the survivor annuity requirements apply only to benefits in which the participant was vested immediately before death. They do not apply to benefits in which the participant’s beneficiary becomes entitled by reason of the participant’s death, or to proceeds of a life insurance contract, to the extent those proceeds exceed the present value of the participant’s nonforfeitable benefits that existed immediately before death.4

The survivor annuity requirements also apply to nonforfeitable benefits payable under any defined contribution plan that is subject to the minimum funding standards of Code section 412 (money purchase pension plans but not profit sharing or stock bonus plans), including the proceeds of insurance contracts.5 The rules also apply to profit sharing and stock bonus plans unless the plans meet the exception described below.

Exception for Profit Sharing, Stock Bonus Plans, and ESOPs

Profit sharing and stock bonus plans and ESOPs must conform unless all the following requirements are met:

Each participant’s vested benefit is payable on death to the surviving spouse, or, if there is no spouse, to a designated beneficiary (a spouse may consent to payments to a designated beneficiary);

The participant has not elected to receive benefits in the form of a life annuity; and

The qualified plan is not the recipient of a direct plan-to-plan transfer of benefits from a defined benefit, money purchase, target benefit, or cash balance pension plan. (If it is the recipient of a direct plan-to-plan transfer, then the general rules apply to the transferred benefit).

In addition, the benefit must be available to the surviving spouse within a reasonable time after the participant’s death. Access within a ninety-day period following the participant’s death is considered reasonable.6 The benefit payable to the surviving spouse must also be adjusted for gains or losses occurring after the participant’s death in accordance with plan rules governing the adjustment of account balances for other distributions.

If these requirements are met, a participant does not need the spouse’s consent to elect to take living benefits in some form other than a joint-and-survivor annuity. Permitted non-joint-and-survivor annuity distribution options would include:

  • term-certain annuities;
  • discretionary (nonannuity) installments; and
  • lump sum distributions.

Exception for Certain Benefits

Benefits are not required to be paid in the form of QPSA or QJSA if, at the time of death or distribution, the participant was vested only in employee contributions and the participant died, or distributions commenced, before October 22, 1986. Also, if the present value of the participant’s nonforfeitable benefit is $5,000 or less, a distribution may occur (usually a lump sum) without satisfying the spousal consent requirements for distributions other than the QPSA or QJSA.9

The REA requirements do not apply to IRAs.

Qualified Preretirement Survivor Annuity (QPSA)

The QPSA is essentially a property right of the spouse created by law. The survivor benefit payable under the QPSA is an immediate annuity for the life of the participant’s surviving spouse equal to the amount that would have been paid under the QJSA if the participant had either retired on the day before death or separated from service on the date of death and survived to the plan’s earliest retirement age, then retired with an immediate joint and survivor annuity. If, before the participant’s annuity starting date, the participant elects a form of joint-and-survivor annuity that satisfies the requirements for a QJSA and then dies before the participant’s annuity starting date, the form of benefit elected is the QJSA, and the QPSA payable to the surviving spouse must be based on that form.

Under a defined benefit plan, the plan must permit the surviving spouse to elect to receive payments under a QPSA no later than the month in which the participant would have reached the earliest retirement age. The plan may permit the surviving spouse to elect to begin receiving payments under the QPSA within a reasonable time after the participant’s death (generally within ninety days), even if this date is before the plan’s earliest retirement age. If the surviving spouse elects to begin receiving payments before the earliest retirement date, the plan may actuarially adjust the value of the benefits to reflect the earlier distribution date.

The participant may elect an alternate form of benefit, if so offered by the plan, but only with spousal consent. Typically, considerable attention is paid to the form of benefit that will be paid at retirement and who should be named as beneficiary, but the form of benefit that will be paid and who should be named as the beneficiary in the event of the participant’s death before retirement is often overlooked. It is important to coordinate elections regarding the QPSA with those anticipated regarding the QJSA. If, for example, the spouse has adequate pension benefits in the spouse’s own right or other sources of retirement income, the participant may wish to name a child, parent, charity, or other person as the beneficiary of the retirement benefits. If this is desirable for retirement benefits, it is presumably also desirable for preretirement benefits. These objectives will be thwarted in the event of the participant’s premature death unless the participant takes positive action to specify his intentions.

The participant may select a benefit other than the preretirement survivor annuity at any time after age thirty-five and can also change this election at any time before retirement. Generally, electing out of the preretirement survivor annuity entirely will increase the benefit payable at retirement, unless the plan specifically subsidizes the retirement benefit. The younger the participant is at the time the participant elects out, the greater, generally, will be the increase in the benefit payable at retirement.

Qualified Joint and Survivor Annuity (QJSA)

The spouse’s survivor benefit under the plan’s default QJSA may be not less than 50 percent and not more than 100 percent of the joint benefit. For a married couple, the QJSA must be at least as valuable as any other optional form of benefit payable under the plan at the same time. Therefore, if a plan has two joint-and-survivor annuity options that would satisfy the requirements for a QJSA (e.g., a joint-and-50 percent survivor annuity and a joint-and-75 percent survivor annuity), but one has a greater actuarial value than the other (e.g., the joint and survivor annuity with 75 percent survivor benefit), the more valuable joint-and-survivor annuity is the QJSA.

If the plan offers two joint and survivor annuities that are actuarially equivalent, the plan must specify which is the QJSA. However, the participant may elect the other equivalent joint and survivor annuity without spousal consent. The participant may elect an alternate form of benefit, if so offered by the plan, but only with spousal consent.

An election to waive the normal form of joint and survivor benefit must be made ninety days before the annuity starting date (the date on which benefit payments begin). Notice of the election period must be provided to participants along with an explanation of the consequences of the election within a reasonable period of time before the annuity starting date, at least ninety days before the annuity starting date.

Spousal ConsentI.R.C. § 417(a)(1).

In general, any waiver of QJSA or QPSA benefits or election of an alternative benefit option will not be effective unless:

  • the participant’s spouse consents in writing to a change in either the QPSA or QJSA benefit;
  • the election designates a beneficiary who may not be changed without spousal consent (unless the spouse expressly permits designation by the participant without further spousal consent);
  • the election designates a form of benefit, which may not be changed without spousal consent;
  • the consent acknowledges the effect of such election on benefit rights; and
  • the consent is witnessed by a plan representative or a notary public.
Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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