Defined Benefit Plan Sponsors in Bankruptcy Have New Flexibility to Modify Plan Distributions

February 6, 2013

Tax-qualification requirements generally prohibit plan sponsors from eliminating optional methods of distribution under a retirement plan. This “anti-cutback” requirement is subject to only a limited number of exceptions. A recent modification to this rule adds a new exception for single-employer defined benefit plans maintained by employers in bankruptcy. Such employers may amend their plans to eliminate lump-sum distribution options if certain conditions are met.

The Anti-Cutback Rule

The anti-cutback rule prohibits a plan from being amended in a manner that eliminates or reduces a participant’s accrued benefit under the plan. Plan amendments that eliminate or reduce an early retirement benefit or retirement-type subsidy, or that eliminate an optional form of benefit, as to previously-accrued benefits are treated as decreasing a participant’s accrued benefit in violation of the anti-cutback rule. An “optional form of benefit” generally includes any distribution option under a plan. A plan amendment may reduce or eliminate an optional form of benefit only if the amendment relates to benefits that have not yet accrued under the plan (i.e., the amendment is prospective only) or if the amendment qualifies under a limited set of exceptions.

As explained below, the Internal Revenue Service and the Treasury Department have added, by adopting a new regulation, an additional exception to allow the elimination of lump-sum distributions under single-employer defined benefit plans sponsored by employers in bankruptcy. The rationale for the exception is that it does not deprive participants of valuable benefits because special plan funding rules generally would prohibit lump-sum distributions and other accelerated payment forms during bankruptcy. Moreover, such distribution forms would not be available in the future if the plan were forced to terminate in a distress or involuntary termination because guaranteed benefits provided by the Pension Benefit Guaranty Corporation (PBGC) do not include lump-sum distributions (except for very small payments).

The Bankruptcy Exception

The new exception permits sponsors of single-employer defined benefit plans who are debtors in a bankruptcy proceeding to eliminate lump-sum distribution options from a defined benefit plan if the following four conditions are met:

  • Certification by the plan’s actuary. The plan’s actuary plan must certify that the plan’s adjusted funding target attainment percentage (AFTAP) is less than 100 percent for the plan year in which the effective date of the amendment occurs.
  • Bankruptcy. The plan sponsor must be a debtor in a bankruptcy case and the plan must be prohibited from paying lump-sum distributions (or other forms of accelerated distributions) under the funding requirements that generally prohibit such types of distributions when the plan sponsor is in bankruptcy.
  • Court approval. The court that is supervising the bankruptcy must issue an order, before the bankruptcy case is completed, concluding that the amendment which eliminates the lump-sum distribution option is necessary to avoid a distress termination or an involuntary termination of the plan under the PBGC’s plan termination rules.
  • PBGC approval. The PBGC must make a determination that (i) the amendment eliminating the lump-sum payment option is necessary to avoid a distress or involuntary termination of the plan before the plan sponsor emerges from bankruptcy and (ii) the plan’s assets are insufficient to provide for payment of PBGC-guaranteed benefits under ERISA.

These conditions must be met by the later of (i) the date the amendment that eliminates the lump-sum option is adopted or (ii) the date the amendment becomes effective.


Defined benefit plans present particular problems for employers experiencing financial distress. Before the new anti-cutback exception was created, employers in bankruptcy had limited options for addressing underfunded defined benefit plans. The new exception will now provide bankrupt employers with greater flexibility in addressing these issues.

AMR Corporation, the parent of American Airlines, may be first debtor in bankruptcy seeking to use the new exception. A bankruptcy judge has approved AMR’s request to eliminate the lump-sum option from its pension plan for pilots. AMR had argued that allowing the lump-sum option to remain might cause a massive wave of pilot retirements, creating a pilot shortage with far-reaching consequences. The unsecured creditors committee in the bankruptcy proceeding told the court that it would have opposed any reorganization plan that kept the lump-sum option.

For more information on the anti-cutback rule, please contact either of the authors, Jeffrey Capwell and Larry Goldstein, or any other member of McGuireWoods’ employee benefits team.