A lump-sum window allows certain defined benefit plan participants a one-time opportunity to elect either an immediate annuity or a lump-sum payment instead of their regular retirement benefit. It has been an attractive strategy for plan sponsors looking to transfer pension risk off the balance sheet, reduce Pension Benefit Guaranty Corporation (PBGC) premiums, and decrease administrative expenses while giving participants greater flexibility over their pension benefits.
Lump-sum windows are primarily offered to participants who have terminated employment with a vested benefit, but may also include active participants who have reached the minimum in-service distribution age (typically age 59½). To avoid unintentionally favoring current or former highly compensated employees (HCEs), plan sponsors must navigate the nondiscrimination rules with care so the plan does not risk disqualification. A lump-sum window could be considered discriminatory if specific provisions in the design or operation disproportionately favor HCEs.
Below are some nondiscrimination testing considerations that plan sponsors should weigh before launching a lump-sum window.
Retirement plan lump-sum windows: Benefits, rights, and features testing
A key hurdle is the Benefits, Rights, and Features (BRF) testing under Internal Revenue Code §401(a)(4). An immediate lump-sum distribution (or immediate annuity) available only during a short window is a BRF. A lump-sum window can satisfy the BRF test by demonstrating that the lump-sum offer is currently and effectively available to a nondiscriminatory group of employees.
- Current availability test: A numeric test to confirm that the group of employees to whom the lump-sum window is offered is nondiscriminatory. This entails comparing the number of HCEs who are eligible for the lump-sum to the number of eligible non-HCEs (NHCEs).
- Effective availability test: A facts and circumstances test to determine if access to the lump-sum window significantly favors HCEs.
A lump-sum window, for example, one offered to all terminated vested participants, will automatically satisfy the Current Availability Test. However, if access is limited to certain participants, further analysis may be needed to demonstrate compliance with the test.
A common lump-sum window design is to limit the eligible group to terminated vested participants with small benefits. This design is useful in reducing the number of participants for PBGC Flat Rate Premium purposes and in limiting the total lump-sum dollars paid to avoid FASB settlement accounting.1 Since the “small benefits” eligible group will generally skew towards NHCEs, this design should easily satisfy the Current Availability Test.
Alternatively, if the lump-sum is limited to a group that is skewed more towards HCEs, it would be harder to pass the test. For example, if the lump-sum window was offered to participants who terminated in the last three years and the company had laid off a large group of executives during the same period, the eligible group may disproportionately consist of HCEs.
If the lump-sum window includes active participants who are above the plan’s minimum in-service distribution age, additional testing hurdles may arise. The key risk is that the eligible group of older active participants often skews toward HCEs, potentially causing the BRF tests to fail.
Even if the lump-sum window is broadly available and passes the Current Availability Test, it could still be considered discriminatory in practice if it is not effectively available to everyone. For example, assume the lump-sum window was not communicated to all eligible participants in a timely manner, resulting in mostly HCEs electing the lump-sum option. Under such a scenario, the group to whom the lump-sum benefit is effectively available may be considered to substantially favor HCEs, thereby failing the Effective Availability Test. This highlights that clear, timely communication to all eligible participants is essential.
An additional consideration when testing former employees is that it may be administratively burdensome to identify who is an HCE. Under IRS rules, a former employee is an HCE if (a) they were an HCE at the time they separated from service, or (b) if they were an HCE at any time after attaining age 55. Plan sponsors will need to retain access to prior payroll records to make this determination.
When are retirement plans prohibited from paying lump-sums?
If a plan's funded status is below 110%, the plan is generally prohibited from paying lump-sums to its 25 highest compensated HCEs unless certain conditions are met. So even if a plan satisfies all nondiscrimination testing, paying a lump-sum to a “top-25” HCE in violation of these funding restrictions would be an operational failure.
Final thoughts on lump-sum windows for retirement plans
A lump-sum window can be a valuable risk mitigation tool and can reduce plan expenses, but failure to meet nondiscrimination rules may require costly corrections or even risk plan disqualification.
Plan sponsors should engage actuaries, ERISA counsel, and their communications team early in the process to:
- Model eligibility scenarios
- Run preliminary nondiscrimination tests
- Confirm the plan’s funded status and review any potential payment restrictions
- Craft clear participant communications and election materials
With careful planning, a lump-sum window can deliver value to both the plan sponsor and participants while staying within regulatory guardrails.
1 For more details, see "Settlement accounting 2025: Seizing de-risking opportunities in a changing interest rate environment" at https://www.milliman.com/en/insight/settlement-accounting-2025-de-risking-interest-rate.