For purposes of this question, an employee (in the top 25) will not be able to receive a lump sum payout due to 1.401(a)(4)-5(B) and plans to work until he dies. The plan provides that survivng spouses receive the account balance converted to an annuity based on her life expectency or a lump sum

Please confirm that the surviving spouse is also restricted from receiving a lump sum because she would be receiving a death benefit not funded by life insurance on behalf of a restricted employee.

Are there any options other than:

(1) take a life annuity,
(2) provide a surety arrangement for 125% of the lump sum amount pursuant to Rev. Rul. 92-76
(3) amend the plan to add a new distribution option that is an annuity with a cash refund feature.

Thanks for your thoughts

Will this help? Calculate the total lump sum and roll into 2 IRA's.One IRA is equal to the unrestricted amount,i.e. one year's single life annuity, and the other equal to the restricted amount. Each year that the restriction is in force you transfer that year's unrestricted amount from the "restricted" IRA to the "unrestricted." You keep doing this until either the restriction no longer applies or the restrcted IRA has been exhausted.Obviously you'll need an attorney to draft the restriction language on the IRA.

It is my understanding that, even if you set up two IRAs, you must also provide a surety bond or letter of credit for an additional 25%.

For example, the unrestricted amount for year 1 is $100,000 and the lump sum would be $1.5 M. The HCE could establish one unrestricted IRA holding $100,000, one restricted IRA holding $1,400,000 and provide a surety bond for $350,000 (possibly more if investments decrease in value).

This "solution" is not palatable to the HCE so we are searching for another alternative.

I haven't found a solution to this that is "palatable". It's a real problem with rates being so low.