IRS Grants Temporary Nondiscrimination Relief to Closed DB Plans

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By Kenneth A. Mason, Esq.  

Spencer Fane Britt & Browne LLP, Overland Park, KS

In recent years, sponsors of many defined benefit ("DB") pension
plans have closed their plans to new entrants.  Following such
a "soft freeze," new hires instead receive contributions (or
larger contributions) to a 401(k) or other defined
contribution ("DC") plan. Unfortunately, some of those closed DB
plans are now in danger of violating the Code rules designed to
ensure that qualified retirement plans do not favor highly
compensated employees ("HCEs") over non-HCEs.  In Notice
2014-5,1 the IRS has
acknowledged this problem allowing somewhat more lenient
nondiscrimination testing during a two-year period, and also
inviting comments on more permanent solutions.

The Underlying Problem  

Even if a DB plan complies with all the Code rules at the time
it is closed to new entrants, it may later violate the "minimum
coverage" requirement if the group of employees participating in
the plan comes to consist of a disproportionate number of HCEs.
This could happen because there is greater turnover among non-HCEs,
or because certain of the non-HCEs participating in the plan move
into the HCE category.

Existing Regulatory Relief  

One solution to such a minimum-coverage failure is to aggregate
the closed DB plan with a DC plan sponsored by the same employer.
This should solve the minimum-coverage problem. However, in order
to aggregate two plans for minimum-coverage purposes, the plans
must also satisfy the Code's "nondiscrimination" requirements on an
aggregated basis. And although IRS regulations do permit DB and DC
plans to be aggregated for this purpose, they must first satisfy
fairly stringent requirements.

For instance, existing nondiscrimination regulations allow for
the aggregation of DB and DC plans only if one of the following
three conditions is met:

  •   Primarily DB in Character. More than
    half of the non-HCEs participating in the aggregated "plan" are
    accruing larger benefits under the DB plan than under the DC
  •   Broadly Available Separate Plans. Each
    of the two plans would separately satisfy the minimum coverage and
    nondiscrimination requirements if they were given a pass on the
    "average benefit percentage test" under the minimum coverage
    regulations; or
  •   Gateway Test. All of the non-HCEs
    participating in the aggregated "plan" receive at least a minimum
    percentage allocation (with the specific minimum tied to the
    highest allocation made to any HCE).

Problems with the Existing Relief  

In the recent Notice, the IRS concedes that even a normal change
in the composition of an employer's workforce can eventually
undermine the employer's reliance on either of the first two
alternatives. That is, the same factors that can cause a closed DB
plan to fail the minimum-coverage requirement when tested on its
own will eventually have that same effect under these two testing

That would still leave the gateway test. However, the minimum
non-HCE allocation required to satisfy this alternative is so large
that many employers would rather freeze their DB plans entirely.
This would undermine the expectations of those employees who were
covered under the closed plan.

The Interim Relief  

In response to requests from sponsors of closed DB plans, the
IRS has announced a two-year period of limited interim relief.
Assuming a DB plan was closed to new entrants before December 13,
2013, that plan may now be aggregated with a DC plan (for both
minimum coverage and nondiscrimination testing purposes) for the
next two plan years if either of the following conditions is

  •   During the plan year beginning in 2013, the DB plan
    satisfied both the minimum coverage and nondiscrimination
    requirements without needing to be aggregated with the DC plan;
  •   For the plan year beginning in 2013, the DB plan was
    aggregated with the DC plan in an arrangement that satisfied one of
    the first two existing alternatives (i.e., the aggregated plan was
    either primarily DB in character or consisted of broadly available
    separate plans).

This interim relief is available only for plan years beginning
before January 1, 2016. Moreover, when aggregating a DB plan with a
DC plan, only employer non-elective contributions to
the DC plan may be considered; matching contributions
may not be taken into account.

Request for Comments  

The Notice makes clear that the IRS is also considering
longer-term solutions to this problem. For instance, the Notice
outlines a number of possible alternatives under which DB and DC
plans might continue to qualify for testing on an aggregated basis.
The IRS has invited comments on these proposals. Any comments must
be received by February 28, 2014. Presumably, the IRS will consider
those comments in time to craft permanent relief before this
interim relief expires.

For more information, in the Tax Management Portfolios, see
Finston and Jewett, 351 T.M.
, Plan Qualification - Pension and
Profit-Sharing Plans,  and in Tax Practice Series, see
¶5520, Plan Qualification Requirements.

© 2014 Spencer Fane Britt & Browne LLP



  1 2014-2 I.R.B. 276.

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