Plan Qualification — Pension and Profit-Sharing Plans (Portfolio 351)

Tax Management Portfolio, Plan Qualification — Pension and Profit-Sharing Plans, 351-6th, examines the rules governing the tax qualification of pension and profit-sharing plans under Code §401(a). The Portfolio examines the various qualification requirements and analyzes discrimination issues that may arise.

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Tax Management Portfolio, Plan Qualification — Pension and Profit-Sharing Plans, 351-6th, examines the rules governing the tax qualification of pension and profit-sharing plans under Code §401(a). The Portfolio examines the various qualification requirements and analyzes discrimination issues that may arise.


Felicia A. Finston

Felicia A. Finston, Arizona State University (B.S. in Personnel Management, magna cum laude, 1982); University of Utah (M.S. in Human Resource Management, with honors, 1983); University of New Mexico School of Law (J.D., with honors, 1986); member, State Bar of Texas, Dallas Bar Association, State Bar of Arizona, Maricopa County Bar Association, American Bar Association, and SouthWest Benefits Association.

Table of Contents

Detailed Analysis

I. Introduction

A. General

B. The Employee Retirement Income Security Act of 1974

1. General

2. Administration

C. Tax Attributes of Qualification

D. Types of Plans

1. Pension Plans Contrasted with Profit-Sharing; Plans Defined Benefit Plans Contrasted with Defined Contribution Plans

2. Specific Types of Defined Contribution Plans

a. Profit-Sharing Plans

b. Money Purchase Pension Plan

c. Thrift or Savings Plan

d. Cash or Deferred Arrangements - The § 401(k) Plan

e. Stock Bonus Plan

f. Employee Stock Ownership Plan (ESOP)

g. SIMPLE Plans

3. Hybrid Plans

a. Target Benefit Plans

b. Cash Balance Plans

c. Floor-Offset Plans

d. Eligible Combined Plans

II. Requirements of a Qualified Retirement Plan

A. Section 401(a)

1. Qualification Requirements

2. Determination Letter

3. Remedial Amendment Period

4. Pre-Approved Plans: Master, Prototype, and Volume Submitter Plans

B. Definition and Purposes of a Qualified Retirement Plan

1. In General

2. Incidental Benefits

a. Life Insurance

b. Medical Benefits

c. Nontraditional Benefits

3. Phased Retirement

C. Formal Requirements

1. Written Plan and Trust

a. Written Plan Requirements - Definite Written Program and Arrangement

(1) Adequately Inform

(2) Enforceability

b. Trust Requirements

2. Plan Created by the Employer

3. Plan for Exclusive Benefit of Employees

4. Definitely Determinable Benefits

a. Employer Discretion

b. Fully Insured Plans

c. Actuarial Assumptions

5. Trust Situs

6. Communication to Employees

a. In General

b. Summary Plan Description

c. Funding Notice

7. Other Formal Requirements

8. Use of Electronic Media in Complying with Certain Formal Requirements: Participant Communications and Plan Administration

D. The Employer

1. Definition

2. Multiple Employers

3. Controlled Group of Corporations and Other Controlled Groups

a. General Rule

b. Affiliated Service Group Rules

c. Employee Leasing Rules

4. Tax-Exempt Organizations

III. Coverage and Participation

Introductory Material

A. Section 410(a)

1. Age and Length-of-Service Rules

2. Definitions

a. Year of Service

b. Hour of Service

3. Breaks in Service

a. In General

b. One-Year Hold-Out Rule

c. "Neutral" Years

d. Maternity- or Paternity-Related Absences and Other Leaves of Absences

4. Equivalencies

a. In General

(1) Definition

(2) Use of Different Equivalencies

b. Hours Worked

c. Regular Time Hours

d. Equivalencies Based on Certain Units of Time

e. Equivalency Based on Earnings

f. Elapsed Time Method

(1) In General

(2) Service Spanning Rules

(3) Maternity and Paternity Absences Under Elapsed Time Method

(4) Other Equivalencies

5. Special Break-in-Service Rules

a. Two-Year 100% Vesting Rule

b. Rule of Parity

6. Eligibility Computation Periods

7. Plan Entry Dates

8. Special Industry Rules

9. Maximum Age Requirements

B. Coverage

1. In General

a. The General 70% Test

b. The "Ratio" Test

c. The "Average Benefits" Test

d. Excluded Employees

2. Section 410(b) Regulations

a. In General

b. Employees Benefiting Under the Plan

(1) In General

(2) Certain Employees Treated as Benefiting

(3) Former Employees

(4) Excludible Employees

c. The "Ratio Percentage" Test

d. Nondiscriminatory Classification Test

(1) In General

(2) Reasonable Classification

(3) Nondiscriminatory Classification

(A) Safe Harbor Percentage

(B) Unsafe Harbor Percentage

(C) Facts and Circumstances Test

e. Average Benefit Percentage Test

f. Acquisitions and Dispositions

g. Definition of Plan and Rules for Plan Aggregation and Disaggregation

(1) In General

(2) Mandatory Disaggregation

(3) Permissive Aggregation

h. Testing Methods

i. Retroactive Correction

C. Section 401(a)(26): The Minimum Participation Rule

1. Overview

2. Applicable to Plans Separately

3. Plans that Are Excepted from § 401(a)(26)

4. Minimum Participation Requirements

5. Testing Former Employees

6. Testing Methods

7. Retroactive Correction

8. Plans Maintained by More Than One Employer

D. Satisfaction of § § 410(b) and 401(a)(26) Based on QSLOBs

1. Overview

2. Determining Lines of Business

3. Determining Separate Lines of Business

a. Separate Organizational Unit and Separate Financial Accountability

b. Separate Work Force and Separate Management

c. Determining QSLOBs

(1) Overview

(2) 50-Employee Requirement

(3) Notice Requirement

d. Administrative Scrutiny

(1) Safe Harbors

(A) Statutory Safe Harbor

(B) Industry Category Safe Harbor

(C) FAS 14 Safe Harbor

(D) Minimum or Maximum Benefits Safe Harbor

(E) Average Benefits Safe Harbor

(F) Merger and Acquisition Safe Harbor

(2) Individual Determination

e. Separate Operating Units

4. Determination of Employees of a QSLOB

a. Assignment of Substantial Service Employees

b. Assignment of Residual Shared Employees

(1) Dominant Line of Business Method

(2) Pro Rata Method

(3) HCE Percentage Ratio Method

(4) Small Group Method

5. Vertical Integration

6. Separate Application of Statutory Requirements

a. Employer-Wide Application

b. QSLOB Application

c. Special Rule for Employer-Wide Plans

d. Definition of "Plan"

e. Coordination with Other Code Provisions

7. Certain Governmental and Tax-Exempt Employers

8. Testing Year Basis of Application

9. Averaging Rules

10. Failure to Comply

E. Special Penalty Applicable to Failure to Satisfy § 401(a)(26) or § 410(b)

IV. The Vesting Rules

A. In General

B. The § 411(a) Rules

1. In General

2. "Cliff" Vesting

3. "Graded" Vesting

4. "Year of Service" for Vesting Purposes

5. Certain Permitted Forfeitures

6. Service that May Be Disregarded for Vesting Purposes

a. The Service Disregard Rules

b. Planning Implications of the Service Disregard and Other Similar Rules

(1) Service Disregard Rules

(2) Rule of Parity and Related Rules

(A) The Rule of Parity

(B) Freezing Pre-Break Service

(C) One-Year Break In Service

(3) Maternity- and Paternity-Related Leaves of Absence

(4) Past Service Credit

(5) Declining to Make Mandatory Employee Contributions

7. Voluntary and Involuntary Cash-Outs

a. Defined Benefit Plan Present Value Requirements

b. Lump Sum Distributions Requirements

c. Immediate Distribution of the Present Value of QPSA or QJSA

d. The Cash Balance Plan Whipsaw

e. Disregard of Certain Past Service

8. Certain Changes in the Vesting Schedule

V. Benefit Accrual

A. In General

B. § 411(b) Benefit Accrual Rules

1. Introduction

2. The Three Methods

a. The 3% Method

b. The 13313 % Method

c. The Fractional Method

C. Special Accrual Rules

1. Backloading and Cash Balance Plans

2. Age Discrimination Prohibitions - General

3. Age Discrimination Rules - The Similarly Situated Employee Rule

4. Special Cash Balance/Hybrid Plan Benefit Accrual Rules

a. Interest Credit Rules

b. Cash Balance Plan Conversion Rules

c. Plan Termination Rules

d. Vesting and Present Value Rules

D. Accrued Benefit Anti-Cutback Rule

1. General § 411(d)(6) Rules

2. Section 411(d)(6) Regulations

a. Rule on Redundant Optional Forms of Benefit

b. Core Options Rule

c. Rules for Determining When an Elimination Creates Significant Burdens and Complexities

d. Benefits Contingent on Unpredictable Events

e. Utilization Test

f. Early Retirement Benefits - Central Laborers' Pension Fund v. Heinz

E. Other Benefit Accrual Issues

1. Changing Actuarial Assumptions

2. Nontraditional Benefits

3. ERISA § 204(h) Notice

4. Rules Relating to Years of Service

5. Special Rule for Defined Benefit Plans Providing for Employee Contributions

6. Seasonal Industry, Maritime and Other Accrual Rules

7. Insured Plan Special Accrual Rules

8. Pre-ERISA Accrual Rules

9. Voluntary and Mandated Cessation of Accruals

10. Limitations on Benefit Accruals

VI. The § 415 Limits on Benefits

A. In General

1. Scope of § 415

2. Section 415 Definition of Compensation

B. Defined Contribution Plan Limits

1. In General

2. Special Rules

3. Limitation Year

C. Defined Benefit Plan Limits

1. In General

a. Dollar Limit on Annual Benefit

b. 100% of High Three Year Average Compensation Limit on Annual Benefit

2. Adjustments to the § 415(b) Limits

a. Adjustment for Other Forms of Benefits

b. Adjustment When Benefits Begin Before Age 62 or After Age 65

c. Government Plans and Plans Maintained by Tax-Exempt Organizations

(1) Exception from Early Retirement Dollar Limit Adjustment

(2) Exception from Average Compensation Limit

(3) Certain Excess Benefit Arrangements Disregarded

(4) Permissive Service Credits

d. Cost-of-Living Adjustments for Defined Benefit Plans

e. Employee Participation or Service Less Than 10 Years

f. Total Annual Benefits Not in Excess of $10,000

3. Section 415 Limits and Collectively Bargained Plans

4. Defined Benefit Plans for Commercial Airline Pilots

5. Multiple Annuity Starting Dates

D. Failure to Comply with Limits

E. Historical § 415 Information

VII. Top-Heavy Rules

A. In General

B. The Top-Heavy Vesting Rules

C. Top-Heavy Minimum Benefits

VIII. Special Rules Regarding Military Personnel and Veterans

A. In General

B. Pension Benefits and Rights

1. Service Credit and Nonforfeiture of Benefits

2. Benefit Funding

3. Make-up Contributions

4. Benefit Accrual

IX. Section 401(a)(4): Nondiscrimination as to Benefits or Contributions

A. Introduction

1. Definition of Highly Compensated Employee (HCE)

2. General § 401(a)(4) Requirements

B. Nondiscrimination Regulations

1. Nondiscriminatory Amount Requirement

a. In General

b. Defined Contribution Plans

(1) In General

(2) Safe Harbors

(A) Uniform Allocation Formula

(B) Uniform Points Allocation Formula

(3) The General Test

c. Defined Benefit Plans

(1) Overview

(2) Safe Harbors

(A) Unit Credit Plans

(B) Plans Using the Fractional Accrual Rule

(C) Insurance Contract Plans

(3) The General Test

d. Corrective Amendments

2. Nondiscriminatory Availability of Benefits, Rights, and Features (BRFs)

3. Nondiscriminatory Effect of Plan Amendments and Terminations

4. Employee Contributions in Defined Benefit Plans

5. Imputation of Permitted Disparity

6. Cross-Testing; Special Rules for Target Benefit Plans, Cash Balance Plans, and Floor-Offset Arrangements

a. Testing Defined Contribution Plans on the Basis of Benefits

(1) Broadly Available Allocation Rates

(2) Age-based Allocation Rates

(3) Uniform Target Benefit Allocations

(4) Gateway for Cross-Testing of New Comparability and Similar Plans

b. Testing Defined Benefit Plans on the Basis of Contributions

7. Plan Aggregation and Disaggregation

8. Nondiscrimination Testing of Former Employees

9. Vesting and Service Crediting

a. Service Crediting Methods

b. Past Service Credit

c. Pre-Participation and Imputed Service

10. Fresh-Start Rules

a. Overview

b. Fresh-Start Date

c. Fresh-Start Formulas

d. Consistency Requirements for Fresh Starts

e. Compensation Adjustments to Frozen Accrued Benefits

(1) Plan Requirements

(2) Meaningful Coverage as of Fresh-Start Date

(3) Meaningful Ongoing Coverage

(4) Meaningful Current Benefit Accruals

(5) Minimum Benefit Adjustments

(6) Adjusted Accrued Benefits

(7) Alternative Determination of Adjusted Accrued Benefit

11. Substantiating Compliance With Nondiscrimination Rules

C. Nondiscriminatory Definition of Compensation

1. In General

2. Safe Harbor Definitions

3. Definitions of Compensation that Satisfy § 414(s)

4. Reasonable Definition of Compensation

5. Use of Rate-of-Pay Definition

6. Crediting Prior-Employer and Imputed Compensation

7. Nondiscrimination Requirement

X. Medical Benefits to Retirees, Their Spouses and Dependents

A. In General

B. Transfers of Excess Pension Assets to § 401(h) Accounts

1. Qualified Transfers

a. Use Requirements

b. Vesting Requirements

c. Minimum Cost Requirements

2. Qualified Future Transfers and Collectively Bargained Transfers

a. Qualified Future Transfers

(1) Determination of Excess Pension Assets

(2) Limitation on Amount of Excess Pension Assets Transferred

(3) Minimum Cost Requirement

b. Collectively Bargained Transfer

(1) Minimum Cost Requirements

(2) Limitation on Amount Transferred

(3) Employer Deduction Limitations

3. Private Right of Action Under § 420

XI. Selected Issues Involving Bankruptcy and Qualified Plans

A. Exclusions from the Bankruptcy Estate

B. Exemptions and Exclusions from the Bankruptcy Estate After the 2005 Bankruptcy Act

1. Retirement Plan Interests

2. Plan Contributions

C. Participant Loans

XII. Prohibited Tax Shelter Transactions

A. In General

B. Entity Level Penalties

C. Entity Manager Penalties

D. Disclosure Requirements

E. Definition of "Party" and Allocation of Net Income or Proceeds Under § 4965

Working Papers

Working Papers

Table of Worksheets

Worksheet 1 Defined Benefit Plan (Benefit Accruals Frozen)

Worksheet 2 Defined Benefit Plan Summary Plan Description

Worksheet 3 Model Qualified Domestic Relations Order Procedures for Defined Benefit Plan

Worksheet 4 Model Qualified Domestic Relations Order for Defined Benefit Plan

Worksheet 5 Administrative Procedure Checklist for Defined Benefit Plan

Worksheet 6 Profit-Sharing Plan

Worksheet 7 Profit-Sharing Plan Summary Plan Description

Worksheet 8 Model Qualified Domestic Relations Order Procedures for Profit-Sharing Plan

Worksheet 9 Model Qualified Domestic Relations Order for Profit-Sharing Plan

Worksheet 10 Administrative Procedure Checklist for Profit-Sharing Plan

Worksheet 11 Sample Notice of Deferral Opt-Out

Worksheet 12 Sample Deferral Opt-Out Form

Worksheet 13 Unnumbered TAM on § 410 - Minimum Participation Standards





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