Temporary Relief Extended for Nondiscrimination Testing for Closed Defined Benefit Plans, IRS Seeks Comments on a Permanent Solution

In Notice 2015-28 the IRS extended the temporary nondiscrimination relief provision described below for plan years beginning before 2017. The extension was granted because the IRS does not believe it will have final regulations in place to address this issue before the original expiration date that applied to plans years beginning on or after January 1, 2016.  The original notice is not other changed except for this extension of the time period for which it will apply.

In recent years a number of employers have decided to switch from offering a defined benefit pension (DB) plan to offering a defined contribution (DC) plan.  In some cases the employers decided to do so by closing the defined benefit plan to employees hired after a certain date (a “closed” plan), but continuing to accrue benefits to employees already in the defined benefit plan.  Notice 2014-5 was issued to deal with a particular issue that arises in this context.

Generally qualified plans must demonstrate they do no discriminate in favor of highly compensated employees (HCEs) as compared to non-highly compensated employees (NHCEs).  When a closed defined benefit plan is involved, the combination of the DB and DC plans is tested for improper discrimination pursuant to options offered under Reg. §1.401(a)(9)‑9(a). 

In many cases the concentration of HCEs in the closed DB plan will increase over time and may make it difficult for the combined plans to meet the discrimination testing.  In such a case the notice comments that an employer will face three potential solutions:

  • Reduce the proportion of HCEs in the closed DB plan (by either opening it to some new NHCEs or by stopping participation by some HCEs);
  • Reconfigure the contributions under the DC plan so that it meets the minimum aggregate allocation gateway; or
  • Cease accruals in the DB plan entirely.

The first option has the obvious negative of either putting new employees in the DB plan (something closing it was meant to stop) or kicking out some of the employees whose benefits the employer sought to protect.  The second option may be deemed to be prohibitively expensive by the employer, especially since the employer may already be making a substantial contribution but not under a method that will count towards the minimum allocation gateway (such as matching contributions).

Thus that leaves only option 3—effectively shutting down the DB plan for the old employees.  Since the IRS considers this a “suboptimal” solution, the notice seeks to offer temporary relief as the IRS searches for a more permanent solution.

The IRS rejected the suggestion of allowing a DB plan that is once able to demonstrate nondiscrimination requirements at the time the plan was closed or at a later date to be treated as permanently nondiscriminatory.  The IRS was concerned that such a rule would apply a lower standard to closed DB plans than active DB plans, encouraging the closing of such plans.

So the IRS has decided instead to create a temporary relief provision for plan years beginning before January 1, 2016 (now, as noted above, extended to years beginning before January 1, 2017) for a DB plan that was amended prior to December 31, 2013 to close the plan if each DB plan in the combined DB/DC plans meets one of the following conditions:

1. For the plan year beginning in 2013, the DB plan was part of a DB/DC plan that either was primarily defined benefit in character (within the meaning of § 1.401(a)(4)-9(b)(2)(v)(B)) or consisted of broadly available separate plans (within the meaning of § 1.401(a)(4)-9(b)(2)(v)(C)), or

2. In the case of a DB plan that was amended, by an amendment adopted before December 13, 2013, to provide that only employees who participated in the DB plan on a specified date continue to accrue benefits under the plan, the DB plan was not part of a DB/DC plan for the plan year beginning in 2013 because the DB plan satisfied the coverage and nondiscrimination requirements without aggregation with any DC plan.

 During this temporary relief periods the plans must continue to meet all of the other nondiscrimination provisions of IRC §401(a)(4).

The IRS goes on to describe some potential future relief options that it might adopt as a permanent solution and requests comments on solving this problem in a more permanent manner.