Closed Pension Plans Could Meet Nondiscrimination Rules

By Sally P. Schreiber, J.D.

Employers will be able to maintain closed defined benefit plans without running afoul of the nondiscrimination rules of Sec. 401(a) under proposed regulations issued by the IRS on Thursday (REG- 125761-14).

Closed defined benefit plans are defined benefit plans that continue in existence covering older employees but that are closed to newer employees. Because the “grandfathered” employees in the closed plan tend to have been with the company longer and the employees who are not in the plan are usually newer employees who are not as highly compensated, the plans often find it difficult to meet the nondiscrimination requirements. Under Notice 2014-5, the IRS allowed defined benefit plans to be combined with defined contribution plans (called DB/DC plans) to meet the nondiscrimination requirements if they satisfied certain criteria. The notice also requested comments on whether other rules should be issued to ease the way for closed plans to continue to operate.

Issued in response to the comments received, the proposed rules cover a number of areas. First, they contain special rules to permit closed plans and similar arrangements to continue to satisfy the nondiscrimination rules in additional situations. To accomplish this, a closed plan rule is added to the plan aggregation and restructuring rules under Regs. Sec. 1.401(a)(4)-9.

Second, the IRS added a special rule to test whether a benefit, right, or feature provided to a grandfathered group of employees under Regs. Sec. 1.401(a)(4)-4 is available on a nondiscriminatory basis. If the eligibility conditions are satisfied, the special testing rule treats a benefit, right, or feature that is provided only to a grandfathered group of employees as satisfying the current and effective availability tests of Regs. Secs. 1.401(a)(4)-4(b) and (c).

The proposed rules also loosen the rules under which a DB/DC plan can satisfy the nondiscrimination-in-amount requirement on the basis of benefits. The new rules are intended to enable the ongoing maintenance of a defined benefit plan that provides coverage to a group of employees that is determined using a reasonable business classification.

Third, the proposed regulations address certain plan arrangements that take advantage of the flexibility in the existing nondiscrimination rules to provide a special benefit formula for selected employees without extending that formula to a classification of employees that is reasonable and is established under objective business criteria.

A plan satisfies the minimum coverage requirements of Sec. 410(b) if the plan’s ratio percentage is 70% or higher or the plan satisfies the average benefit test. Under Regs. Sec. 1.410(b)-4, to satisfy the average benefit test, the group of employees must be determined using a classification that is reasonable and established under objective business criteria and must have a ratio percentage described in Regs. Sec. 1.410(b)-4(c) (including safe-harbor and unsafe-harbor percentages).

The preamble refers to a classification of employees that is reasonable and established under objective business criteria as a “reasonable business classification.” To the extent that a plan provides a special benefit formula and can still pass the nondiscrimination requirements, the plan sponsor can use a qualified retirement plan to provide benefits that would otherwise be provided under a nonqualified plan. These arrangements are sometimes referred to as qualified supplemental executive retirement plans (QSERPs).

The regulations are proposed to apply generally to plan years beginning after they are adopted as final. Most of these rules, however, can be applied before they are finalized. All of the above rules, except for the “basis of benefits” rules, can be applied retroactively to plan years beginning on or after Jan. 1, 2014.  

Sally P. Schreiber ( is a Tax Adviser senior editor.  

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