IRS Notice 2014-5 Provides Temporary Nondiscrimination Relief for Closed Defined Benefit Plans | Practical Law

IRS Notice 2014-5 Provides Temporary Nondiscrimination Relief for Closed Defined Benefit Plans | Practical Law

The Internal Revenue Service (IRS) issued Notice 2014-5, which permits certain employers that sponsor a closed defined benefit plan and a defined contribution plan to demonstrate that the aggregated plans comply with the nondiscrimination requirements of IRC Section 401(a)(4) on the basis of equivalent benefits, even if the aggregated plans do not satisfy the current conditions for testing on that basis. The Notice also requests comments on possible permanent changes to the nondiscrimination rules under IRC Section 401(a)(4).

IRS Notice 2014-5 Provides Temporary Nondiscrimination Relief for Closed Defined Benefit Plans

by Practical Law Employee Benefits & Executive Compensation
Law stated as of 13 Dec 2013 • USA (National/Federal)
The Internal Revenue Service (IRS) issued Notice 2014-5, which permits certain employers that sponsor a closed defined benefit plan and a defined contribution plan to demonstrate that the aggregated plans comply with the nondiscrimination requirements of IRC Section 401(a)(4) on the basis of equivalent benefits, even if the aggregated plans do not satisfy the current conditions for testing on that basis. The Notice also requests comments on possible permanent changes to the nondiscrimination rules under IRC Section 401(a)(4).
On December 14, 2013, the IRS issued Notice 2014-5 (Notice), which permits certain employers that sponsor a closed defined benefit plan, which is also referred to as a plan in a "soft freeze" (see Practice Note, Freezing Defined Benefit Plan: Types of Defined Benefit Plan Freezes), and a defined contribution plan to demonstrate that the aggregated plans comply with the nondiscrimination requirements of IRC Section 401(a)(4) on the basis of equivalent benefits, even if the aggregated plans do not satisfy the current conditions for nondiscrimination testing on that basis (IRS Notice 2014-5, (Dec. 14, 2013)).
The Notice also requests comments on possible permanent changes to the nondiscrimination rules under IRC Section 401(a)(4), which must be received by February 28, 2014.

Closed Defined Benefit Plans and Current Nondiscrimination Rules

In this economic climate many employers have chosen to freeze or close their defined benefit pension plans to new participants and establish a defined contribution plan for new employees. In this situation:
  • Benefits continue to accrue for the participants in the closed plan but are limited to some or all of the employees who participated in the plan on a specified date.
  • The proportion of highly compensated employees (HCEs) in the closed plan increases over time, due to:
    • non-highly compensated employees (NHCEs) becoming HCEs; and
    • a higher turnover rate for NHCEs as compared to HCEs.
  • It becomes difficult for the closed plan to satisfy the coverage requirement of IRC Section 410(b) unless the closed plan is aggregated with the new defined contribution plan.
If the closed plan is aggregated with a new defined contribution plan that covers new employees to satisfy the coverage requirement, then it is also required to be aggregated with the defined contribution plan to satisfy the nondiscrimination requirements of IRC Section 401(a)(4).
Typically, the aggregated plans will fail to meet the requirements of IRC Section 401(a)(4) unless plan sponsors are permitted to demonstrate compliance with the nondiscrimination rules on the basis of equivalent benefits. The IRS acknowledged in the Notice that there are situations in which plan sponsors cannot satisfy any of the three alternative conditions for testing on the basis of equivalent benefits and must either:
  • Reduce the proportion of HCEs in the closed defined benefit plan (by either opening it to some new NHCEs or by stopping participation by some HCEs).
  • Change the structure and amount of contributions under the DC plan so that it meets the minimum aggregate allocation gateway (one of the conditions for testing on the basis of equivalent benefits).
  • Completely cease benefit accruals in the closed plan.
In response in part to concerns that many employers are choosing to completely cease benefit accruals in closed plans, the Treasury Department and the IRS received a number of requests that the nondiscrimination regulations under IRC Section 401(a)(4) be amended to provide additional alternative means of satisfying the nondiscrimination requirements in the case of a closed plan.

Temporary Nondiscrimination Relief for Closed Plans

The Notice provides temporary relief permitting sponsors of a closed defined benefit plan that is aggregated with a new defined contribution plan (DB/DC plan) to demonstrate compliance with the nondiscrimination in amount requirement of Treasury Regulation Section 1.401(a)(4)-1(b)(2) on the basis of equivalent benefits, even if the DB/DC plan does not satisfy any of the existing eligibility conditions for testing on that basis.
Under this alternative, the DB/DC plan may demonstrate compliance on the basis of equivalent benefits for a plan year that begins before January 1, 2016, if:
  • It includes a closed defined benefit plan that was amended before December 13, 2013 to provide that only employees who participated in the plan on a specified date continue to accrue benefits under the plan.
  • For the plan year beginning in 2013, the closed plan:
    • was part of a DB/DC plan that either was primarily defined benefit in character or consisted of broadly available separate plans under the IRC Section 401(a)(4) regulations; or
    • was not part of a DB/DC plan for the 2013 plan year because the defined benefit plan satisfied the coverage and nondiscrimination requirements without aggregation with any defined contribution plan.
During the period for which this temporary relief applies, the remaining provisions of the nondiscrimination regulations under IRC Section 401(a)(4) continue to apply.

Request for Comments on Alternative Relief

The Treasury Department and the IRS are considering whether the regulations under IRC Section 401(a)(4) should be amended to provide additional alternatives that would allow a DB/DC plan to demonstrate satisfaction of the nondiscrimination in amount on the basis of equivalent benefits. The Notice requests comments on several possible alternatives.
Also, the Treasury Department and the IRS request comments on modifying the rules more significantly to make it less burdensome for employers who wish to freeze defined benefit plans and provide comparable benefits to new employees through defined contribution plans.
Comments must be received by February 28, 2014.