United States: Retirement Plan Update

Executive Overview

Recent IRS guidance on the retirement plan front.

On March 24, 2004, the IRS issued proposed regulations under Code Section 411(d)(6)(B), which provide guidance on the conditions under which a retirement plan amendment may eliminate or reduce an early retirement benefit, a retirement-type subsidy, or an optional form of benefit. The proposed regulations are in response to changes in the law made by EGTRRA, permitting the elimination of certain protected benefits if the benefits create significant burdens or complexities and the elimination does not significantly affect plan participants.

Generally, a retirement plan may eliminate an optional form of benefit if the plan retains a similar form or if the plan permits participants to select among a group of core options. In each of these cases, an available form must have the same value as the eliminated form and may not subject participants to restrictions more burdensome than those in the eliminated form. Further, a lump sum benefit cannot be eliminated, and special rules apply if a benefit includes either a Social Security leveling feature or a refund of employee contributions feature.

To be considered a similar form, a benefit option must be in the same family. The proposed regulations describe the following six families: (1) the 50% or more joint and contingent family; (2) the below 50% or less joint and contingent family; (3) the 10 years or less term certain and life annuity family; (4) the greater than 10 years term certain and life annuity family; (5) the 10 years or less level installment family; (6) and the greater than 10 years level installment family.

If a plan permits participants to choose a benefit form from a set of core options, it can eliminate non-core forms. The core options are a straight life annuity, a 75% joint and contingent annuity, a 10-year certain and life annuity, and the most valuable option for a participant with a short life expectancy. The most valuable option for a participant with a short life expectancy is the optional form of benefit that is reasonably expected to result in payments that have the largest actuarial present value. For this purpose, the proposed regulations contain a safe harbor in which such requirement is satisfied with a lump sum option if such option has an actuarial present value that is not less than the present value of any option to be eliminated.

The proposed regulations have additional requirements if the retained optional form of benefit or core option does not have the same annuity starting date or if it has a lower actuarial present value than the eliminated form (such as elimination of early retirement benefits or early retirement subsidies). The plan may eliminate such a benefit only if the optional form creates significant burdens and complexities for the plan and plan participants and if plan participants are not significantly affected by the elimination. Whether a protected benefit is significantly burdensome is a facts and circumstances test. Examples of factors that could be considered include: (1) the number of categories of early retirement benefits; (2) whether the terms and conditions applicable to the plan’s early retirement benefits are difficult to clearly summarize; and (3) whether the early retirement subsidies are the result of plan mergers, acquisitions or other business transactions. If these requirements are met, the plan sponsor may amend the plan without regard to whether the amendment has the effect of eliminating an early retirement benefit or reducing a retirement-type subsidy.

Under the proposed regulations, plan participants may have a right to receive an advance notice of the elimination. The proposed regulations cannot be relied upon until they are adopted in final form.

On December 17, 2003, the IRS issued final regulations under Code Section 417 that provide guidance regarding the required description of the relative values of optional forms of benefits under a retirement plan as compared to the value of the qualified joint and survivor annuity (QJSA). Under the regulations, the description of the relative value of an optional form of benefit compared to the value of the QJSA must be expressed in a manner that provides a meaningful comparison of the relative economic values of the two forms of benefit without the participant having to make calculations using interest or mortality assumptions. Several techniques may be used for this purpose, including expressing the actuarial present value of the optional form as a percentage or factor of the actuarial present value of the QJSA; stating the amount of an annuity payable at the same time and under the same conditions as the QJSA that is the actuarial equivalent of the optional form of benefit; or stating the actuarial present value of both the QJSA and optional form of benefit.

In recognition that it could be too burdensome to disclose the relative value of every optional form available under a plan, the regulations contain several simplifications. Two or more optional forms of benefit that have approximately the same value can be grouped for purposes of the disclosure. Optional forms will be treated as having approximately the same value if they do not vary in relative value in comparison to the QJSA by more than 5%. In addition, any optional form of benefit that has an actuarial present value of at least 95% of the actuarial present value of the QJSA is treated as having approximately the same value as the QJSA. The final regulations permit a plan to treat all of its forms of benefit as approximately equal, if the actuarial present value of all of those forms is not less than 95% of the actuarial present value of the QJSA. Plans that compare the relative value of optional forms to the value of the QJSA for a married participant may treat every available optional form that has an actuarial present value of at least 95% of the actuarial present value of the QJSA as having approximately the same relative value as the QJSA. Plans that compare the value of optional forms to the value of the single life annuity may treat all available forms of distribution as approximately equal in value if the optional forms of benefit have actuarial present values of at least 95% and not greater than 102.5% of the actuarial present value of the single life annuity. The plan’s actuarial assumptions are not required to be included in the disclosure, but such assumptions must be provided upon the participant’s request.

We recommend that plan sponsors review their disclosure forms for any needed changes as soon as possible. The final regulations are effective for annuity starting dates on and after October 1, 2004 and for disclosures provided on or after July 1, 2004.

In Revenue Ruling 2004-12, the IRS addressed whether distributions of rollover amounts must comply with the distribution requirements applicable to other distributions from the plan. The IRS held that as long as the rolled-over amounts were separately accounted for under the plan, distribution of those amounts was not subject to the restrictions on timing that may apply to other distributions under the plan. Therefore, the plan could permit distribution of rollover amounts before termination of employment upon a participant’s request, subject to spousal consent, where applicable. Distributions would be subject to the normal withholding rules and the 10% excise tax, if applicable.

In Revenue Ruling 2004-10, the IRS addressed whether a defined contribution plan could charge the accounts of former participants, but not current participants, with a pro rata share of the plan’s reasonable administrative expenses without violating the consent requirements under Code Section 411(a)(11). Regulations under Code Section 411(a)(11) provide that consent to a distribution is not valid if, under the plan, a significant detriment is imposed on any participant who does not consent to the distribution. The IRS held that the allocation of reasonable administrative expenses to the account of a participant who does not consent to a distribution is not a significant detriment because analogous fees would be imposed in the marketplace, either implicitly or explicitly, for a comparable investment outside of the plan.

Code Section 410(b)(6) provides a special transition period for plan coverage changes due to a merger, acquisition or disposition. During the transition period, the requirements of Code Section 410(b) will be deemed to be met, provided that such requirements were met immediately prior to the transaction and neither the plan nor the coverage under the plan is significantly changed during the transition period (other than by reason of the transaction). In Revenue Ruling 2004-11, the IRS addressed the application of Code Section 410(b) to a plan that was divided into component plans for purposes of discrimination testing under Code Section 401(a)(4) and found that the transition rule could be applied separately to each component plan (provided that the requirements were otherwise satisfied with respect to such component plan). The IRS also held that where the plan benefits are significantly changed during the transition period, the plan does not lose the relief provided by the transition rule retroactively to the date of the transaction. Rather, the normal provisions of Code Section 410(b), without regard to the transition rules, apply as of the effective date of the significant change in benefits. Note that the revenue ruling is specific to the facts described. The IRS also requested comments on three additional fact situations described in the ruling. Any comments should be submitted by May 17, 2004.

Application of Top-Heavy Rules to 401(k) Plans

The IRS also provided guidance on the top-heavy rules under Code Section 416 for plans that are intended to meet the 401(k)(12) and 401(m)(11) safe harbors. In Revenue Ruling 2004-13, the IRS described several situations in which a design-based safe harbor plan may still be subject to the top-heavy rules for some plan years. For example, if the plan contains a discretionary employer contribution, the plan would be subject to the top-heavy rules for any year in which a discretionary contribution is made. If the plan reallocates forfeitures of matching contributions for a plan year as a percentage of compensation, it would be subject to the top-heavy rules for such year.

A plan that benefits both highly and nonhighly compensated employees and permits elective deferrals immediately upon commencement of employment, but does not provide matching contributions until the employee has completed a year of service, would be subject to the top-heavy rules because, in that situation, a highly compensated employee who had satisfied the one year of service requirement would receive a higher rate of matching contributions than a nonhighly compensated employee who had not satisfied the service requirement. Such a plan could satisfy the safe harbor under 401(k)(12) but would not satisfy the safe harbor under 401(m)(11). A plan must satisfy both safe harbors to be eligible for the exemption from the top-heavy rules under Code Section 416(g)(4)(H).

The IRS has also issued Revenue Procedure 2004-15 setting forth updated procedures for requesting waivers of the minimum funding standard for defined benefit plans, effective for all requests received after February 17, 2004. The revenue procedure supersedes Revenue Procedure 94-14 and modifies Revenue Procedures 2004-4, 2004-5 and 2004-6.

Copyright 2004 Gardner Carton & Douglas

This article is not intended as legal advice, which may often turn on specific facts. Readers should seek specific legal advice before acting with regard to the subjects mentioned here.