IRS Gives Limited Pension Nondiscrimination Relief

Just 10 days ago, I wrote about the request to the IRS and Treasury from Senators Portman and Cardin to provide pension nondiscrimination testing relief to sponsors who have soft frozen their defined benefit (DB) plans. In Notice 2014-5, the IRS has done that, albeit on a temporary basis.

For background, a DB plan is soft frozen typically when a grandfathered group of participants are allowed to continue accruing benefits, but no new entrants are allowed into the plan. From a testing standpoint under Code Sections 401(a)(4) and 410(b), the plan will typically pass in the early years as the group benefiting under the plan will look a lot like the group that was benefiting immediately before the soft freeze. Eventually, however, as turnover tends to be higher among nonhighly compensated employees (NHCEs) than among highly compensated employees (HCEs) and because more participants will 'graduate' from NHCE status to HCE status than conversely, testing results get worse.

The typical alternative then is to aggregate the soft frozen DB plan with one or more DC plans for testing purposes. The aggregated plan is then referred to as a DB/DC plan, a name that does not quite roll off the tongue, but is descriptive nonetheless. DB/DC plans may be tested on a benefits basis (usually will pass) or on a contributions basis (usually will fail), but in order to be tested on a benefits basis, the DB/DC plan must jump through one of a number of hoops. Without going into detail, this is usually easy in the early years and gets more and more difficult with each passing year. Add to that that the DC plan being aggregated with the DB plan cannot be a plan subject to Code Section 401(k) or 401(m) (or a part of a larger plan subject to one of those sections) or be an ESOP and the process gets a little bit more difficult to deal with.

According to the Notice, if a sponsor soft froze its DB plan before December 13, 2013 and its DB/DC plan met one of the requirements to be cross-tested on a benefits basis for the 2013 plan year, then for any plan year that begins before 2016, the sponsor generally may continue to test this DB/DC plan on a benefits basis. In the meantime, IRS has requested comments on this notice and will continue to evaluate how such situations should be handled.

This relief is only short-term in nature and there are many situations that will not be helped by this relief, but if you are one of the lucky sponsors, this may give you the help you were looking for.