BLOG POST

ML BeneBits

Closed defined benefit plans—i.e., defined benefit plans that are frozen to new participants but that allow existing “grandfathered” participants to continue to accrue benefits—are nearly certain to face challenges in passing nondiscrimination testing. This is because, over time, the grandfathered group that continues to accrue benefits is likely to become disproportionately highly compensated as a result of their longer service and the absence of shorter-service employees participating when they are first hired.

In order to address this problem, which predictably can lead to more completely frozen defined benefit plans (that is, plans without any future benefit accruals) and plan terminations, the IRS began issuing narrow testing relief for qualifying defined benefit plans in 2014. That first relief, issued in Notice 2014-5, addressed the increasingly common situation of a closed defined benefit plan, and presumed that the plans sponsor of the closed defined benefit plan would provide a defined contribution plan for its new hires. The relief under Notice 2014-5 didn’t waive testing but permitted testing an eligible closed defined benefit plan together with nonelective (but not matching) contributions to a defined contribution plan. No relief was made available for benefits, rights, and features testing, for failing the minimum participation requirement under Code Section 401(a)(26), or for plans that only provide matching contributions to the employees excluded from the closed defined benefit plan.

Each year since 2014, the IRS has further extended the relief under the same terms, including through recently issued Notice 2019-49 (for example, our earlier blog post addressed the prior extension granted by Notice 2017-45). And in an effort to craft a more permanent fix, the IRS issued proposed regulations on January 26, 2016, to more broadly address closed defined benefit plan testing issues, which we previously discussed. Notice 2019-49 extends the temporary nondiscrimination testing relief through plan years beginning before January 1, 2022, which is presumably long enough for the IRS to finalize the 2016 proposed regulations.

However, the IRS was not done. Comments to the 2016 proposed regulations gave rise to additional closed defined benefit plan guidance issued in Notice 2019-60. Like the initial guidance, the new guidance provides relief for closed plans only if the amendment closing the plan was adopted before December 13, 2013. But this relief was only available for plans that satisfied coverage and nondiscrimination testing for 2013 either on a standalone basis or under one of two “gateway” testing methods that relied on the sponsor also providing defined contribution plan benefits. The new relief in Notice 2019-60 doesn’t impose such a requirement for benefits, rights, and features testing relief; that is, eligibility for this relief does not depend on the method used to satisfy the nondiscrimination requirements for the plan year beginning in 2013.

Under this new relief, the eligible defined benefit plan is treated as satisfying current and effective availability for the plan year with respect to a benefit, right, or feature that was provided under the plan at the time the amendment closing the plan was adopted (provided the amendment was adopted prior to November 13, 2013) if either of the following conditions is met:

  1. The plan has not adopted an amendment after January 29, 2016, that expands or restricts eligibility for the benefit, right, or feature; or
  2. If the plan has adopted an amendment after January 29, 2016, that expands or restricts the eligibility for the benefit, right, or feature, the post-amendment ratio percentage of the group of employees eligible for the benefit, right, or feature was not less than the pre-amendment ratio percentage of the group of employees eligible for the benefit, right, or feature.

This new nondiscrimination testing relief for closed defined benefit plans is available for plan years ending after November 13, 2019, and beginning before January 1, 2021. Presumably, if the IRS finalizes the 2016 proposed regulations before the end of 2020, the benefits, rights, and features relief will be part of those final regulations.

Legislation passed by the House and pending before the Senate known as the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 (HR 1994) would provide more comprehensive nondiscrimination testing relief for closed defined benefit plans than Notices 2019-49 and 2019-60 and even the 2016 proposed regulations. The SECURE Act, which we discussed in an earlier LawFlash, has broad bipartisan support and is widely considered to stand a good chance of being enacted. However, in the absence of any legislative solution provided by Congress, the IRS’s continued efforts to address the nondiscrimination testing challenges faced by closed defined benefit plans is encouraging for plan sponsors and grandfathered participants alike.