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IRS Issues Guidance Aimed at Helping Frozen DB Plans Pass Nondiscrimination Testing


December 2013

The IRS issued Notice 2014-5 which provides temporary relief to frozen defined benefit plans with regard to the required annual nondiscrimination and coverage tests under the Internal Revenue Code. The Notice provides temporary guidance that allows the sponsor of a frozen defined benefit plan to satisfy the annual nondiscrimination testing requirements under Code Section 401(a)(4) by providing equivalent benefits under a separate defined contribution plan to employees who are not eligible to participate in the defined benefit plan, even if the plan is not permitted under current testing rules to test on this basis.

To provide some background, when a defined benefit plan is “frozen” (i.e., existing participants continue to accrue benefits, but new employees are no longer eligible to participate), the plan may eventually have difficulty passing certain required annual nondiscrimination and coverage tests. This happens because the plan’s existing participants typically become more highly compensated over time as compared to newer employees who are not accruing any benefits in the plan. Eventually, this disparity can make it difficult or impossible for the plan to satisfy the nondiscrimination and coverage tests in the Internal Revenue Code. Sponsors of defined benefit plans have in recent years asked Congress and the IRS to help alleviate this problem, to help plan sponsors avoid the need to stop all benefit accruals under their defined benefit plans.

Although Congress has so far failed to take any meaningful action in response to this issue, the IRS, in Notice 2014-5, has provided some limited temporary relief to frozen plans with regard to the nondiscrimination test under Code Section 401(a)(4). Under this temporary guidance, a defined benefit plan that is aggregated with a defined contribution plan for nondiscrimination and coverage testing purposes can satisfy the nondiscrimination test on the basis of equivalent benefits provided to participants in the defined contribution plan, even if the two plans do not otherwise meet the normal requirements to test on the basis of equivalent benefits. For many frozen defined benefit plans, testing on the basis of equivalent benefits is not currently an option, so Notice 2014-5 will help many frozen plans comply.

Importantly, this new testing option is generally only available for defined benefit plans that, for the plan year beginning in 2013, satisfied the nondiscrimination and coverage tests under the existing rules. Finally, the testing option is only available for defined benefit plans that were frozen before December 13, 2013, and it can only be used for plan years beginning before January 1, 2016. Between now and 2016, the IRS has said that it expects to engage in a formal rulemaking process to provide a more permanent solution for frozen plans.

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