IRS Proposes Permanent Nondiscrimination/Coverage Relief for Closed Pension Plans
February 3, 2016
By Hrishi Shah
The Internal Revenue Service (IRS) has issued proposed regulations that would provide permanent relief from certain coverage and nondiscrimination testing requirements to defined benefit plans that are closed to new participants, but that provide ongoing accruals to “grandfathered” employees, i.e. some or all employees who were participants in the plan as of a specified date. In recent years, many employers have closed their defined benefit plans to new participants except to groups of grandfathered employees, who continue accruing benefits in the closed plan (this is often referred to as a “soft freeze”). Over time, a soft-frozen plan may become more concentrated with highly-compensated employees (since longer-service employees tend to be higher paid on average). This often makes it difficult for closed plans to pass the Internal Revenue Code’s nondiscrimination/coverage testing requirements.
As we wrote in a previous alert, the IRS initially offered this relief on a temporary basis in Notice 2014-5, and extended the relief for an additional year in Notice 2015-28. These proposed regulations would make the relief permanent. The proposed regulations permit closed plans and similar arrangements to satisfy applicable nondiscrimination testing rules in additional situations. For example, the rules establish a special testing rule providing that if a benefit, right, or feature of a closed plan is only available to a group of grandfathered employees, this does not cause the plan to fail nondiscrimination testing if certain other requirements are met.
If finalized, these regulations will be a very positive development for employers and other plan sponsors with soft-frozen defined benefit plans. It may, for example, encourage some employers and plan sponsors to reconsider intentions to freeze benefits for all plan participants (a so-called “hard freeze”).