On December 13, 2013, the IRS issued Notice 2014-5 which provides temporary relief for satisfying the nondiscrimination requirements under Section 401(a)(4) of the Internal Revenue Code (the “Code”) for plan sponsors that maintain defined benefit plans which have been closed to new hires.
Many defined benefit plan sponsors have implemented “soft freezes” of their plans, closing them to new hires, but continuing defined benefit plan accruals for participants hired before the “soft-freeze.” These employers might then implement a new or enhance an existing defined contribution plan for new hires. Over time, the defined benefit plan might no longer pass coverage testing under Code Section 410(b) on its own because of greater turnover among the non-highly compensated employee group covered by the plan relative to the highly compensated employee population. As a result, the frozen defined benefit plan must be aggregated with the defined contribution plan to satisfy the coverage requirements of the Code (the defined benefit plan, when aggregated with the defined contribution plan for testing is referred to as the “Aggregated Plan”).
Then, if the defined benefit plan and the defined contribution plan are aggregated for coverage testing, they also must be aggregated for nondiscrimination testing. To satisfy the nondiscrimination requirements, that Aggregated Plan must be tested on the basis of “equivalent benefits” (i.e., by converting the defined contribution amounts to equivalent benefits and then aggregating those benefits with the benefits under the defined benefit plan) by satisfying one of three conditions. Specifically the Aggregated Plan must:
- be primarily defined benefit in character;
- consist of broadly available separate plans; or
- meet the minimum aggregate allocation gateway.
Meeting one of the first two conditions above is most likely during the early years following a “soft freeze.” Eventually, however, the demographics will change such that the Aggregated Plan will be required to satisfy the minimum aggregate allocation gateway, which requires that each nonhighly compensated employee in the Aggregated Plan have a minimum aggregate normal allocation rate that is a function of the highest aggregate normal allocation rate of the highly compensated employees. Because many defined contribution plans may not provide for allocations that would satisfy this gateway requirement, the Aggregated Plan will end up not satisfying the nondiscrimination requirements.
Notice 2014-5 offers temporary relief for plan sponsors that maintain closed defined benefit plans. This relief helps these plans meet the Code’s technical nondiscrimination requirements for plan years beginning before January 1, 2016, even if the equivalent benefit conditions cannot be satisfied, as long as the defined benefit plan in the Aggregated Plan situation was amended to exclude new hires prior to December 13, 2013 and meets one of the following two conditions:
- for plan year beginning in 2013, the defined benefit plan was part of an Aggregated Plan that was either primarily defined benefit in character; or
- the defined benefit plan passed nondiscrimination testing on its own, without any aggregation, for the plan year beginning in 2013.
The IRS noted that all other provisions under Code Section 401(a)(4) concerning nondiscrimination testing apply during this period temporary relief.
Although the relief provided by Notice 2014-5 is certainly welcome, it is questionable how helpful it actually will be to plan sponsors. Perhaps more significantly, the Notice also includes a number of proposals for a permanent resolution to resolve these issues in the future. Plan sponsors facing the challenges addressed in the Notice should certainly consider filing comments on these proposals. Written or electronic comments are being accepted by the IRS until February 28, 2014.