n-14-66.pdf

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Notice 2014-66

Lifetime Income Provided Through Target Date Funds in Section 401(k) Plans and
Other Qualified Defined Contribution Plans

I. PURPOSE

This notice provides a special rule that enables qualified defined contribution
plans to provide lifetime income by offering, as investment options, a series of target
date funds (TDFs) that include deferred annuities among their assets, even if some of
the TDFs within the series are available only to older participants. This special rule
provides that, if certain conditions are satisfied, a series of TDFs in a defined
contribution plan is treated as a single right or feature for purposes of the
nondiscrimination requirements of § 401(a)(4) of the Internal Revenue Code. This
permits the TDFs to satisfy those nondiscrimination requirements as they apply to rights
or features even if one or more of the TDFs considered on its own would not satisfy
those requirements.

II. BACKGROUND

Section 401(a)(4) provides in general that a plan is a qualified plan only if the
contributions or the benefits provided under the plan do not discriminate in favor of
highly compensated employees.

Section 1.401(a)(4)-4 of the Income Tax Regulations provides that optional forms
of benefit, ancillary benefits, and other rights and features must be currently available to
a group of employees that satisfies the nondiscriminatory classification requirement of
§ 410(b) (without regard to the average benefit percentage test). In addition, the group
of employees to whom these benefits, rights, and features are effectively available must
not substantially favor highly compensated employees.

Section 1.401(a)(4)-4(e)(1) provides that the term “optional form of benefit”
means a distribution alternative (including the normal form of benefit) that is available
under a plan with respect to benefits described in § 411(d)(6)(A) or a distribution
alternative that is an early retirement benefit or retirement-type subsidy described in
§ 411(d)(6)(B)(i), including a “qualified social security supplement” (QSUPP) as defined
in § 1.401(a)(4)-12.

Section 1.401(a)(4)-4(e)(2) provides that the term “ancillary benefit” means social
security supplements (other than QSUPPs), disability benefits not in excess of a
qualified disability benefit described in § 411(a)(9), ancillary life insurance and health
insurance benefits, death benefits under a defined contribution plan, preretirement
death benefits under a defined benefit plan, shut-down benefits not protected under
§ 411(d)(6), and other similar benefits.

Section 1.401(a)(4)-4(e)(3)(i) provides that the term “other right or feature”
generally means any right or feature applicable to employees under the plan. Different
rights or features exist if a right or feature is not available on substantially the same
terms as another right or feature. Section 1.401(a)(4)-4(e)(3)(ii) provides that a right or
feature is not considered an other right or feature if it is an optional form of benefit or
ancillary benefit, or cannot be expected to be of meaningful value to an employee.
Section 1.401(a)(4)-4(e)(3)(iii)(C) provides, as an example, that the right to a particular
form of investment is an other right or feature.

Section 1.401(a)(4)-1(d) provides that the Commissioner may, in revenue rulings,
notices, and other guidance, published in the Internal Revenue Bulletin, provide any
additional guidance that may be necessary or appropriate in applying the
nondiscrimination requirements of § 401(a)(4), including additional safe harbors and
alternative methods and procedures for satisfying those requirements.

Questions have arisen regarding compliance with the nondiscrimination
requirements of § 401(a)(4) for an arrangement under which a plan’s investment options
include a series of TDFs, some of which hold deferred annuities. Under the
arrangement, the TDF series is a group of TDFs managed by an investment manager
and each of the TDFs is invested in a manner appropriate for a particular age group,
with the mix of equity and fixed income exposure becoming more conservative over
time in order to reflect the applicable age group’s advancing age.

Some of the fixed income exposure in the TDFs for older age groups results from
the purchase of deferred annuities, which will be distributed to participants when the
TDF is dissolved at its target date. As each group’s age advances, an increasing
portion of the portfolio is applied to the purchase of deferred annuities. Stakeholders
indicate that it would not be actuarially reasonable for an insurer to offer a deferred
annuity at a price that does not vary based on the age of the purchaser, and that,
accordingly, a TDF that holds deferred annuities should not be expected to permit
participants whose ages fall outside the designated age-band for the TDF to hold an
interest in that TDF.

If the deferred annuity within a TDF is made available only to older participants,
these participants could disproportionately consist of highly compensated employees
(because, as a group, older employees are often higher paid than younger employees).
If so, making TDFs with deferred annuities available only to older participants presents
the question of whether the use of age-restricted TDFs could violate the current
availability or effective availability requirement for benefits, rights, and features under
§ 1.401(a)(4)-4. Stakeholders have requested guidance that the use of a series of
TDFs to provide lifetime income in this manner does not violate those nondiscrimination
requirements of § 401(a)(4).

III. TREATMENT OF A TDF SERIES AS A SINGLE RIGHT OR FEATURE

The right to each form of investment available under a plan, including each TDF
in a series of TDFs, is an other right or feature within the meaning of § 1.401(a)(4)-
(4)(e)(3)(iii)(C). Therefore, each TDF must be made available in a nondiscriminatory
manner and must otherwise satisfy the nondiscrimination requirements under
§ 401(a)(4) and § 1.401(a)(4)-4.

Pursuant to the Commissioner’s authority under § 1.401(a)(4)-1(d) to provide an
alternative method for satisfying the nondiscrimination requirements, a series of TDFs
under a defined contribution plan in which participation in some TDFs is restricted to
participants in particular age-bands is permitted to be treated as a single “other right or
feature” for purposes of § 1.401(a)(4)-4, provided that the following conditions are
satisfied:
1. The series of TDFs is designed to serve as a single integrated investment
program under which the same investment manager manages each TDF and
applies the same generally accepted investment theories across the series of
TDFs. Thus, the only difference among the TDFs is the mix of assets selected
by the investment manager, which difference results solely from the intent to
achieve the level of risk appropriate for the age-band of individuals participating
in each TDF. In accordance with the consistent investment strategy used to
manage the series of TDFs, the design for the series is for the mix of assets in a
TDF currently available for older participants to become available to each
younger participant as the asset mix of each TDF for younger participants
changes to reflect the increasing age of those participants.
2. Some of the TDFs available to participants in older age-bands include deferred
annuities, and none of the deferred annuities provide a guaranteed lifetime
withdrawal benefit (GLWB) or guaranteed minimum withdrawal benefit (GMWB)
feature.
1

3. The TDFs do not hold employer securities, as described in section 407(d)(1) of
the Employee Retirement Income Security Act of 1974, Public Law 93-406, as
amended (ERISA), that are not readily tradable on an established securities
market.
4. Each TDF in the series is treated in the same manner with respect to rights or
features other than the mix of assets. For example, the fees and administrative
expenses for each TDF are determined in a consistent manner, and the extent to

1
Under a contract that provides GLWBs with respect to a participant’s account, the participant is
guaranteed to receive a specified lifetime stream of income regardless of the investment performance of
the account, while still retaining access to the funds in the account. This GLWB feature permits a
participant to withdraw annually a certain percentage (for example, 5 percent) of a contractually specified
income or benefit base. In the event that the participant’s account balance (determined without regard to
any potential future GLWB payments) is reduced to $0 as a result of these guaranteed annual withdrawal
amounts, the insurer will continue to pay the guaranteed withdrawal amount annually for the remainder of
the participant’s life. A GMWB feature is similar to a GLWB feature, but a stream of income is guaranteed
for a specified period rather than for the lifetime of the contract owner or annuitant. Treasury and the IRS
are considering whether or not to provide guidance related to issues arising from the use of GLWB and
GMWB features in defined contribution plans.

which those fees and expenses are paid from plan assets (rather than by the
employer) is the same.

IV. EXAMPLE OF A TDF SERIES ELIGIBLE FOR RELIEF

Employer X sponsors Plan A, which is a profit-sharing plan qualified under
§ 401(a) that includes a qualified cash or deferred arrangement described in § 401(k).
Participants in Plan A can commence distribution upon attainment of age 65, the normal
retirement age under Plan A, or upon severance from employment. Plan A provides
participants the opportunity daily to direct the investment of assets held in, or
contributed to, their accounts in a broad array of investment alternatives.

The designated investment alternatives available to all participants under Plan A
include a series of TDFs managed by an investment manager (as defined in section
3(38) of ERISA) who acknowledges in writing that the investment manager is a fiduciary
with respect to the plan. The TDFs are designed to provide varying degrees of long-
term appreciation and capital preservation through a mix of equity and fixed-income
exposures based on generally accepted investment theories. The same investment
manager manages all the TDFs under Plan A, and makes asset allocation decisions
using a consistent investment strategy under which the asset mix is designed to change
over time, becoming more conservative through a gradual reduction in the allocation to
equity investments and a gradual increase in the allocation to fixed-income exposure as
the participants in each TDF grow older. None of the TDFs holds or permits the
acquisition of employer securities.

Each TDF is available only to participants who will attain normal retirement age
within a limited number of years around the target date for the fund. For example,
investment in the 2020 TDF is restricted to participants who will attain normal retirement
age in 2019, 2020 or 2021.

Each TDF is intended to be a qualified default investment alternative (QDIA)
within the meaning of § 2550.404c-5(e) of the Department of Labor regulations, which
describes the attributes necessary for an investment fund, product, model portfolio, or
managed account to be a QDIA.
2
The plan sponsor also represents that it will satisfy
the conditions of § 2550.404c-5(c) of the QDIA regulation, including the requirement
that participants be furnished a notice of the circumstances under which their assets
may be invested in the QDIA, their right to direct the investment of their assets into any
other plan investment alternatives, and the investment objectives, risk and return
characteristics, and fees and expenses attendant to the QDIA.

2
The Department of Labor has informed the Department of the Treasury that the use of unallocated
deferred annuity contracts as fixed income investments would not cause the TDFs to fail to meet the
requirements of § 2550.404c-5(e)(4)(i) of the QDIA regulation. It is also the Department of Labor’s view
that the distribution of annuity certificates as each TDF dissolves on its target date, as described in the
example in this notice, is consistent with § 2550.404c-5(e)(4)(vi) of the QDIA regulation. See the Letter to
J. Mark Iwry at the Department of the Treasury (October 23, 2014) from Phyllis C. Borzi, at
http://www.dol.gov/ebsa/regs/ils
.

Each TDF available to participants age 55 or older holds unallocated deferred
annuity contracts as a portion of its fixed-income exposure. The deferred annuity
contracts are purchased from an insurance company that is independent from the
investment manager. None of the TDFs provides a GLWB or GMWB feature.

As the age of the group of participants in such a TDF increases, a larger portion
of the assets in the TDF will be used to purchase deferred annuities each year. The
TDFs available to participants younger than age 55 do not include deferred annuity
contracts. However, the series of TDFs is designed so that, as the asset allocation
changes over time, each TDF will include deferred annuity contracts beginning when
the participants in that TDF attain age 55.

Each TDF is dissolved at its target date. When a TDF is dissolved, a participant
who has an interest in that TDF will receive an annuity certificate representing the
participant’s interest in the annuity contract held in the TDF. The certificate provides for
immediate or deferred commencement of annuity payments in accordance with the
terms of the annuity contract and the plan. The remaining portion of a participant’s
interest in that TDF is reinvested in other investment options within Plan A.

The investment manager and Employer X treat each TDF in the series in the
same manner with respect to rights or features other than the mix of assets. For
example, with respect to each TDF, the investment manager determines the fees and
administrative expenses in a consistent manner, and the percentage of those fees and
expenses that are paid from plan assets (rather than by Employer X) is the same.

Pursuant to the alternative method of compliance with the nondiscrimination
requirements of § 401(a)(4) under section III of this notice, the series of TDFs in this
example is treated as a single other right or feature for purposes of § 1.401(a)(4)-4.
Therefore, each of the TDFs will satisfy the nondiscrimination requirements of
§ 1.401(a)(4)-4.

DRAFTING INFORMATION

The principal authors of this notice are Yaguo Zhang and Diane Bloom of the
Employee Plans, Tax Exempt and Government Entities Division. Questions regarding
this notice may be sent via e-mail to RetirementPlanQuestions@irs.gov.