n-14-05.pdf

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing.

This collection currently includes the publisher’s available advance-release directory. Historical bulletin renditions are discovered separately; an advance-release record alone does not certify the collection archive complete.

Notice 2014-5

Temporary Nondiscrimination Relief for Closed Defined Benefit Plans and
Request for Comments

I. PURPOSE

This notice provides temporary nondiscrimination relief for certain “closed”
defined benefit pension plans (i.e., defined benefit plans that provide ongoing accruals
but that have been amended to limit those accruals to some or all of the employees who
participated in the plan on a specified date). Closing a defined benefit (DB) plan often
occurs in conjunction with an amendment that provides new or greater contributions
under a defined contribution (DC) plan intended to replace accruals under the DB plan
for new hires or other employees to whom the DB plan is closed.

This notice permits certain employers that sponsor a closed DB plan and a DC
plan to demonstrate that the aggregated plans comply with the nondiscrimination
requirements of § 401(a)(4) on the basis of equivalent benefits, even if the aggregated
plans do not satisfy the current conditions for testing on that basis. In addition, this
notice requests comments on possible permanent changes to the nondiscrimination
rules under § 401(a)(4).

II. BACKGROUND

A. Law and Regulations

Section 410(b) provides in general that a plan is a qualified plan only if the
classification of employees who benefit under the plan does not discriminate in favor of
highly compensated employees (HCEs). Section 410(b)(6)(B) provides that two or
more plans can be aggregated for purposes of satisfying § 410(b), but only if those
plans are also aggregated for purposes of § 401(a)(4).

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
HCEs. Compliance with § 401(a)(4) can generally be demonstrated on the basis of
either contributions or benefits (including equivalent benefits). Section 1.401(a)(4)-9(b)
of the Treasury regulations contains special rules that apply for purposes of determining
whether an aggregation of plans that includes one or more DB plans and one or more
DC plans (referred to as a DB/DC plan) satisfies the requirements of § 401(a)(4). See

§ 1.401(a)(4)-9(a). A DB/DC plan can demonstrate compliance with § 401(a)(4) on the
basis of equivalent benefits only if the DB/DC plan satisfies one of three alternative
conditions, specifically that it

• be primarily defined benefit in character,

• consist of broadly available separate plans, or

1

• meet the minimum aggregate allocation gateway.

See § 1.401(a)(4)-9(b)(2)(v).

A DB/DC plan is primarily defined benefit in character
within the meaning of
§ 1.401(a)(4)-9(b)(2)(v)(B) “if, for more than 50% of the non-highly compensated
employees (NHCEs) benefitting under the plan, the normal accrual rate for the NHCE
attributable to benefits provided under DB plans that are part of the DB/DC plan
exceeds the equivalent accrual rate for the NHCE attributable to contributions under DC
plans that are part of the DB/DC plan.”

A DB/DC plan consists of broadly available separate plans
within the meaning of
§ 1.401(a)(4)-9(b)(2)(v)(C) if the DC plan and the DB plan that are part of the DB/DC
plan each would satisfy the requirements of § 410(b) and the nondiscrimination in
amount requirement of § 1.401(a)(4)-1(b)(2) if each plan were tested separately
(assuming that the average benefit percentage test of § 1.410(b)-5 were satisfied).

The minimum aggregate allocation gateway under § 1.401(a)(4)-9(b)(2)(v)(D)
requires that each NHCE in the DB/DC plan have a minimum aggregate normal
allocation rate that is a function of the aggregate normal allocation rate of the HCE in
the aggregated plans who has the highest aggregate normal allocation rate. If this
highest aggregate normal allocation rate is less than 15%, the minimum aggregate
normal allocation rate is one third of the highest rate. If the highest aggregate normal
allocation rate for any HCE is greater than 15% but not greater than 25%, the minimum
aggregate normal allocation rate is equal to 5%. If the highest aggregate normal
allocation rate for any HCE is greater than 25%, the minimum aggregate normal
allocation rate increases on a sliding scale up to 7.5% (which applies if the highest
aggregate normal allocation rate exceeds 35%).

B. Closed Defined Benefit Plans

A number of DB plans have been closed to new entrants. The plan sponsor of a
closed DB plan typically provides a DC plan for its new hires. Under these
arrangements, in the early years after the DB plan has been closed to new entrants, the
plan may be able to satisfy the coverage requirement of § 410(b) without being
aggregated with the DC plan. However, the § 410(b) minimum coverage test typically
becomes more difficult for the closed DB plan to satisfy over time, as the proportion of
plan participants who are HCEs increases. This might occur for several reasons,
including the tendency of NHCEs to have higher rates of turnover than HCEs, as well as
the potential for some of the NHCEs in the closed plan to become HCEs as they
continue employment and their pay increases.

If the closed DB plan cannot satisfy the coverage requirement of § 410(b) on its
own, it will need to be aggregated with another plan in order to satisfy that coverage
requirement. If the DB plan is aggregated with a DC plan that covers the employer’s

2

new hires to satisfy the coverage requirement, then it is also required to be aggregated
with the DC plan for purposes of satisfying the nondiscrimination requirements of
§ 401(a)(4). In the typical case, the aggregated plans will fail the requirements of
§ 401(a)(4) unless they are permitted to demonstrate compliance with the
nondiscrimination requirements on the basis of equivalent benefits. The aggregated
plans usually will be permitted to demonstrate nondiscrimination on the basis of
equivalent benefits in the initial years of aggregation, because the aggregated plans will
either be primarily defined benefit in character or consist of broadly available separate
plans. However, the same demographic forces that drive the increase in the proportion
of HCEs in the closed plan might also over time lead to the aggregated plans being
neither primarily defined benefit in character nor consisting of broadly available separate
plans. When this occurs, the aggregated plans will be permitted to demonstrate
nondiscrimination on the basis of equivalent benefits only if the plans satisfy the
minimum aggregate allocation gateway.

In many cases, the DC plan provides sufficient allocations to enable the DB/DC
plan to satisfy the nondiscrimination requirements on the basis of equivalent benefits if
the DB/DC plan were permitted to demonstrate satisfaction of the nondiscrimination
requirements on that basis. However, the DC plan may not provide for allocations that
satisfy the minimum aggregate allocation gateway. If the DB/DC plan does not meet
any of the three alternative conditions for testing on the basis of equivalent benefits,
then the DB/DC plan is not permitted to demonstrate satisfaction of the
nondiscrimination requirements on that basis. As a result, the aggregated plans will fail
to satisfy § 401(a)(4) unless one or both of the plans are changed. In circumstances
such as these, a plan sponsor generally has three choices: (1) reduce the proportion of
HCEs in the closed DB plan (by either opening it to some new NHCEs or by stopping
participation by some HCEs); (2) reconfigure the contributions under the DC plan so
that it meets the minimum aggregate allocation gateway; or (3) cease accruals in the
DB plan entirely.

Some plan sponsors have chosen to reduce the proportion of HCEs by stopping
participation in the DB plan for some of the HCEs; however, this approach might not be
consistent with a plan sponsor’s goal of preserving the retirement expectations of some
or all of the current participants in the DB plan while covering others, such as new hires,
in a DC plan. A number of plan sponsors are making substantial contributions to a DC
plan, but those contributions are not always structured as nonelective contributions at a
level that is sufficient to meet the minimum aggregate allocation gateway. For example,
a portion of the contributions under the DC plan for new hires might be matching
contributions that are not taken into account under the minimum aggregate allocation
gateway. Some plan sponsors have indicated that they are sufficiently committed to the
specific design of their DC plan that they are considering ceasing accruals in the DB
plan rather than restructuring the DC plan.

The nondiscrimination regulations under § 401(a)(4) provide 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

3

appropriate in applying the nondiscrimination requirements of § 401(a)(4), including
additional safe harbors and alternative methods and procedures for satisfying those
requirements. See
§ 1.401(a)(4)-1(d).

III. TEMPORARY PERMISSION TO TEST A CLOSED DB PLAN THAT IS
AGGREGATED WITH A DC PLAN ON THE BASIS OF EQUIVALENT BENEFITS

A. Consideration of Requested Relief for Closed DB Plans

The Treasury Department and the IRS have received a number of requests that
the nondiscrimination regulations under § 401(a)(4) be amended to provide additional
alternative means of satisfying the nondiscrimination requirements in the case of a
closed DB plan. Some have suggested that if a closed DB plan that is aggregated with
a DC plan was eligible to demonstrate satisfaction of the nondiscrimination
requirements on the basis of benefits (or equivalent benefits) at the time the plan was
closed (or at a later time), then the aggregated plans should be permanently eligible,
without further conditions, to be tested for nondiscrimination on that basis.

This suggestion raises a number of considerations and potential concerns. For
example, it would apply a lower nondiscrimination standard with respect to closed DB
plans than with respect to other DB plans that must be aggregated with DC plans to
satisfy the requirements of § 410(b) as a result of changes in the composition of the
employer's workforce (such as the acquisition of another entity with a significant number
of NHCEs). Such a lower standard could provide an incentive for such an employer to
close its DB plan. In addition, this approach would require the development of anti-
abuse provisions to ensure that the closing of the DB plan was not motivated by the
availability of the lower standard and that the new rule was not used inappropriately to
increase benefits for HCEs or to reduce benefits for NHCEs.

The Treasury Department and the IRS believe that it is appropriate to consider
modifying the nondiscrimination requirements under § 401(a)(4), while taking into
account these considerations and potential concerns. This consideration and potential
modification will be undertaken through the regulatory process in order to provide the
opportunity for public comment on any proposed changes. Section III.B of this notice
provides temporary relief to permit certain closed DB plans to continue accruals while
possible regulatory changes to the nondiscrimination rules are being considered.

B. Temporary Eligibility Rule for Testing Certain DB/DC Plans on the Basis
of Equivalent Benefits

Pursuant to the Commissioner’s authority under § 1.401(a)(4)-1(d) to provide
alternative methods for satisfying the nondiscrimination requirements, this section III.B
provides a temporary additional eligibility criterion that permits a DB/DC plan to
demonstrate satisfaction of the nondiscrimination in amount requirement of
§ 1.401(a)(4)-1(b)(2) on the basis of equivalent benefits even if the DB/DC plan does
not meet any of the existing eligibility conditions for testing on that basis under

4

§ 1.401(a)(4)-9(b)(2)(v). Under this alternative, the DB/DC plan may nonetheless make
that demonstration on the basis of equivalent benefits for a plan year that begins before
January 1, 2016, if it includes a DB plan providing ongoing accruals that was amended,
by an amendment adopted before December 13, 2013, to provide that only employees
who participated in the DB plan on a specified date continue to accrue benefits under
the plan, and if each of the DB plans in the DB/DC plan satisfies one of the following
conditions:

1. For the plan year beginning in 2013, the DB plan was part of a DB/DC plan
that either was primarily defined benefit in character (within the meaning of
§ 1.401(a)(4)-9(b)(2)(v)(B)) or consisted of broadly available separate plans (within the
meaning of § 1.401(a)(4)-9(b)(2)(v)(C)), or

2. In the case of a DB plan that was amended, by an amendment adopted
before December 13, 2013, to provide that only employees who participated in the DB
plan on a specified date continue to accrue benefits under the plan, the DB plan was not
part of a DB/DC plan for the plan year beginning in 2013 because the DB plan satisfied
the coverage and nondiscrimination requirements without aggregation with any DC
plan.

During the period for which this temporary relief applies, the remaining provisions
of the nondiscrimination regulations under § 401(a)(4) (including the rules relating to the
timing of plan amendments under § 1.401(a)(4)-5) continue to apply. Thus, for
example, a plan amendment made to add accruals to the closed DB plan during this
temporary period must not discriminate significantly in favor of HCEs.

IV. Request for Comments

A. Comments Regarding the Ability of a DB/DC Plan to Satisfy
Nondiscrimination Requirements on a Benefits Basis

The Treasury Department and the IRS are considering whether the regulations
under § 401(a)(4) should be amended to provide additional alternatives that would allow
a DB/DC plan to demonstrate satisfaction of the nondiscrimination in amount
requirement of § 1.401(a)(4)-1(b)(2) on the basis of equivalent benefits. This section
IV.A describes possible alternatives that would allow for such combined testing on the
basis of equivalent benefits. Comments are requested on whether or not any of these
additional alternatives should be made available, and whether there are any other
alternatives that should be considered.

1. Alternative for DC plans with age- and/or service-graded contribution
rates

Under this alternative, current rules that permit averaging of equivalent allocation
rates for NHCEs in a DB plan could be extended to apply to NHCEs in an aggregated
DC plan. For example, this alternative might allow a plan with an age- and/or service-

5

graded contribution rate that starts at 3% for newer or younger employees with higher
rates for older or longer-service employees to satisfy the minimum aggregate allocation
gateway if a sufficient number of NHCEs are actually receiving allocations at those
higher rates.

2. Alternative for DC plans with combination of nonelective and matching
contributions

Under this alternative, a portion of the minimum aggregate allocation gateway
could be satisfied based on the average matching contribution rate for all NHCEs under
the DC plan. For example, if under a DC plan the minimum aggregate allocation rate
must be 6% in order to satisfy the minimum aggregate allocation gateway and the plan
sponsor provides matching contributions to NHCEs that result in an average
contribution of 2% of compensation, this alternative might allow the plan to satisfy this
gateway by providing to each NHCE a nonelective contribution of 4% of compensation.

3. Alternative for DC plans that could satisfy nondiscrimination using a
lower interest rate

Under this alternative, a DB/DC plan would be eligible for testing on the basis of
equivalent benefits (without the need to satisfy the minimum aggregate allocation
gateway or an alternative condition for eligibility) if the DB/DC plan could demonstrate
satisfaction of the nondiscrimination in amount requirement of §1.401(a)(4)-1(b)(2) on
the basis of equivalent benefits using an interest rate specified in the regulations that
would be lower than the current standard interest rate for normalizing benefits of 7.5%
to 8.5%.

4. Safety valve alternative under which plans can request permission to
disregard outliers

Under this alternative, a DB/DC plan that does not satisfy the minimum
aggregate allocation gateway because the aggregate normal allocation rate of the HCE
with the highest rate is unusually large would be permitted to disregard that HCE under
rules similar to the rules that permit the disregard of certain violations under
§ 1.401(a)(4)-3(c)(3). Under those rules, an employer can request that the
Commissioner disregard the violation if the plan would satisfy the nondiscrimination
rules by disregarding up to 5% of the plan’s HCEs.

B. Other Possible Related Modifications to Other Nondiscrimination
Requirements

The Treasury Department and the IRS are also considering whether other
changes to the regulations under §§ 401(a)(4) and 401(a)(26) are appropriate to
facilitate the continuation of accruals under the existing formulas of some or all
employees in a DB plan when that plan is later amended. In many cases, employers
would like to preserve retirement expectations of existing participants while offering a

6

7
new formula under a DC plan for new hires. This section IV.B describes two possible
modifications to other nondiscrimination requirements that may be affected by such an
arrangement. Comments are requested on whether or not either of the following
possible modifications should be made available (and, if so, what conditions (if any)
should apply) and whether there are any other modifications that should be considered.

1. Benefits, rights, and features under DB plans with grandfathered
formulas

Under this proposed modification, if a DB plan has two or more benefit formulas,
one or more of which are applicable to a closed group of participants, and one or more
other formulas that are applicable to other participants, the benefits, rights, and features
that apply only to the formula or formulas for the closed group would not prevent the
plan from complying with the requirements of § 1.401(a)(4)-4 if appropriate conditions
are satisfied.

2. Treatment of matching contributions

Under this proposed modification, matching contributions would be permitted to
be used to enable a DB/DC plan to satisfy not only the minimum aggregate allocation
gateway if modified as described in section IV.A.2 of this notice, but also the
nondiscrimination in amount test.

C. Due Date and Contact Information

Written or electronic comments must be received by February 28, 2014. Send
submissions to CC:PA:LPD:PR Notice 2014-5, Room 5203, Internal Revenue Service,
POB 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand
delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to:
CC:PA:LPD:PR Notice 2014-5, Courier’s Desk, Internal Revenue Service, 1111
Constitution Avenue, NW., Washington, DC. Alternatively, comments may be
submitted via the Internet at notice.comments@irscounsel.treas.gov. Please include
“Notice 2014-5” in the subject line of any electronic communication. All materials
submitted will be available for public inspection and copying.

DRAFTING INFORMATION

The principal author of this notice is Adrien R. LaBombarde of the Employee
Plans, Tax Exempt and Government Entities Division. Questions regarding this notice
may be sent via e-mail to RetirementPlanQuestions@irs.gov.