As Internal Revenue Service officials grapple with how to prevent employers from providing lopsided retirement benefits that discriminate in favor of higher-paid employees, plan sponsor advocates are holding their collective breath that regulators won't make it so complicated plan sponsors simply give up.
At issue are non-discrimination testing rules originally written for open defined benefit plans. As more sponsors close plans, they move closer to violating non-discrimination rules. That's because the salaries of people in the closed plan continue to rise, leading to a higher retirement benefit, while other employees are enrolled in a defined contribution plan.
Running afoul of the IRS is not a risk that sponsors are willing to take for themselves or their employees, with benefits and tax advantages for both at stake.
“Instead of focusing on one or two (defined benefit plans) that might take advantage, we'd like to see the IRS focus on the bigger picture and on the plans that aren't going to be able to pass,” said Will Hansen, senior vice president of retirement policy with the ERISA Industry Committee in Washington. “The DB system is still a valid system that we need to support. There's just too much at risk here.”
Plan sponsors have been urging IRS officials for years to issue non-discrimination testing relief for plans that are closed to new entrants instead of using rules intended for ongoing plans. In January 2014, IRS officials responded with temporary relief for three years that allowed plans to be considered in compliance if they were at the time the plan closed.
In the Jan. 29 Federal Register, the IRS proposed new rules aimed at making it easier for closed DB plans to comply, but attached several strings and put in more wrinkles for how sponsors would test all types of plans to ensure the system isn't being gamed at the expense of lower-paid employees.
A 2016 Aon Hewitt survey of 165 plans found that 85% of those closed to new entrants would need more relief under the IRS proposal to be compliant, and 39% of plans with frozen accruals would need more relief than the proposed rules related to contributions provided by employers.
Maria Sarli, U.S. retirement resource actuary with Willis Towers Watson PLC in Atlanta, told IRS officials at a May 19 hearing that while about one-third of their clients would benefit, “a lot of clients would not be helped. Some pension plans are very, very close to failing.”
Kent Mason, an attorney at law firm Davis & Harman who is outside counsel for the American Benefits Council, estimates that as many as 1 million plan participants could be negatively affected.
“All of these plans are going to have an issue. It's just a question of timing,” said Eric Keener, Aon Hewitt partner and chief actuary.
As proposed, the new rules allow some plans to satisfy non-discrimination rules in certain situations, but only after they've been closed for at least five years, with no significant changes made in that time, along with other tests. But because plan administrators often make routine amendments on early retirement factors or options such as lump sums, consultants say few plans can pass that hurdle. It also rules out companies with plans affected by any corporate mergers or acquisitions.