Employers Seek Compliance-Test Relief for Frozen Pensions

Society for Human Resource Management joins others in submitting comments to IRS

By Stephen Miller, CEBS May 5, 2016
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Sponsors of “frozen” pension plans are seeking a bit of regulatory warmth from the IRS.

Many companies have closed their defined benefit (DB) pensions to new hires but grandfathered existing employees under the benefit formula in effect when the pension was frozen. But doing this raises the odds that plan sponsors will fail the plan’s annual “nondiscrimination” compliance tests, meant to ensure that high-earners don’t benefit unfairly under a workplace retirement plan. Businesses in this situation are asking the IRS to provide permanent relief that, among other changes, would allow more flexibility when aggregating together frozen DB plans and 401(k)-type defined contribution (DC) plans for testing purposes.

To this end, the Society for Human Resource Management (SHRM) joined with other organizations and employers in submitting comments to the IRS, dated April 28, on the agency’s proposed regulations to provide relief for frozen DB plans.

“We believe the proposed regulations are a tremendous first step in addressing concerns as companies modify plans to meet the needs of the workforce and businesses,” the comment letter said. But in light of the complexity of the issues involved, the signatories asked the IRS to consider making the present temporary relief permanent and more flexible.

The ‘Soft Freeze’ Conundrum

A “soft freeze” happens when a DB plan is closed to new workers (who often receive additional employer contributions under the company’s DC plan), while allowing existing employees to continue to participate in the pension. This can help employees participating in the plan to—late in their careers—realize significant tenure-related benefits commonly provided under DB plan formulas.

Under current law, DB plans cannot benefit highly paid employees disproportionately from other employees. To determine whether a plan is in compliance, employers must perform annual nondiscrimination testing. But under a soft freeze, plans are confronted with the prospect of failing the annual nondiscrimination test because, with attrition, the employees who remain covered under the DB plan become proportionately higher paid and, in general, have greater seniority within the company.

Temporary Guidance

In December 2013, the IRS issued Notice 2014-05 (and its subsequent extension, Notice 2015-28), which provided temporary relief for nondiscrimination requirements for frozen plans through Jan. 1, 2017. The notice made it easier for employers to combine their DB and DC plans for nondiscrimination testing, for instance.

Among other issues, however, the temporary relief did not address the nondiscrimination requirements for benefits, rights and features (BRFs). Specifically, under current rules, certain plan BRFs must separately pass nondiscrimination testing requirements, and these features run into issues over time similar to the broader plan testing issues when a plan is closed to new employees—raising the likelihood employers will face nondiscrimination testing failure.

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