By Jenny Kiffmeyer, J.D – The Retirement Learning Center
ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
A recent call with an advisor in Michigan is representative of a common inquiry related to plan permanency. The advisor asked: “I have a client who set up a defined benefit plan last year and now, because of a financial downturn in his business, wants to terminate the plan. Does the IRS require an employer to maintain a defined benefit (DB) or defined contribution (DC) plan for a certain number of years?”
Highlights of Discussion
- While the IRS does not require that a plan sponsor maintain its plan (DB or DC) for a certain number of years, it does state in its Treasury regulations, “The term ‘plan’ implies a permanent, as distinguished from a temporary, program,” [Treasury Regulation 1.401-1(b)(2)].
- The regulation goes on to say, although the plan sponsor may reserve the right to change or terminate the plan, and to discontinue contributions thereunder, the abandonment of the plan for any reason other than business necessity within a few years after it has taken effect will be evidence that the plan, from its inception, was not a bona fide program for the exclusive benefit of employees in general. The IRS, in such an instance, could deem the plan was never qualified and, consequently, revoke its tax-favored status—making the plan’s assets immediately taxable to participants, and any tax deductions taken null and void.
- For a bit more insight, the IRS has ruled in Revenue Ruling 72-239 that a plan that has been in existence for over 10 years can be terminated without a business necessity. In IRS Revenue Ruling 69-25, the IRS provided that if a plan is terminated within a few years of its inception and there were no unforeseeable, negative developments in the business that made it impossible to continue the plan, then this is evidence that the employer did not intend the plan as a permanent program. The employer can rebut this presumption by showing that it abandoned the plan as a result of an unforeseeable business necessity. Business necessity, in this context, means adverse business conditions, not within the control of the employer, under which it is not possible to continue the plan, including bankruptcy or insolvency, and discontinuance of the business, along with merger or acquisition of the plan sponsor, as long as the merger or acquisition was not foreseeable at the time the plan was created.
- In the end, the IRS will judge a plan as permanent or temporary based on the facts and circumstances of the surrounding case. The IRS’s Employee Plans Guidelines for Plan Terminations at 184.108.40.206 outlines what examiners will consider for permanency requirements and what reasons for termination will be considered valid for business necessity.
- The regulation further states, “In the event a plan is abandoned, the employer should promptly notify the district director, stating the circumstances which led to the discontinuance of the plan.”
- A plan sponsor’s decision to terminate and reasons for terminating its qualified retirement plan should be thoroughly documented and retained.
Employers who have established or who may be contemplating establishing a qualified retirement plan must be aware that the IRS expects the arrangement will be a permanent one. And although plan sponsors reserve the right to terminate their qualified retirement plans, the IRS views “business necessity” as the only legitimate reason for plan abandonment.