Reprinted with permission from Employee Benefit Plan Review - July 2016

At the end of January, the Internal Revenue Service issued new proposed regulations for so-called “closed” or “frozen” defined benefit plans. The purpose of these regulations is to help plan sponsors satisfy the non-discrimination rules with respect to plans that do not allow new entrants, and that cover a grandfathered population.


Section 401(a)(4) of the Internal Revenue Code contains the rules that a plan must satisfy in order to avoid discrimination in favor of highly compensated employees. These rules were significantly rewritten in the early 1990s. As a very general matter, the rules were written to cover plans covering an active population. In the last decade or so, it has been common for employers to move away from defined benefit plans. Oftentimes, those employers will “grandfather” their defined benefit plans to continue to cover all or a portion of the individuals covered at the time of the move toward a defined contribution environment. When the rules are applied to this situation, there is a kind of square peg in a round hole issue. The new proposed regulations are meant to help, though there are still some issues that remain.

Scenario 1 – Defined Benefit Plan Replacement

Certain plan sponsors may have completely frozen their defined benefit plan(s). Some of those plan sponsors may want to try to make a portion of the group previously covered by a defined benefit formula “whole” for the change in benefits. In other words, if a plan sponsor moves away from a defined benefit plan to a defined contribution plan with a uniform contribution, older workers are disadvantaged because an equal contribution is not “worth” as much to them due to their age. So, the employer may want to give increased contributions to this population.

One method by which such an allocation could be made is as a “defined benefit replacement allocation” (“DBRA”) under Treas. Reg. §1.401(a)(4)-8. This is basically a special exception to the cross-testing rules. In order to take advantage of this exception, a number of requirements must be met (including some that are controversial aspects of the proposed regulations). The key rules that must be satisfied are:

  1. Replacement Allocation – the allocation is designed so that it is reasonably expected to replace some or all of the value of the benefit accounts that each employee would have been provided under the closed defined benefit plan.
  2. Closed Defined Benefit Plan – the closed plan’s formula must have provided for accruals that increased as employees attained higher ages or were credited with more years of service. The closed plan must have satisfied Sections 401(a)(4) and 410(b) (without aggregation) prior to the closure; and the plan must have been in effect for the five-year period ending on the closure date without any significant change to the benefit formula nor the coverage group.
  3. Nondiscriminatory Group – for each plan year that began before the fifth anniversary of the closure date, the grandfathered group must have been a nondiscriminatory group (as defined in the proposed regulations).

Scenario 2 – Closed Plan/Aggregation and Restructuring

Other plan sponsors may have frozen new participation in their defined benefit plan, yet continued benefit accruals for the grandfathered population. Often, particularly as the grandfathered group earns more compensation due to increased seniority and longevity, it is necessary for the plan sponsor to test the grandfathered plan for nondiscrimination purposes by using the aggregation and restructuring rules under Treas. Reg. §1.401(a)(4)-9.

The proposed regulations add a new exception to the requirement that when a defined benefit plan is aggregated with a defined contribution plan for testing purposes, it must satisfy a minimum aggregate allocation gateway (the details of which are beyond the scope of this article). The exception applies for plan years that begin on or after the fifth anniversary of the closure date (so there is no immediate relief from the gateway requirement). As in the above scenario, the plan must have been in effect for the five-year period ending on the closure date, and during such period there can have been no plan amendment that significantly changed the plan’s benefit formula or coverage. There are certain amendments that are permitted without failing the test (such as certain nondiscriminatory amendments or de minimus changes). In addition, there are special rules available regarding the interest rate to be used for nondiscrimination testing and the use of average allocations for non-highly compensated employees and matching contributions.

Scenario 3 – Benefits, Rights and Features

Separate and apart from determining whether benefit accruals under a defined plan are nondiscriminatory, plan sponsors must also be able to show that the benefits, rights and fixtures (BRF’s) that are offered do not discriminate. So, for example, the same discrimination issues that are raised in the two scenarios above could also occur if the right to receive a lump sum distribution was limited to a grandfathered group.

And, as is similar to the above scenarios, the following requirements must be satisfied to qualify for the relief:

  1. The relief only applies on or after the fifth anniversary of the BRF being closed.
  2. Subject to certain exceptions, there can have been no amendments to the BRF, starting with the date that is five years before the closure.
  3. The amendment restricting the availability of the BRF must have also resulted in a significant change in the type of the defined benefit plan’s formula (such as a conversion to a cash balance plan).

It should be noted that there is also a special rule for matching contributions, the right to which is technically a BRF.

The proposed regulations will not become effective until after final rules are published in the Federal Registrar (for plan years beginning after such date). In the interim, and subject to certain exceptions, plan sponsors can rely on the proposed rules for plan years beginning on or after Jan. 1, 2014. As the rules are somewhat controversial and do not address some seemingly innocent situations where relief would make sense, plan sponsors with plans that fall into the scenarios discussed above should consult with their actuaries and monitor developments in future guidance.