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DC Plan Amendments and Accrued Benefits

“My client wants to amend his 401(k) plan to add a last day requirement to receive a profit sharing contribution for the current plan year. Right now the contribution is discretionary and there is no service or last day requirement to receive the contribution. Can he make that change before year end?”

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 a financial advisor from Tennessee is representative of a common inquiry related to plan amendments.

Highlights of the Discussion

The IRS has taken the position that the right to receive a contribution under a defined contribution plan’s existing allocation formula is protected once the participant has satisfied the plan’s allocation conditions [Technical Advice Memorandum (TAM) 9735001].[1] If participants in the plan have already accrued a right to receive an allocation (a “protected allocable share”)—even though the contribution may be discretionary—the contribution cannot be taken away.

A plan amendment cannot decrease the accrued benefit of any plan participant [IRC § 411(d)(6)(A)]. These anti-cutback rules only protect benefits that accrue prior to the amendment [Treas. Reg. § 1.411(d)-3(b)].

In the question at hand, since there are no requirements to receive the profit sharing contribution, anyone who has completed an hour of service for the year has accrued a right to any profit sharing allocation the sponsor may or may not make for the year.

In contrast, let’s say the plan had a 1,000 hour of service requirement to receive a discretionary profit sharing contribution and the plan sponsor wanted to add a last day requirement. In that case, the plan sponsor could amend the plan to add the last day up to the point that someone completes 1,000 hours of service—which could be mid-year, based on 2,080 hours worked in a full year.

Similarly, suppose the plan required 501 hours of service to receive a contribution. The sponsor would only be able to change the allocation method up until the date on which the first participant works his/her 501st hour for the year. After that point, changing the method would eliminate a right the participant has already earned according to TAM 9735001.

Of course, a plan sponsor has the right to amend the plan’s contribution formulas on a prospective basis.

Conclusion

It’s always very important to check the plan document for contribution eligibility requirements. A plan amendment cannot decrease the accrued benefit of any plan participant. The right to receive a contribution under a defined contribution plan’s existing allocation formula is protected once the participant has a protected allocable share of the contribution.

[1] Technical Advice Memorandum Number: 9735001

Internal Revenue Service

February 20, 1997

SIN# 411.03-00

INTERNAL REVENUE SERVICE

NATIONAL OFFICE TECHNICAL ADVICE MEMORANDUM

ISSUE

Whether §411(d)(6) is violated by a retroactive amendment of an allocation formula under a discretionary profit-sharing plan adopted after the end of the plan year, but before the due date for the employer’s return for the corresponding taxable year, resulting in lower allocations for some participants than the allocations they would have received under the allocation formula in the plan during the plan year.

FACTS

The Employer maintains the Plan, a discretionary profit-sharing plan. Section 2.1 of the Plan defines “account balance” as the aggregate balance of a participant’s account as of a determination date. Section 2.12 defines “determination date” as the last day of the preceding plan year. Section 2.35 defines “plan year” as the calendar year.

Section 5.3 of the Plan provides that the amount of the contribution to the Plan for each plan year shall be paid to the trustees, either in a single payment or in installments, not later than the last day of the period provided by the relevant provisions of the Code and other applicable laws for the payment of a deductible contribution for the taxable year in which the plan year ends. Any payment made prior to the end of the plan year on account of the contribution for such plan year shall be held by the trustees in a suspense account until the end of such plan year.

Article VI of the Plan deals with accounts and allocations. Section 6.3 provides that the contribution to the Plan (including forfeitures occurring during the plan year) for any plan year shall be deemed to have been made as of the last day of such plan year and shall be allocated to the trust fund and apportioned among and credited to the accounts of those participants who are employed on said date, in the ratio that each participant’s compensation bears to the aggregate compensation of all such participants.

Section 6.6 of the Plan provides, in relevant part, that on each valuation date the amount which shall be credited to the account of each participant shall be (i) the account balance on the preceding valuation date, plus (ii) the participant’s allocated portion of the contributions (and, if applicable, forfeitures) made with respect to the plan year ending on the current valuation date, plus or minus (iii) the participant’s pro rata share of the increase or decrease since the preceding valuation date in the fair market value of the trust fund. Section 2.45 defines “valuation date” as the anniversary date and, if applicable, the date of termination of employment of a participant where there has occurred a twenty percent or more decrease in the value of the trust fund since the last valuation date and distribution is to be made to the participant prior to the next valuation date. Section 2.3 defines “anniversary date” as December 31 of each year.

The Plan contained a definite pre-determined allocation formula during the 1992 plan year (“existing formula”). Relying on § 404(a)(6), the Employer made its contribution for the 1992 plan year on or about January 7, 1993 (“1992 contribution”), but the contribution was not immediately allocated among participants.

On March 15, 1993, the Employer adopted an amendment to the Plan that added a new allocation formula (“new formula”). The effective date of this amendment was January 1, 1992. Under the new formula some participants received larger allocable shares of the 1992 contribution, and the remaining participants received smaller allocable shares of the 1992 contribution, compared with their allocable shares under the existing formula. On June 23, 1993, the 1992 contribution was allocated to participants’ accounts under the new formula. Thus, the March 15, 1993 plan amendment reduced the amounts allocated to the accounts of some participants, compared with the amounts that would have been allocated under the existing formula. The reduced allocations in turn resulted in decreased account balances for those participants.

LAW

Section 401(a) prescribes the qualification requirements for a trust forming part of a stock bonus, pension, or profit-sharing plan. Under §1.401-1(b)(1)(ii), a profit-sharing plan must provide a definite predetermined formula for allocating plan contributions among participants. Under §1.401-1(c), qualified status must be maintained throughout the trust’s entire taxable year.

Section 411(d)(6)(A) generally provides that a plan will not be treated as satisfying §411 if the accrued benefit of a participant is decreased by a plan amendment. Under §411(a)(7)(A)(ii) and §1.411(a)-7(a)(2), in the case of a defined contribution plan, “accrued benefit” mean the balance of the employee’s account held under the plan.

Under §1.411(d)-4, A-1(a), §411(d)(6) protected benefits, to the extent they have accrued, are subject to the protection of §411(d)(6) and, where applicable, the definitely determinable requirement of §401(a). Accordingly, such benefit cannot be reduced, eliminated or made subject to employer discretion, except to the extent permitted by regulation.

Section 1.411(d)-4, A-1(d), lists examples of benefits that are not §411(d)(6)-protected. The list includes “(8) the allocation dates for contributions, forfeitures, and earnings, the time for making contributions (but not the conditions for receiving an allocation of contributions or forfeitures for a plan year after such conditions have been satisfied), . . . .” The parenthetical language in §1.411(d)-4, A-1(d)(8), indicates that, once the conditions for receiving an allocation have been met, a plan amendment that adds further conditions would violate §411(d)(6).

Section 404(a)(6) allows a contribution made after the end of the employer’s taxable year, but before the due date of the employer’s return, to be treated as made on the last day of the preceding taxable year if the contribution is made on account of the preceding year. Rev. Rul. 76-28, 1976-1 C.B. 106 and Rev. Rul. 90-105, 1990-2 C.B. 69 provide that a contribution made after the close of an employer’s taxable year will be deemed to have been made on account of the preceding taxable year under § 404(a)(6) if, among other conditions, the contribution is treated by the plan in the same manner as the plan would treat a contribution actually received on the last day of the preceding taxable year.

Section 411(d)(6) was added to the Internal Revenue Code under Title II of the Employee Retirement Income Security Act of 1974 (“ERISA”). Title I of ERISA provides an identical provision to §411(d)(6) at §204(g), which was enacted at the same time and has been interpreted in participants’ suits challenging employer plan amendments. Several ERISA §204(g) cases involve plan amendments that were retroactively effective and that changed the valuation date used in determining the account balance of a terminated employee under the plan. In Pratt v. Petroleum Production Management, Inc. Employee Savings Plan & Trust , 920 F.2d 651 (10th Cir. 1990), and Kay v. Thrift and Profit Sharing Plan for Employees of Boyertown Casket Co. , 780 F.Supp. 1447 (E.D. Pa. 1991) the courts addressed such plan amendments.

In Pratt , the petitioner separated from service at a time when the plan provided that a separated participant was to receive his vested interest in his account valued as of the next preceding valuation date, which was defined as the last day of the plan year. However, before Pratt received his distribution and subsequent to the applicable valuation date (as defined under the terms of the plan when he separated, i.e., prior to the adoption of the amendment) a plan amendment was adopted that permitted interim valuation dates as necessary to account for a material change in the value of trust assets. Stocks that were a part of Pratt’s account had seriously declined in value in the time period between the original valuation date and Pratt’s separation date (and the new interim valuation date under the amended plan). The district court granted Pratt relief on the basis of both ERISA §204(g) and under ERISA §502(a), breach of contract. On review, the appellate court noted that a participant’s accrued benefit in an account-type plan consists of the participant’s account balance. The appellate court looked to the terms of the plan prior to the adoption of the amendment when Pratt separated to ascertain his vested rights and how his account balance should be valued. The appellate court affirmed the district court’s decision, stating that the retroactive amendment, under these circumstances, reduced Pratt’s accrued benefit. Thus, the amendment was precluded by ERISA §204(g).

Kay differs from Pratt in that the retroactive amendment made on December 22, 1987, changing the valuation date from September 30, 1987 (as defined under the terms of the plan when Kay separated from service) to October 30, 1987, was made before the September 30, 1987 valuation was completed. Citing Pratt , the court held that the plan administrator was required to determine the value of Kay’s accrued benefits in accordance with the terms of the plan at the time of Kay’s termination, and that retroactive application of the amendment permitting interim valuation dates violated §204(g) of ERISA. The effect of this holding is that Kay’s ERISA-protected accrued benefit was his account balance determined as of the original valuation date, even though the valuation of his account as of that date had not actually been made at the time the plan was amended.

ANALYSIS

In the case of a defined contribution plan, an employee’s accrued benefit is the balance of the employee’s account held under the plan. With respect to the employer’s contributions, it could therefore be argued that §411(d)(6) protection applies only to amounts actually credited to the participant’s account. However, the accrued benefit includes amounts to which the participant is entitled under the terms of the plan, even though the bookkeeping process of crediting those amounts to the participant’s account has not actually occurred.

Prior to the adoption of the March 15, 1993 amendment, the account balance under the terms of the Plan was the aggregate balance of the participant’s account as of December 31, 1992. The Plan provided that, as of December 31, 1992, the participant’s account was to be credited with the participant’s allocated portion of the contribution for the 1992 plan year. The Plan provided for the 1992 contribution to be apportioned among and credited to the accounts of the participants employed on December 31, 1992, and specified the formula, that is, the existing formula, under which the 1992 contribution was to be allocated among participants’ accounts. Under the terms of the plan, each participant became entitled to his or her allocable share of the 1992 contribution as of December 31, 1992, determined under the existing formula (“protected allocable share”).

For purposes of §411(d)(6), each participant’s protected allocable share of the 1992 contribution under the existing formula became part of the participant’s account balance, and thus part of the accrued benefit, as of December 31, 1992, even though the bookkeeping process of determining account balances did not actually occur on that day. Thus, the March 15, 1993 retroactive amendment of the formula under which the 1992 contribution was allocated, reducing the protected allocable shares of the 1992 contribution of some participants, resulted in a reduction of those participants’ accrued benefits and violated §411(d)(6).

Under §1.411(d)-4, A-1(d)(8), the conditions for receiving an allocation of contributions or forfeitures for a plan year are subject to § 411(d)(6) after such conditions have been satisfied. That is, once a participant has satisfied the conditions for receiving an allocation, the participant’s right to an allocation becomes §411(d)(6)-protected, and a plan amendment cannot add further conditions. In this case, amendment of the allocation formula after the end of the 1992 plan year, when participants had satisfied the conditions for receiving an allocation, is analogous to a change in the conditions for receiving an allocation in violation of §411(d)(6).

The Employer argues that, in the case of a discretionary profit-sharing plan, the employer has no obligation to make a contribution; therefore, participants do not accrue benefits under the plan until a contribution is actually made. We note that, in this case, the contribution had in fact been made at the time of the March 15, 1993 plan amendment. Moreover, as described above, under the terms of the plan, a participant became entitled to his allocable share of any contribution for 1992 as of December 31, 1992. Where a contribution is in fact made for 1992, the participant’s protected allocable share of that contribution is determined as of December 31, 1992, under the existing formula.

The Employer also refers to §404(a)(6), which allows an employer to make a contribution after the end of the plan year. Section 404(a)(6) is irrelevant in determining when a participant’s right to an allocation becomes §411(d)(6)-protected. The sole effect of § 404(a)(6) is to deem a payment to have been made on the last day of the preceding plan year for deduction purposes. The employer’s exercise of the right to make a contribution after the end of the plan year cannot be used to circumvent §411(d)(6) protection that attaches as of the end of the plan year.

CONCLUSION

Pursuant to the terms of the Plan, each participant’s protected allocable share of the 1992 contribution under the existing formula became part of the participant’s account balance, and for purposes of §411(d)(6), part of the accrued benefit as of December 31, 1992. Therefore, the March 15, 1993 retroactive amendment of the formula under which the 1992 contribution was allocated, reducing the protected allocable shares of the 1992 contribution of some participants, resulted in a reduction of those participants’ accrued benefits and violated §411(d)(6).

 

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