3860 / What are the requirements with respect to the nondiscriminatory availability of plan benefits, rights, and features?

Editor’s Note: The SECURE Act made changes that make it easier for certain sponsors of closed defined benefit plans to satisfy their nondiscrimination testing requirements.¹ See below for details.

The benefits, rights, and features provided under a plan (i.e., all optional forms of benefit, ancillary benefits, and other rights and features available to any employee under a plan) must be made available in a nondiscriminatory manner. Benefits, rights, and features generally will meet this requirement only if each benefit, right, and feature satisfies a “current availability” requirement and an “effective availability” requirement.²

The current availability requirement generally is satisfied if the group of employees to whom the benefit, right, or feature is currently available during the plan year satisfies the minimum coverage test of section 410(b) ( Q 3842) without regard to the average benefit percentage test.³

Current availability is based on the current facts and circumstances of the employee; the fact that an employee may satisfy an eligibility condition in the future does not make the benefit option currently available to that employee. Conditions based on termination of employment, disability, hardship, or conditions based on age or length of service may be disregarded in determining current availability.⁴

To satisfy the effective availability requirement, the group of employees to whom a benefit, right, or feature is effectively available must not substantially favor highly compensated employees, based on all the facts and circumstances.⁵ Thus, for example, a matching contribution that is available only to employees deferring a relatively high percentage of income would fail this requirement if the level of deferral required makes the match effectively unavailable to most non-highly compensated employees.

A plan that offers catch-up contributions will not be treated as violating these requirements merely because participants age 50 or over make, or have the right to make, catch-up contributions under the provisions of IRC Section 414(v), so long as a universal availability requirement is met ( Q 3761).⁶

The IRS has issued guidance under which two optional forms of benefit that differ only with respect to the timing of their commencement generally may be aggregated and treated as a single optional form of benefit for purposes of satisfying the nondiscriminatory current and effective availability requirements.⁷ For example, a preretirement age 73 (72 for 2020-2022 and 70½ pre-2020) distribution option that is available only to 5 percent owners, as required under IRC Section 401(a)(9) ( Q 3895), may be aggregated with another optional form of benefit that differs only in the timing of the commencement of payments, provided certain requirements are met.⁸

The fact that subsidized early retirement benefits and joint and survivor annuities are based on an employee’s Social Security retirement age generally will not result in their being treated as unavailable to employees on the same terms.⁹

Employers may demonstrate compliance with the current availability requirement by using snapshot testing on a single day during the plan year, provided that that day is representative of the employer’s work force and the plan’s coverage throughout the plan year.¹⁰

The IRS determined that a plan, in operation, violated IRC Section 401(a)(4) when it permitted highly compensated employees to direct their own investments, which resulted in their earning a substantially higher return than that earned on contributions by rank and file employees. The IRS commented that even if the investment decisions had resulted in a lower return or a loss, the opportunity for only highly compensated employees to make their own investment decisions still would result in discrimination.¹¹

SECURE Act Changes

Many employers who have closed defined benefit plans to new participants have continued to allow groups of “grandfathered” employees to earn benefits under the closed defined benefit plans. Because of this, many of these plans have had difficulties meeting the applicable nondiscrimination requirements as more of these grandfathered employees become “highly compensated” over time. For a number of years, the IRS provided relief from the nondiscrimination rules for closed defined benefit plans. The SECURE Act essentially codifies a number of these relief provisions.

Generally, a defined benefit plan cannot discriminate in favor of highly compensated employees with respect to any plan benefit, right or feature. Under the SECURE Act, defined benefit plans will be treated as passing nondiscrimination testing with respect to benefits, rights and
features if:

(1)  the plan passes nondiscrimination testing in the plan year during which the plan closure takes place, and the two subsequent plan years,

(2)  the plan was not amended after closure to discriminate in favor of highly compensated employees, either by modifying the closed class or the benefits, rights and features provided to that class and

(3)  the plan was closed before April 5, 2017 or there was no substantial increase in value of either coverage or value of the benefits, rights and features for the five-year period before the plan was closed.¹²

A plan is treated as having had a “substantial increase” in coverage or value of the benefits, rights, or features during the applicable five-year period only if, during that period:

“(i) the number of participants covered by such benefits, rights, or features on the date the five-year period ends is more than 50 percent greater than the number of such participants on the first day of the plan year in which the period began, or

“(ii) the benefits, rights, and features have been modified by plan amendments in such a way that, as of the date the class is closed, the value of the benefits, rights, and features to the closed class as a whole is substantially greater than the value as of the first day of such five-year period, solely as a result of the amendments.¹³

Additionally, closed defined benefit plans can be aggregated with the employer’s defined contribution plans for purposes of compliance testing if

(1)  the defined benefit plan provides benefits to a closed group of participants,

(2)  the defined benefit plan passes nondiscrimination and coverage testing in the plan year during which the plan closure takes place, and the two subsequent plan years,

(3)  no amendments that discriminate in favor of highly compensated employees were made after the plan closed, and

(4)  the plan was closed before April 5, 2017 or there was no “substantial increase” in value of either coverage or value of the benefits, rights and features for the five-year period before the plan was closed.¹⁴

If the defined benefit plan is aggregated with a plan that provides matching contributions, the defined benefit plan must also be aggregated with the portion of the DC plan that provides elective deferrals and the matching contributions must be treated in the same way as nonelective contributions for purposes of nondiscrimination and coverage testing.¹⁵

The nondiscrimination relief was effective immediately beginning in 2020, but plans have the option of applying this relief retroactively to plan years beginning after December 31, 2013.