The ERISA consultants at the Retirement Learning Center Resource 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 plans. 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 or defined contribution 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 that although the plan sponsor may reserve the right to change or terminate the plan and to discontinue contributions, 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 could, in such an instance, deem that 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.
- 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 7.12.1.3 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 that have established or may be contemplating establishing a qualified retirement plan must be aware that the IRS expects that 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 abandoning a plan.
Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Consumers should consult with their tax advisor or attorney regarding their specific situation.
©2020, Retirement Learning Center, LLC. Used with permission.
