Case of the Week: Complete Discontinuance of Plan Contributions

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. A recent call with a financial advisor from Colorado is representative of a common inquiry related to ongoing contributions to a profit sharing plan. The advisor asked:

“I came across a prospect that froze its profit sharing plan several years ago, and has not made contributions since. Are there any concerns regarding the plan?”

Highlights of Discussion

While contributions to profit sharing plans are generally discretionary, meaning that a plan sponsor can decide from year to year whether to make a contribution or not, the IRS expects that contributions will be “recurring and substantial” over time in order for a plan to be considered ongoing and to remain viable [Treas. Reg. § 1.401-1(b)(2)].

If contributions cease, a complete “discontinuance of contributions” has occurred in the IRS’s eyes, which triggers a plan termination and complete (100%) vesting of participants’ accounts [Treas. Reg. § 1.411(d)-2(a)(1)]. Contrast this with a “suspension of contributions” under the plan, which is merely a temporary cessation of contributions by the employer. A complete discontinuance of contributions still may occur even though the employer makes contributions if such contributions are not substantial enough to reflect the intent on the part of the employer to continue to maintain the plan (e.g., only forfeitures are allocated).

The IRS makes a determination as to whether a complete discontinuance of contributions under a plan has occurred by considering all the facts and circumstances in the particular case, and without regard to any employee contributions (i.e. pre-tax deferrals, designated Roth or after-tax contributions). According to the IRS’s exam guidelines at Part 7.12.1.4, examiners are to review IRS Form 5310, line 19a, which indicates employer contributions made for the current and the five prior plan years, to determine if the plan has had a complete discontinuance of contributions. In a defined contribution plan, if the plan sponsor has failed to make substantial contributions in three out of five years, there may be a discontinuance of contributions. Other considerations include whether the employer is calling an actual discontinuance of contributions a suspension of such contributions in order to avoid the requirement of full vesting, and whether there is a reasonable probability that the lack of contributions will continue indefinitely.

Under Treas. Reg. § 1.411(d)-2(d)(2) a complete discontinuance becomes effective for a single employer plan on the last day of the employer’s tax year after the tax year for which the employer last made a substantial contribution to the profit sharing plan. For a plan maintained by more than one employer, a complete discontinuance becomes effective the last day of the plan year after the plan year within which any employer last made a substantial contribution.

If a plan suffers a complete discontinuance and the plan sponsor has made partially vested distributions, the plan’s qualified status is at risk. The plan sponsor can fix the error by using the Employee Plans Compliance Resolution System. The correction will require restoring previously forfeited accounts to affected participants, adjusted for lost earnings, and correcting IRS Form 5500 filings for the plan.

For additional information, please refer to the IRS guidance, No Contributions to your Profit Sharing/401(k) Plan for a While? Complete Discontinuance of Contributions and What You Need to Know.

Conclusion

While employer contributions to a profit sharing or stock bonus plan are discretionary in most cases (check the document language), the IRS still expects them to be recurring and substantial to a certain extent. For example, if the plan sponsor has failed to make substantial contributions in three out of five years, there may be a discontinuance of contributions, which triggers plan termination and complete vesting of benefits.

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“Case of the Week” is the winner of an APEX Award for Publication Excellence for 2017.

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.

©2018, Retirement Learning Center, LLC. Used with permission.

Add Your Comments

3 Comments

  1. url url'>Chris Rylands
    Posted April 4, 2018 at 10:43 am | Permalink

    If this statement is true “without regard to any employee contributions (i.e. pre-tax deferrals, designated Roth or after-tax contributions).” then no deferral-only plan could ever be qualified. Is that how you understand this to work?

  2. url url'>Chris Rylands
    Posted April 4, 2018 at 10:50 am | Permalink

    As a follow-up, I note that 1.401(k)-1(a)(4)(ii) states elective deferrals are employer contributions for purposes of 401(a).

  3. John Henry
    Posted April 4, 2018 at 10:55 am | Permalink

    If the plan is designed as a deferral only defined contribution plan without a discretionary profit sharing component, then they are ok.

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