The ERISA consultants at the Columbia Management Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call from an advisor in Michigan is representative of a common inquiry related to plan permanency. The advisor asked:
“Does the IRS require an employer to maintain a defined benefit (DB) or defined contribution (DC) plan for a certain number of years? 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.”
While the IRS does not require that a plan sponsor maintain its plan (DB or DC) for a certain number of years, the relevant Treasury regulations do state, “The term ‘plan’ implies a permanent, as distinguished from a temporary, program” (Treas. Reg. 1.401-1(b)(2)).
The regulation goes on to say, “Although the plan sponsor may reserve the right to change or terminate the plan, and to discontinue contributions thereunder, 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 regulation further states, “In the event a plan is abandoned, the employer should promptly notify the district director, stating the circumstances that led to the discontinuance of the plan.”
Additionally, a plan sponsor’s decision and reasons for terminating its qualified retirement plan should be thoroughly documented and retained.
Conclusion
Employers who have established or who may be contemplating establishing a qualified retirement plan must be aware that the IRS expects 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 plan abandonment.
Financial advisors who are aware of the plan permanency rules are better positioned to support their plan sponsor clients.
The Columbia Management Retirement Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC, a third-party industry consultant that is not affiliated with Columbia Management. For informational purposes only. Please consult a tax advisor or attorney for specific tax or legal needs. © 2012 Columbia Management Investment Advisers, LLC. Used with permission.
