Discriminatory Retirement Plan Amendments Briefs. Vol. 13, No. 1

The Internal Revenue Code does not suffer from any lack of anti-discrimination rules — rules designed to ensure that rank and file employees will enjoy retirement benefits that are roughly comparable (in terms of a percentage of pay) to those provided the highly paid. Similarly, benefits practitioners do not suffer from any lack of effort to circumvent the rules. To thwart the circumventers, the IRS has promulgated what are essentially if-the-normal-rules-don’t-get-you-these-rules-will rules. One of the real head-scratchers says that a plan will be disqualified if the timing of any plan amendment, or series of plan amendments, including the establishment or termination of a plan, discriminates significantly in favor of highly compensated employees, taking into account all the facts and circumstances. The principal fact or circumstance is the extent to which the highly paids benefit from an amendment compared with the non-highly paids. There is a big problem with this rule: if applied literally, plan changes could be made only in the direction of ratcheting up the benefits for the rank and file. Seemingly benign amendments that otherwise satisfy all the usual anti-discrimination rules but benefit only highly paids pose an apparent risk of disqualification (e.g., making highly paids newly eligible for a plan after previously excluding them for cost reasons, or adding to the definition of compensation incentive pay or some other element of pay that only the highly paids receive).

It is not clear how this discrimination-by-amendment rule will eventually play out but we have at least received some modest guidance from the IRS. Rev. Rul. 99-51, 1999 IRB LEXIS 433 (12/13/99). It seems that once upon a time an employer had a single defined benefit pension plan. It then took the following steps: (1) the plan was divided into two separate plans, one for the highly paids and one for the non-highly paids; (2) benefits under the plan for the non-highly paids continued to accrue but benefits under the plan for the highly paids were frozen; (3) after a decent interval of time the highly paids were made eligible to participate in the plan for the non-highly paids; and (4) the highly paids were given past service credit for all service with the employer under what had been the plan for the non-highly paids. Although it seems unlikely this arrangement could have gotten through the minefield of normal anti-discrimination and benefit limitation rules, it apparently did, thereby allowing the IRS to pull out its no-discrimination-by-amendment blunderbuss to kill the beast. This was not exactly a difficult assignment since any dummy can see that the end result of these machinations was to give the highly paids, but not the non-highly paids, duplicate benefits for the prior service period (one benefit under the highly paids’ frozen plan and a second under the newly united plan).

We don’t really need to have the IRS point out that one cannot give the highly-paids twice the benefits of the non-highly paids. The real guidance we need is on the second to last step in this chain of actions, the one that made the highly paids eligible to participate in the plan for the non-highly paids. Going by the numbers, it would appear that this change benefited 100% of the highly paids and 0% of the non-highly paids, a fairly damming fact and circumstance. What one would have hoped from the Service is some recognition that if what we are doing is trying to be fair to the highly paids (i.e., to let them participate on an equal basis), we shouldn’t have to worry about being in the sights of our friendly IRS auditor.