3736 / What special qualification requirements regarding the payment of definitely determinable benefits apply to pension plans but not to profit sharing plans?

A pension plan must provide for the payment of definitely determinable benefits to employees upon retirement or over a period of years after their retirement or to their beneficiaries. Benefits must be determined without regard to the employer’s profits.¹ Benefits actually payable need not be definitely determinable, provided the contributions can be determined actuarially on the basis of definitely determinable benefits. This is the theoretical basis for defined benefit plans of the “assumed benefit” or “variable benefit” type (so-called “target” plans). Benefits are “definitely determinable” under a money purchase pension plan that calls for contributions of a fixed percentage of each employee’s compensation.²

Benefits that vary with the increase or decrease in the market value of the assets from which such benefits are payable or that vary with the fluctuations of a specified and generally recognized cost-of-living index are consistent with a plan providing for definitely determinable benefits.³ A plan provides a definitely determinable benefit if, in the case of an insured plan, the practice of the insurer is to provide a retirement annuity that is the higher of an annuity bought at an annuity rate guaranteed in the contract surrendered in exchange for the same type of annuity purchased at current annuity rates.⁴

The IRS determined that a governmental cash balance plan in which the interest rate credited on contributions was set by a board appointed under state law nonetheless provided a definitely determinable benefit.⁵ In a TE/GE Memo to plan examiners, the IRS indicated that a cash balance plan can meet the definitely determinable requirement when the formula under which a credit is determined by looking at compensation, if the compensation information is otherwise available outside the terms of the plan, like in a W-2.⁶

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Planning Point: The IRS has directed its examination staff to focus on the issue of “definitely determinable benefits” in audits since compliance with this requirement is a precondition to qualification. Hence, plan sponsors may wish to have legal counsel to periodically review their plan for compliance under current IRS guidance in order to assure themselves of continuing plan qualification in the event of an audit.

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To be definitely determinable, a plan that credits interest must specify how the plan determines interest and must specify how and when interest is credited. Interest must be credited at least annually.

Regulations specify two methods that a plan can use to determine the plan’s interest crediting rate: the applicable periodic interest crediting rate that applies over the current period or the rate that applied in a specified lookback month with respect to a stability period.⁷ A plan is permitted to round the calculated interest rate or rate of return in accordance with regulations issued in 2015.⁸

A defined benefit plan will not be treated as providing definitely determinable benefits unless the actuarial assumptions used to determine the amount of any benefit (including any optional or early retirement benefit) are specified in the plan in a way that precludes employer discretion.⁹

Under certain plans, a participant receives not only a defined benefit specified in the plan but also amounts that have been credited to individual accounts each year based on excess earnings; in other words, actual trust earnings in excess of the investment yield assumption used in the valuation of the cost of providing the defined benefit (an excess earnings plan). Where contributions to these plans are discretionary, the amount of excess interest allocations to the defined contribution portion of the plan is not definitely determinable, and the plan will not qualify.¹⁰

Retirement benefits are not definitely determinable under a plan that permits the withdrawal of employer contributions. Hence, a pension plan may not permit the withdrawal of employer contributions or earnings thereon, even in the case of financial need, before death, retirement, disability, severance of employment, or termination of the plan.¹¹ Withdrawals may be made once the employee has reached normal retirement age even if the employee has not actually retired.¹²

A pension plan may permit withdrawal of all or part of an employee’s own contributions plus interest actually earned thereon when the employee discontinues participation in the plan, even though the employee continues to work for the employer.¹³

In addition, a pension plan may permit an employee to withdraw his or her nondeductible voluntary contributions without terminating his or her participation in the plan, provided the withdrawal will not affect the employee’s participation in the plan, the employer’s past or future contributions on his or her behalf, or the basic benefits provided by both the employee’s and the employer’s mandatory contributions, and no interest is allowable with respect to the contributions withdrawn either at the time of withdrawal or in computing benefits at retirement.¹⁴

The IRS takes the position that all benefits payable under a plan, including early retirement, disability pension, and preretirement death benefits, must be definitely determinable. Thus, a pension plan funded by a combination of life insurance and an auxiliary fund, which provided a pension on early retirement or disability, the amount of which was based in part on the participant’s interest in the auxiliary fund, failed to qualify because the employer was not required to maintain the fund at a particular level or to make contributions at any particular time.¹⁵

Similarly, a defined benefit pension plan that provided a preretirement death benefit equal to the amount of the pension benefit funded for a participant as of the date of the participant’s death failed to qualify.¹⁶

Likewise, a change in actuarial factors that affects the calculation of a participant’s optional or early retirement benefit would result in plan disqualification.¹⁷

Benefits under a defined benefit plan will be considered definitely determinable even if they are offset by benefits provided by a profit sharing plan, if determination of the amount of the offset is not subject to the employer’s discretion. The actuarial basis and the time for determining the offset must be specified in the defined benefit plan to preclude employer discretion.¹⁸

Pension benefits will not fail to be definitely determinable because a factor or condition, determinable only after retirement, is used to compute benefits in accordance with an express provision in the plan if the factor or condition is not subject to the discretion of the
employer.¹⁹

Forfeitures

Related to the definitely determinable benefits rule is the requirement that a pension plan provide that forfeitures must not be applied to increase the benefits any employee would otherwise receive under the plan.²⁰