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

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.

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.