- 4.72.8 Valuation of Assets in Defined Contribution Plans
- 18.104.22.168 Overview
- 22.214.171.124 Form 5500 Information
- 126.96.36.199.1 Examination Steps
- 188.8.131.52 Timing of Asset Valuations
- 184.108.40.206 Determining Asset Values
- 220.127.116.11 Types of Plan Assets
- 18.104.22.168.1 Partnerships
- 22.214.171.124.1.1 Examination Steps
- 126.96.36.199.2 Real Estate
- 188.8.131.52.2.1 Examination Steps
- 184.108.40.206.3 Life Insurance Contracts
- 220.127.116.11.3.1 Examination Steps
- 18.104.22.168 Effects of Improper Valuation
- 22.214.171.124 ESOP Issues
Part 4. Examining Process
Chapter 72. Employee Plans Technical Guidelines
Section 8. Valuation of Assets in Defined Contribution Plans
August 29, 2016
(1) This transmits revised IRM 4.72.8, Employee Plans Technical Guidelines, Valuation of Assets in Defined Contribution Plans.
(1) Made editorial updates throughout.
(2) Updated IRM to meet the requirements of P.L. 111-274 (H.R. 946), the Plain Writing Act of 2010. The Act provides that writing must be clear, concise, well-organized, and follow other best practices appropriate to the subject or field and intended audience.
(3) Appended additional informational sentences onto IRM 126.96.36.199.2 (2) and IRM 188.8.131.52 (1).
(4) Added new IRM 184.108.40.206.2 (4) and IRM 220.127.116.11 (4).
Robert S. Choi
Director, Employee Plans
Tax Exempt and Government Entities
This IRM provides guidance on valuing assets in qualified defined contribution retirement plans.
For plans to comply with the requirements of the Internal Revenue Code (Code) and Title I of the Employee Retirement Income Security Act (ERISA), it is essential that they accurately assess the fair market value (FMV) of assets. For instance, the FMV of assets must be accurately determined to preclude any of the following:
Prohibited transaction under IRC 4975
Exclusive benefit violation under IRC 401(a)
Violation of the limitation on contributions and other additions under IRC 415(c)
Excess deduction under IRC 404
Violation of the minimum funding requirements under IRC 412
Discrimination violation under IRC 401(a)(4)
This IRM does not address the valuation of assets in a defined benefit plan. See 26 CFR 1.412(c)(2)-1 and 26 CFR 1.430(g) -1(c) for the FMV of assets and actuarial value of assets in a defined benefit plan.
In a profit sharing, money purchase or stock bonus plan, the valuation of assets will determine the value of a participant’s account, and ultimately, a participant’s distribution.
In an Employee Stock Ownership Plan (ESOP), the valuation will affect both the deduction and distribution. For employer securities that are not readily tradable on an established securities market, IRC 401(a)(28)(C) requires all valuations with respect to activities carried on by the plan to be made by an independent appraiser. See Notice 2011-19, 2011-11 IRB 550 and 26 CFR 1.401(a)(35)-1(f)(5) for the definition of readily tradable on an established security market.
Whether a formal valuation is required will depend on the transactions that occur with the plan and the form of the plan.
Whether a plan’s method for valuing assets is reasonable is based on the facts and circumstances. Except for certain employer securities held by an ESOP, there is no absolute requirement that a plan’s annual valuation be based on an independent appraisal. On the other hand, it may be reasonable for you to request an appraisal for hard-to-value assets under certain circumstances, such as when distributions are made to plan participants. Whether an independent appraisal is required or not, the valuation guidelines expressed in Rev. Rul. 59-60, 1959-1 CB 237 may be used to support your review for reasonableness.
Form 5500, Annual Return/Report of Employee Benefit Plan, Schedule H, Financial Information, Schedule I, Financial Information--Small Plan, and Form 5500-SF, Short Form Annual Return/Report of Small Employee Benefit Plan require a statement of plan assets information.
The asset and liability section requires FMV and plan liability as of the beginning and end of the current plan year.
The income and expense section asks for the contribution, earnings on investments, benefit payments and expenses. In addition, Form 5500 Schedule H and I specifically asks for unrealized appreciation or depreciation of plan assets.
A question on Form 5500 Schedules H and I asks whether any non-cash contributions (real estate, collectibles and closely held stock, etc.) were made to the plan, the value of which was neither readily determinable on an established securities market nor set by an independent third party appraiser.
The Service’s position is that contributions of property to pension plans and certain other defined contribution plans are prohibited transactions if they are not covered by a statutory or administrative exemption. The Supreme Court ruled in favor of the Service in Keystone Consolidated Industries v. Commissioner, 508 U.S. 152 (1993).
A question on Form 5500 (Schedules H and I) asks whether the plan holds any assets whose current value was neither readily determinable on an established market nor set by an independent third-party appraiser.
A question on Form 5500 applicable to ESOPs (Schedule R, Retirement Plan Information), asks if the ESOP holds any stock that is not readily tradable on an established securities market.
Determine whether the plan reports assets with the same values in successive years. If the same value for an asset was reported on Form 5500 for the prior year, it may indicate a yearly valuation was not performed, requiring further examination.
Determine whether there is a sudden jump in plan asset values in the year the plan makes a large distribution to highly compensated employees. The plan assets may not have been revalued in prior years, when the plan only made distributions to non-highly compensated employees. This indicates there might be discrimination under IRC 401(a)(4).
For plan terminations submitted for a determination letter including Form 6088, Distributable Benefits from Employees’ Pension Benefit Plan, ascertain whether only the accounts of highly compensated employees remain at plan termination. Compare it to Form 5500 for the current year to see if any non-highly compensated employees participate in the plan. If none participate in the current year, look at Form 5500 for prior years to determine whether the plan only made distributions to non-highly compensated employees in those years.
For plans not terminating, check Form 8955-SSA, Annual Registration Statement Identifying Separated Participants With Deferred Vested Benefits, to see if mostly separated highly compensated employees’ accounts remain in the trust.
Refer to the Form 5500 question on unrealized appreciation/depreciation. There may be a valuation problem if there is no response to this question when the plan reports investments in any corporate stock or security.
Look at the Form 5500 question on non-cash contributions. If the plan sponsor contributed the property, determine whether and by whom the property was valued in the year of the contribution.
Look at the Form 5500 question on plan assets whose current value was neither readily determinable nor set by an independent third party appraiser. If there is an affected asset, determine whether and by whom the asset was valued.
For ESOPS, look at the Form 5500 (Schedule R) question on stock that is not readily tradable on an established securities market. If the plan holds any non-readily tradable stock not appraised by an independent third-party appraiser, determine whether the securities were valued that year and by whom. See IRM 4.72.4, Employee Stock Ownership Plans (ESOPs) and IRM 18.104.22.168, ESOP Issues.
In defined contribution plans, amounts allocated or distributed to participants must be ascertainable. Therefore, the plans must value their trust investments under Rev. Rul. 80–155:
At least once a year
On a specified date
In accordance with a method consistently followed and uniformly applied
Under Rev. Rul. 69-494, one requirement for an investment to satisfy the exclusive benefit rule of Code section 401(a) is that the cost of the investment must not exceed the fair market value at time of purchase. Accordingly, when employer securities are acquired or sold, the securities must be valued at the time of the transaction.
Under Rev. Rul. 80–155, in addition to the required annual valuation, interim valuations are permitted. So, a plan provision allowing interim valuations at a trustee’s discretion is permitted as long as these valuations aren’t discriminatory under IRC 401(a)(4).
A plan with a valuation date of January 1, the first day of the plan year, which also requires interim valuations at the end of each month in which assets had significant market fluctuations (as defined in the plan) may not be discriminatory.
However, if a defined contribution plan was amended to provide for interim valuations during a time in which plan asset values were rising and in which highly compensated employees were receiving distributions, the plan could violate IRC 401(a)(4).
The valuation dates for account balances are not IRC 411(d)(6) protected benefits. So, a decrease in benefits caused by a change in the date for valuing plan assets is not a decrease in benefits prohibited by IRC 411(d)(6). See 26 CFR 1.411(d)–4, Q& A –1(d)(8).
Determine whether plan assets have been valued annually at FMV.
If there are interim valuations, determine that the plan has an annual valuation date and permits interim valuations.
Check whether interim valuations are discriminatory under IRC 401(a)(4).
If the provided valuation does not appear to be accurate, consider making a referral requesting an Engineer specialist in valuation, in accordance with IRM 22.214.171.124, EP Group Procedures – Specialist Referral System (SRS). A DOL referral may also be warranted.
Rev. Rul. 59–60 provides guidance for determining the value of plan assets. This revenue ruling provides methods for valuing shares of stock of closely held corporations for estate and gift tax purposes and you may use the listed factors to determine values of assets in qualified plans.
Determine how much of the plan’s valuation details you should examine based on the plan assets involved.
Where appropriate, stock values should be discounted due to a lack of marketability and, if appropriate, a control premium should be added to the stock value.
There are a number of factors to consider when determining the value of an asset. See Rev. Rul. 59-60. For example:
Nature and history of the business issuing the security
General economic outlook and the outlook for the specific industry
Book value of the securities and the financial condition of the business
Company’s earning capacity
Company’s dividend paying capacity
Recent stock sales
ERISA 3(18) applies for some prohibited transaction exemptions under both ERISA and the Code.
ERISA 3(18) defines the term adequate consideration for "assets other than a security for which there is a generally recognized market" as the FMV of the asset as determined in good faith by the trustee or named fiduciary pursuant to the terms of the plan and in accordance with regulations promulgated by the Secretary.
Proposed Department of Labor (DOL) Reg. 2510.3–18(b)(2) defines "fair market value" as the price at which an asset would change hands between a willing buyer and a willing seller when either party is not under any compulsion to enter into the transaction.
Determine, after you carefully review the plan asset valuation, if the value assigned to an asset differs from what you expect.
Determine the value of publicly traded securities by checking their prices through online resources.
In determining the FMV of closely held stock, determine how closely held company shares were valued.
Check whether the share prices as reported on Form 5500, auditor report, rise and fall with its earnings. If the company’s earnings have fallen but the report says the price per share has risen or remained constant, it may indicate an incorrect valuation. Request an explanation.
Determine whether there have been any recent sales of the company’s stock. Make sure the sales price is consistent with the valuation.
If the current valuation relies on a previous valuation, check the employer’s audit report to see if the company’s earnings have fallen since the valuation report was written. If they have, the value of the shares should have also likely fallen. The plan fiduciary can no longer rely on the price per share from the valuation report because the facts on which it was based have changed. Similar rules apply if the company’s earnings have risen since the valuation report was written.
Use other factors to determine the FMV of closely held stock include their book value, dividend paying capacity and the goodwill value of the company.
In an investment or holding company, determine whether the valuation gave the greatest weight to the assets underlying the security to be valued. In a company which sells products or services, determine whether the valuation gave the greatest weight to earnings.
If the valuation appears to be inadequate, verify its accuracy by asking for another valuation from a fiduciary or qualified appraiser.
Plans may invest a portion of their assets in limited partnerships and invest directly in real property, or in mortgages on real property. Section 404(a)(1)(C) of ERISA requires that investments be diversified to minimize the risk of large losses unless it is not prudent to do so.
Plans may also invest in life insurance contracts. See below for a safe harbor that plans may use when they distribute these contracts.
The partnership itself can invest in virtually any type of asset.
Generally, limited partnership interests are not listed on national securities exchanges.
The valuation of a plan’s interest in a partnership is especially important in a year in which the plan makes a distribution.
Ask for information regarding how and when the FMV of the partnership was determined.
Ask whether there were sales of or offers for the partnership interests, secondary market trades or quotes, and whether the fiduciary used the general partner’s valuation.
Determine the basis for the valuation of the partnership, i.e., if the partnership’s value was based on the original cost of the investment, or the capital account (reported on the Schedule K–1, which shows the partner’s pro rata share of the partnership’s income, losses, credits and deductions). These valuations may not reflect the FMV of the partnership.
The fact that a partnership has had no earnings may indicate that the partnership is worthless. To determine whether the partnership had earnings, request the partnership’s K–1s. Depending on the circumstances, you may want to request K-1s for prior years.
Plan ownership of real estate or mortgages may be valued incorrectly if based solely on their purchase prices.
Under certain circumstances, a plan’s ownership of a mortgage might need to be re-valued to reflect the current value of the encumbered real property.
To determine the value of real estate, check the appraisal report, tax assessment document, and the property insurance policy.
Compare the loan or mortgage balance to the appraised value of the property.
The property’s best use is one criteria in valuing the asset. Determine what the property is actually used for. If the property’s best use is different than the property’s actual use, then the property may not have been properly valued.
Individuals who receive a distribution of property from a qualified plan must include its FMV in income (26 CFR 1.402(a)-1(a)(1)(iii)).
Prior to its amendment, 26 CFR 1.402(a)-1(a)(2) provided that the individual who received a distribution of a retirement income, endowment, or other life insurance contract had to include the "entire cash value" at the time of distribution.
Proposed amendments dated February 13, 2004, to the 402 regulations stated that the fair market value standard controls when such a contract is distributed or sold.
Final regulations issued on August 29, 2005 adopted the fair market value standard. The final regulations provide that the amendments to 26 CFR 1.402(a)-1(a) are effective for distributions occurring on or after February 13, 2004. The final regulations under 26 CFR 1.402(a)-1(a)(1)(iii) include special effective date provisions for bargain sales of these contracts.
Q&A-10 of Notice 89-25 described a distribution from a qualified plan of a life insurance policy with a value substantially higher than the cash surrender value stated in the policy. The notice concluded that the practice of using cash surrender value as fair market value is not appropriate where the total policy reserves, including life insurance reserves (if any) computed under IRC 807(d), together with any reserves for advance premiums, dividend accumulations, etc., represent a much more accurate approximation of the policy’s fair market value.
Since Notice 89-25 was issued, life insurance contracts have been marketed that are structured in a manner which results in a temporary period during which neither a contract’s reserves nor its cash surrender value represent the fair market value of the contract.
Some life insurance contracts may offer large surrender charges and other charges that are not expected to be paid because they are expected to be eliminated or reversed in the future (under the contract or under another contract exchanged for the first contract), but this future elimination or reversal is not always reflected in the calculation of the contract’s reserve. If such a contract is distributed prior to the elimination or reversal of those charges, both the cash surrender value and the reserve under the contract could significantly understate the fair market value of the contract. Therefore, in some cases, it wouldn’t be appropriate to use either the net surrender value (i.e., the contract’s cash value after reduction for any surrender charges) or, because of the unusual nature of the contract, the contract’s reserves to determine its fair market value.
Rev. Proc. 2004-16 provides a safe harbor to determine the fair market value of variable and non-variable contracts to apply the rules under the proposed regulations issued under IRC 402(a).
Rev. Proc. 2005-25 modified and superseded Rev. Proc. 2004-16. It provides two safe harbor formulas that, if used to determine the value of an insurance contract, retirement income contract, endowment contract, or other contract providing life insurance protection that is distributed or otherwise transferred from a qualified plan, will meet the definition of fair market value for purposes of IRC 402(a).
These safe harbor formulas also meet the definition of fair market value for purposes of IRC 402(b) and the definition of vested accrued benefit for purposes of IRC 402(b)(4)(A).
Rev. Proc. 2005-25 applies to distributions, sales, and other transfers made from an exempt employee’s trust on or after February 13, 2004, and to non- exempt employees’ trusts under IRC 402(b) for periods on or after February 13, 2004. Taxpayers may rely on the safe harbors of Rev. Proc. 2005-25 for periods before May 1, 2005. Taxpayers may also rely on the safe harbors in Rev. Proc. 2004-16 for periods on or after February 13, 2004, and before May 1, 2005.
Determine whether a life insurance policy distributed by a plan is valued properly:
In the case of a non-variable life insurance contract, compare the premiums paid with the value of the contract. Generally, the value of a non-variable life insurance contract should be close to the premiums paid under the contract accumulated at a reasonable rate of interest (at least two or three percent) less reasonable cost of insurance charges (generally, except for very high ages, less than $5,000 per $1 million of death benefit) less reasonable policy expenses (generally, less than $1,000 per $1 million of death benefit).
In the case of a variable life insurance contract, consider the actual investment return. Generally the value of a variable life insurance contract should be close to the premiums paid under the contract accumulated at the actual investment return rate earned by the contact (which can vary widely because the premiums paid under such contracts are generally invested in mutual fund like instruments) less reasonable cost of insurance charges (generally, except for very high ages, of less than 5,000 per $1 million of death benefit) less reasonable policy expenses (generally, less than $2,000 per $1 million of death benefit).
Protect the statute of limitations on the related Form 1040, U.S. Individual Income Tax Return, resulting from any adjustments to the recipient's taxable income. See IRM 4.71.4, Discrepancy Adjustments.
Defined contribution plan assets must be revalued at least annually (Rev. Rul. 80–155). If Rev. Rul. 80–155 requirements are not met, the plan is not qualified.
If assets are valued more frequently than annually in a way that favors distributions to highly compensated employees, it could result in prohibited discrimination under IRC 401(a)(4).
Improperly valuing qualified plan assets can cause a plan to exceed the IRC 415 limits.
This could occur, for example, if there was an exempt contribution of undervalued property to a plan and the resulting annual additions to participant accounts based on the improper valuation are within the limits of IRC 415, but the annual additions based on FMV of the contributed property would exceed the IRC 415 limits.
Similarly, there could be excess annual additions if property were sold by the plan for more than FMV.
If assets are sold to or by the plan at a value other than FMV, a prohibited transaction may result if a disqualified person is involved.
In extreme cases, an exclusive benefit violation under IRC 401(a)(2) may occur if a qualified plan engages in a prohibited transaction in which it acquires property for more than FMV.
Contributing property to a plan may be allowed if it is covered by a prohibited transaction exemption. A contribution need not be paid in cash to be deductible under IRC 404. If overvalued property is contributed to the plan, the employer may have deducted an amount in excess of that is allowed under IRC 404.
Contributing overvalued property to a money purchase pension plan may cause it to not satisfy the minimum funding standards of IRC 412.
A plan may acquire and hold qualifying employer securities and qualifying employer real property (IRC 4975(d)(13) and ERISA 408(e)).
A plan’s acquisition of qualifying employer securities or qualifying employer real property is exempt under IRC 4975(d)(13) only if the securities or real property is acquired for "adequate consideration" as defined under ERISA 3(18). This requires a proper valuation. See IRM 4.72.11, Prohibited Transactions.
Evaluate a plan’s purchase of employer securities and employer real property. Determine if it complies with the prohibited transaction exemption requirements and the exclusive benefit requirements.
If a contribution of property to a plan is covered by a prohibited transaction exemption, determine whether an employer exceeded contribution or deduction limitations by contributing undervalued property to a qualified defined contribution plan. The IRC 4972 excise tax may apply.
Determine whether an improper valuation has caused the plan to violate IRC 415.
ESOPs must satisfy the annual valuation requirements of Rev. Rul. 80–155 for defined contribution plans. However, in a transaction between an ESOP and a disqualified person (as defined in IRC 4975(e)(2)), the value must be determined as of the date of the transaction. See 26 CFR 54.4975-11(d)(5).
ESOPs have special valuation rules in certain circumstances. See IRM 4.72.4, Employee Plans Technical Guidance, Employee Stock Ownership Plans (ESOPs).
An ESOP is not a qualified plan unless all valuations of employer securities that are not readily tradable on an established securities market, with respect to activities carried on by the ESOP, are performed by an independent appraiser (IRC 401(a)(28)(C)).
Valuation by an independent appraiser is not required in the case of employer securities that are readily tradable on an established securities market per 26 CFR 1.401(a)(35)-1(f)(5). See Notice 2011-19.
Valuation by an independent appraiser is not required unless the ESOP holds employer securities acquired after December 31, 1986.
An appraiser is independent if he/she satisfies the requirements under IRC 170(a)(1) for a "qualified appraiser" . 26 CFR 1.170A–13(c)(5) provides that a "qualified appraiser" must make a declaration on the appraisal summary that the appraiser:
Holds himself/herself out to the public as an appraiser or performs appraisals on a regular basis.
Is qualified to make appraisals of the type of property being valued; and provides a description of his/her qualifications pursuant to 26 CFR 1.170A–13(c)(3)(ii)(F).
An appraiser is not independent if he/she is:
The taxpayer that maintains the ESOP (or a member of the controlled group of corporations that includes the taxpayer).
A party to the transaction in which the ESOP acquired the property.
Employed by the taxpayer maintaining the ESOP (or any entity described in subparagraphs a) or b), above).
Regularly used by any entity described above and does not perform a majority of his/her appraisals for entities other than those described above.
Employer X has an ESOP and uses a large, national accounting firm for its auditing and tax requirements. The accounting firm proposes to use its valuation division to perform an appraisal for the ESOP. The valuation division is qualified to perform appraisals of the property and holds itself out to the public as an appraiser. Is the accounting firm’s valuation division an independent appraiser for purposes of IRC 401(a)(28)(C)?
Yes, as long as the accounting firm’s valuation division performs a majority of its appraisals for entities other than Employer X or its related entities, the valuation division is an independent appraiser.
A valuation of employer securities by an independent appraiser is required with respect to any activities carried on by the plan. These activities include the contribution of employer securities to an ESOP, the purchase of employer securities by an ESOP and distributions to participants.
Employer securities are not necessarily required to be valued by IRC 401(a)(28)(C) as of the date of the plan activity. The plan can generally use the most recent annual valuation done on the plan’s valuation date by an independent appraiser.
Plan activities requiring valuations also include the offer of employer securities to the employer by a participant under a right of first refusal, the exercise of a put option by a participant to sell shares to the employer and the allocation of assets to participants’ accounts. See 26 CFR 54.4975–11(d)(5).
A participant’s diversification election under IRC 401(a)(28)(B) is a plan activity requiring a valuation by an independent appraiser.
IRC 401(a)(35) requires defined contribution plans to provide employees with the freedom to divest publicly traded employer securities.
Review Form 5500 to see if a current appraisal of employer securities was made immediately before such stock was contributed to or purchased by an ESOP for the plan year.
If the answer is "no," a valuation problem may be indicated and the plan may be disqualified.
If the answer is "yes," check Form 5500 to see if the appraisal was made by an unrelated third party. If the answer is "no," a valuation problem may be indicated and the plan may be disqualified.
Make sure the appraiser is an "independent appraiser" within the meaning of IRC 401(a)(28)(C).