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Issue Snapshot - Change in Retirement Plan Vesting Schedules

For various reasons, a plan sponsor may need to change a plan’s vesting schedule, either to comply with changes in the law or due to a design choice. Other indirect plan changes, such as a change to how hours of service are credited to employees, may also have the effect of changing a participant’s vesting computation percentage. This Snapshot discusses the requirements when a plan changes its vesting schedule.

IRC Sections and Treas. Regulations

Resources

  • Pub. 6389, Alert Guidelines 2, Minimum Vesting Standards Defined Contribution Plans

Analysis

Subject to the conditions discussed below, a vesting schedule may be changed either in the discretion of the plan sponsor or to comply with changes in the law. For example, a plan merger or spin-off may result in a change in vesting schedules.

A vesting schedule may also have to be amended to comply with statutory requirements, such as the minimum vesting schedules for top-heavy plans and hybrid defined benefit plans.

Background

Any amendment to a vesting schedule, for whatever reason, must comply with IRC Sections 411(a)(10), 411(d)(6) and regulations thereunder. IRC Section 411(a)(10)(A) provides that a plan amendment changing any vesting schedule under the plan is noncompliant if the nonforfeitable percentage of the accrued benefit derived from employer contributions (determined as of the later of the date the amendment was adopted or became effective) of any participant in the plan is less than the nonforfeitable percentage computed without regard to the amendment.

IRC Section 411(a)(10)(B) provides that a plan amendment changing any vesting schedule under the plan is also noncompliant unless each participant having at least 3 years of service is permitted to choose to remain under the prior schedule in effect before the amendment.

Reg. Section 1.411(a)-8(b)(2) provides that the period during which a participant may elect the pre-amendment vesting schedule begins on the date the amendment is adopted and ends on the latest of:

  1. 60 days after the amendment is adopted.
  2. 60 days after the amendment becomes effective.
  3. 60 days after the participant is issued written notice of the amendment by the employer or plan administrator.

Plan amendments that change a vesting schedule are also subject to the anti-cutback rules in IRC Section 411(d)(6). In general, these anti-cutback rules protect a participant’s accrued benefit, early retirement benefit, retirement type subsidies, and other forms of optional benefits offered under a qualified retirement plan.

Section 411(d)(6) generally provides that the accrued benefit of a participant may not be decreased by an amendment to the plan, and any amendment that has the effect of eliminating or reducing an early retirement benefit or a retirement type subsidy, or eliminating an optional form of benefit, is treated as impermissibly reducing accrued benefits for this purpose.

Reg. Section 1.411(d)-3(a) provides that plan amendments that decrease a participant’s accrued benefit or add restrictions or conditions on the receipt of accrued benefits violate the anti-cutback rules under IRC Section 411(d)(6), even if such amendments are permitted under the vesting rules in IRC Sections 411(a)(3) through (11). Thus, it is possible for a plan amendment changing a vesting schedule to comply with IRC Section 411(a)(10), but still violate IRC Section 411(d)(6).

The following example illustrates these requirements:

Example of impermissible change to vesting

Employer O sponsors Plan D, a qualified defined contribution plan under which each employee has a nonforfeitable right to a percentage of his or her employer-derived accrued benefit based on the following table:

Completed Years of Service Vested Percentage
Fewer than 2 0%
2 20%
3 40%
4 60%
5 80%
6 100%

In January 2010, Employer O acquires Company X, which maintains Plan E, a qualified defined contribution plan under which each employee who has completed 3 years of service has a nonforfeitable right to 100% of the employer-derived accrued benefit.

In 2011, Plan E is merged into Plan D. On the effective date for the merger, Plan D is amended to provide that the vesting schedule for participants of Plan E is the 6-year graded vesting schedule of Plan D. In accordance with IRC Section 411(a)(10)(A), the plan amendment provides that any participant of Plan E who had completed 3 years of service prior to the amendment is fully vested.

There is no need to provide a vesting schedule election because all participants who have at least 3 years of service prior to the amendment are fully vested.

Participant G, who has an account balance of $10,000 on the applicable amendment date, is a participant in Plan E with 1 year of service as of the applicable amendment date.

As of the date of the merger, Participant G's nonforfeitable right to employer contributions is 0% under both the 6-year graded vesting schedule of Plan D and the 3-year cliff vesting schedule of Plan E.

The plan amendment does not satisfy the requirements of Reg. Section 1.411(d)-3(a) and violates IRC Section 411(d)(6), because the amendment places greater restrictions or conditions on the rights to IRC Section 411(d)(6) protected benefits with respect to Participant G and any participant who has fewer than 3 years of service and who elected (or was made subject to) the new vesting schedule.

A method of avoiding a IRC Section 411(d)(6) violation with respect to a participant’s accrued benefit as of the applicable amendment date would be for Plan D to provide for the vested percentage of Participant G and each other participant in Plan E to be no less than the greater of the vesting percentages under the two vesting schedules (for example, for Participant G and each other participant in Plan E to be 20% vested upon completion of 2 years of service and fully vested upon completion of 3 years of service) for the accrued benefit ($10,000). See Example 4 of Reg. Section 1.411(d)-3(a)(4).

Note: All post-amendment contributions (accruals) will vest under the new vesting schedule, as Participant G was 0% vested and only had one year of vesting service. See IRC Section 411(a)(10).

Audit tips

  1. What vesting schedule applies to benefits that have already accrued?
  2. Has the vesting schedule been changed?
  3. Have participants been notified of the change?
  4. Is the new vesting schedule more restrictive, at any time, than the old vesting schedule? If yes, does it apply to benefits that have already accrued?
  5. If 4 is “yes,” were participants with at least 3 years of service notified that they were permitted to remain under the old vesting schedule?
  6. If 5 is “yes,” did the period for electing to remain under the old schedule comply with the time period set forth in Reg. Section 1.411(a)-8(b)(2)? The election period must begin no later than the date the plan amendment is adopted and end no earlier than the latest of the following dates:
  7. The date which is 60 days after the day the plan amendment is adopted,
  8. The date which is 60 days after the day the plan amendment becomes effective, or
  9. The date which is 60 days after the day the participant is issued written notice of the plan amendment by the employer or plan administrator.
  10. If 6 is “yes,” did any participants elect to remain under the old vesting schedule?
  11. If 7 is “yes,” check the employee census data to ensure that vesting is calculated pursuant to the correct vesting schedule.