EP Examination Process Guide - Section 2 - Compliance Monitoring Procedures - Top Ten Issues - Defined Benefit Plans


Top ten issues identified during examinations of defined benefit plans.

1. Minimum Funding

Internal Revenue Code Section 412 violation - funding deficiency

Plans subject to Internal Revenue Code Section 412 minimum funding requirements are failing to receive contributions necessary to satisfy this code section. The results of plan examinations have determined that one reason for this failure is that not all eligible employees were being included in the plan which led to improper funding calculations. It was also determined that, in some cases, compensation was being included for funding purposes that should have been included in a subsequent or prior year. In addition, participating employers responsible for the excise taxes that result are not filing the appropriate excise tax return (Forms 5330) and/or paying the tax.

Delinquent/late contributions

Plans subject to Internal Revenue Code Section 412 minimum funding requirements are failing to receive contributions by certain dates necessary to satisfy this code section. When the plan receives these contributions late (see IRC 412(c)(10)), there are consequences which can include excise taxes being assessed under IRC 4971, and/or deductions being disallowed on the employer's tax return.

2. Inadequate or No Fidelity Bond

Plans are required to have a fidelity bond equal to at least 10% of the most current handled assets (DOL Regs. 2580.412-11). The maximum bond required is $500,000. Effective for plan years beginning after December 31, 2007, the fidelity bond maximum is increased from $500,000 to $1 million for plans holding employer securities. No deductible is allowed in the bond and it must be in the name of the plan or trust (not the employer) or the bond must specifically state that the plan or plans (by name) are covered and that the general bond deductible doesn't apply per ERISA requirements.

3. Vesting or Benefit Accruals

Internal Revenue Code Section 411 violations including cash-out/forfeitures from lost participants, wrong vesting schedule used, and error in vesting percentages

Every plan is required to have provisions regarding how participants are vested in their benefits. Normally, the percentage a participant is vested is dependent on their credited service. If employers and/or union do not track a participant's service correctly, the vesting percentage could be incorrect.

Errors that have been cited include the following:

  • Erroneous cash-outs and forfeitures,
  • Wrong vesting schedules being used, and
  • Errors when calculating a participant's vesting percentage.

4. Prohibited Transactions

Loans are being made out of plans that don't provide for them. In addition, loans are being made to people considered to be disqualified under IRC 4975. A specific trouble area relates to loans being made to HCEs that violate one or more of the exemptions listed under 4975(d). There are also 72(p) violations due to the original excessive length and/or amount of the loan exceeding either 72(p) or plan requirements. IRC 72(p) violations are also being found in relation to the failure to meet the level amortization requirements which require that payments be made at least quarterly.

5. Participation/Coverage

Plans are failing to meet the testing requirements of section 410(b) due to the fact that they are not following the participation entry requirements of the plan and law which is resulting in the late entry of employees who must be included for testing purposes.

6. Discrimination of Contributions/Benefits

Plan did not make required actuarial adjustments for benefit payments beginning after Normal Retirement Date

The required actuarial adjustments or interest adjusted back payments are not being paid to participants whose retirement benefits first commence after the Normal Retirement Date as stipulated in the plan. This issue tends to be more prevalent when plans have normal retirement ages that are less than 65 because many participants are unaware of their eligibility to receive these benefits at this earlier age and thus fail to apply for their benefits.

Errors made in benefit calculations, crediting service, reduction factors, general administration

Errors are made when participant benefits are calculated. The following reasons for these mistakes have been identified:

  • Benefit provisions in the plan are misapplied,
  • Applicable law is not understood,
  • Faulty participant data is used and/or provided (by employer and/or union), or
  • Combinations of above.

7. Deductions (Including Actuarial)

Contributions are not being made timely due to the fact that they aren't meeting the following: Deductions are deemed timely paid on the last day of the preceding taxable year if the payment is on account of such taxable year and is not made later than the time prescribed by law for filing the return for such taxable year (including extensions). Negative consequences, as outlined in item 1 above, can result.

Excess contributions are being made

Basically, the maximum amount, that can be contributed to a defined benefit plan, is:

  • The amount necessary to meet the 412(a) minimum funding requirements;
  • The amount necessary to provide all employees under the trust the remaining unfunded cost of their past and current service credits distributed as a level amount, or a level percentage of compensation, over the remaining future service of each such employee;
  • An amount equal to the normal cost of the plan plus, if past service is provided, an amount necessary to amortize those unfunded costs over 10 years.

8. Non/Late Amender

Examinations have revealed the presence of late amenders for TRA 86 (12-31-94), GUST and EGTRRA. For GUST and EGTRRA, the remedial amendment period can be as late as 1-31-04 (see Rev. Proc. 2003-72 for details). Generally it is 2-28-02. With the proper adoption of a Master & Prototype (M&P) it would be the later of 9-30-03 or the end of the twelfth month following the issuance of the Favorable Determination Letter (FDL) for the M&P adopted (actually the end of the twelfth month following the issuance of any FDL issued for a M&P of that particular sponsor). Keep in mind, in reference to 401(a)(9) final regulations, that with the delay of the finalization of 1.401(a)(9)-6, Revenue Procedure 2003-10 provided that Defined Benefit Plans are not required to be amended until calendar years beginning after 12-31-2005 provided that they follow either the 1987 Proposed Regulations, the 2001 Proposed Regulations or the 2002 Final and Temporary Regulations. However, an employer can choose to apply the final 1.401(a)(9)-6 regulations, published on 6-15-2004 to their Defined Benefit Plan for the 2003, 2004, or 2005 calendar years.

9. Required Distributions

Internal Revenue Code Section 401(a)(9) violation (required minimum distributions)

Because administrators typically rely on participants to apply for benefits before addressing such issues, the required minimum distribution requirements of Internal Revenue Code 401(a)(9) are not being met. Specifically many plans have failed to make required distributions to participants by the first of April following the later of the year he/she turns 70 ½ or the calendar year in which he/she retires. In addition, when participants die the rules governing the timing of such distributions to their beneficiaries are not being followed.

Note: The SECURE Act deferred the age 70 ½ requirement to age 72, for participants turning age 70 ½ after December 31, 2019.

10. Joint and Survivor Annuity

Internal Revenue Code Section 417 violations including spousal consent, QJ&S application, joint and survivor annuity adjustment when the non-spouse beneficiary is more than 10 years younger than the employee, and QDRO.

This issue deals with the specific rules affecting married participants who are approaching retirement and/or are ready to commence receiving benefits who elect to receive their benefit in a form other than the Qualified Joint & Survivor Annuity.

Note: The IRS has a system of correction programs for sponsors of retirement plans, including defined benefit plans, which are intended to satisfy Internal Revenue Code requirements but have not met the requirements for a period of time. This system, the Employee Plans Compliance Resolution System (EPCRS), permits employers to correct plan failures and thereby continue to provide their employees with retirement benefits on a tax-favored basis.