Compliance January 17, 2017

Proposal Would Amend QNEC, QMAC Definitions

Commenters expressed concerns that the current definitions would preclude them from using forfeiture accounts to fund the contributions.
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The Internal Revenue Service (IRS) is proposing amendments to the definitions of qualified matching contributions (QMACs) and qualified nonelective contributions (QNECs) under regulations relating to certain qualified retirement plans that contain cash or deferred arrangements under Section 401(k) of the Employee Retirement Income Security Act (ERISA) or that provide for matching contributions or employee contributions under Section 401(m).

Under the proposed regulations, employer contributions to a plan would be able to qualify as QMACs or QNECs if they satisfy applicable nonforfeitability and distribution requirements at the time they are allocated to participants’ accounts, but need not meet these requirements when they are contributed to the plan.

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The IRS explained that it has received comments with respect to the definitions of QMACs and QNECs in Sections 1.401(k)-6 and 1.401(m)-5 of ERISA. In particular, commenters assert that employer contributions should be able to qualify as QMACs and QNECs as long as they satisfy applicable nonforfeitability and distribution requirements at the time they are allocated to participants’ accounts, rather than when they are first contributed to the plan.

Commenters contend that interpreting sections 401(k)(3)(D)(ii) and 401(m)(4)(C) to require satisfaction of applicable nonforfeitability and distribution requirements at the time amounts are first contributed to the plan would preclude plan sponsors with plans that permit the use of amounts in plan forfeiture accounts to offset future employer contributions under the plan from applying such amounts to fund QMACs and QNECs. This is because the amounts would have been allocated to the forfeiture accounts only after a participant incurred a forfeiture of benefits and, thus, generally would have been subject to a vesting schedule when they were first contributed to the plan.

Commenters have requested that QMAC and QNEC requirements not be interpreted to prevent the use of plan forfeitures to fund QMACs and QNECs. 

NEXT: Proposed changes

After consideration of the comments the Treasury Department and the IRS are proposing to amend Section 1.401(k)-6 to provide that amounts used to fund QMACs and QNECs must be nonforfeitable and subject to distribution restrictions in accordance with Section 1.401(k)-1(c) and (d) when allocated to participants’ accounts, and to no longer require that amounts used to fund QMACs and QNECs satisfy the nonforfeitability and distribution requirements when they are first contributed to the plan. The agencies note that while the second sentence of each of the current definitions of QMACs and QNECs refers to the “vesting” requirements of Section 1.401(k)-1(c), those requirements are more appropriately characterized as “nonforfeitability” requirements consistent with Section 401(k)(2)(C) and the title of Section 1.401(k)-1(c). 

Accordingly, these proposed regulations would amend these definitions to clarify those references by replacing the word “vesting” with “nonforfeitability” in each definition; these changes are not otherwise intended to have any substantive impact on this or any other section of the regulations. 

These proposed regulations would also amend the definitions of QMACs and QNECs in Section 1.401(m)-5 to provide cross-references to the definitions of QMACs and QNECs under Section 1.401(k)-6. The amendments to Section 1.401(m)-5 are being made to ensure a consistent definition of QMACs and QNECs in both sections.

The IRS is requesting comments about the proposed changes. Information about how to comment is in the proposal.
Compliance January 17, 2017

PBGC Monitors Actions That Can Signal DB Plan Distress

On an updated web page, the agency lists transactions, events, or trends that may be of concern.
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An important aspect of the pension preservation mission of the Pension Benefit Guaranty Corporation (PBGC) is its Early Warning Program (EWP) for single-employer defined benefit (DB) plans.

In an updated page on its website, PBGC says its experience under the EWP is that it can avoid terminating a plan by working with the plan sponsor to obtain protections before a business transaction significantly increases the risk of loss.

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PBGC regularly monitors corporate transactions, events, or trends that could affect a plan sponsor’s ability to continue to support its DB plan. The agency internally identifies about 300 transactions, events, or trends each year that are potentially of concern and engages the plan sponsors to obtain additional information. It assesses the impact of these situations based on each employer’s financial and operational ability to support its pension promises. PBGC may follow this initial inquiry with a more in-depth review. Its engagement with these companies averages about 100 early warning cases each year.

Transactions, events, or trends that may be of concern include:

  • A change in the group of companies legally responsible for supporting a pension plan (a controlled group), including a spin-off of a subsidiary – When a controlled group is split up, a plan may remain with or be transferred to a financially weaker sponsor or a sponsor made weaker by separation from the controlled group. A transfer of significantly underfunded pension liabilities related to the sale of a business. As in the case of a controlled group breakup, a plan may be left with or transferred to a weaker sponsor or controlled group.
  • A major divestiture by an employer that retains significantly underfunded pension liabilities – Remaining business entities may not generate sufficient revenue to be able to afford the plan.
  • A leveraged buyout involving the purchase of a company using a large amount of secured debt – The sponsor’s debt service requirements may make it difficult for the firm to afford to maintain its pension plan; risk of loss to participants and PBGC’s premium payers is then greater. In a leveraged buyout, this risk is magnified because the new debt is secured by company assets, which have priority over unsecured obligations such as pension funding obligations and PBGC’s claim for underfunding.
  • A substitution of secured debt for a significant amount of unsecured debt – Lender requirements for secured debt may signal that the sponsor is facing challenges that could put plan funding at risk.  Additionally, in the event of bankruptcy, secured debt reduces PBGC recoveries on claims for unpaid pension contributions and unfunded pension liabilities.
  • The payment of a very large dividend to shareholders – A plan sponsor that uses its free cash flow or debt proceeds to pay substantial dividends or buy back its own stock may not leave itself with sufficient resources to fund its pension plan.
  • Significant credit deterioration – Downgrading of a plan sponsor’s credit ratings could signal that the sponsor is, or is becoming, unable to support the plan.
  • A downward trend in cash flow or other financial factors – Declining cash flow could signal that the sponsor is becoming unable to support the plan.

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