Rev. Rul. 56-656

Advice has been requested whether an employees' profit-sharing plan will meet the requirements of section 401(a) of the Internal Revenue Code of 1954 if it contains a provision permitting a participant to irrevocably elect, prior to retirement, to have all or a part of his nonforfeitable interest in the plan, which would otherwise become available to him during his lifetime, paid only to his designated beneficiary after his death.

The employer corporation adopted a profit-sharing plan for the benefit of its employees. Under the provisions of the plan, a participant acquires a vested interest in his proportionate interest in the trust fund according to the number of years of his service. After a stated number of years of continuous participation, the entire amount of his proportionate interest in the fund is fully vested. A participant may not receive benefit payments from the trust except upon discontinuance or termination of the plan, or upon retirement, death, or total incapacity of the participant, or upon his termination of service, and then only to the extent that his interest in the trust fund is nonforfeitable and fully vested. The normal retirement date under the plan is age 65, although a participant may remain in the employ of the corporation and continue to participate in the plan until he is 70 years of age.

Provision is made in the plan that a participant may, within two years prior to his normal retirement date, irrevocably elect that all or a part of his nonforfeitable interest in the trust fund, which would otherwise become available to him during his lifetime, shall be paid to his designated beneficiary after his death.

Section 1.401-1(b)(1)(ii) of the Income Tax Regulations defines an employees' profit-sharing plan, which may qualify, as a plan established and maintained by an employer to provide for the participation in his profits, by his employees or their beneficiaries, based on a definite predetermined formula for allocating the contributions made to the plan among the participants and for distributing the funds accumulated under the plan after a fixed number of years, the attainment of a stated age, or upon the prior occurrence of some event such as layoff, illness, disability, retirement, death, or severance of employment.

It is believed that the requirement in the regulations that the funds be distributed after a fixed number of years, or the attainment of a stated age, was intended to mean `distributed to the employee.' Payments to others should be merely incidental as, for example, in a joint and survivor annuity contract, or where an unused balance in the account of the employee is paid to a beneficiary upon the death of the employee.

Under the provision in the profit-sharing plan permitting deferment of benefits until after death, it is possible for an employee to elect to have a beneficiary receive the entire amount standing to his account. This is not a benefit within the intendment of a qualified profit-sharing plan under section 401.

Accordingly, it is held that an employee's profit-sharing plan which contains a provision permitting a participant to irrevocably elect, prior to retirement, to have all or a part of his nonforfeitable interest in the plan, which would otherwise become available to him during his lifetime, paid to his designated beneficiary after his death, will fail to meet the requirements of section 401(a) of the Code for exemption from tax under section 501(a) of the Code. It is also held that the above principles are equally applicable to employees' pension or stock bonus plans. See subparagraphs (i) and (iii) of section 1.401-1(b)(1) of the Income Tax Regulations.