Rev. Rul. 74-397

Advice has been requested whether, under the circumstances described below, a plan qualifies under section 401(a) of the Internal Revenue Code of 1954.

An employer established a qualified integrated unit benefit pension plan covering all of his employees. The plan provided an annual retirement benefit for each participant, commencing at retirement age 65, in an amount equal to 11/4 percent of the first $4800 of average annual salary plus two percent of the excess over $4800 for each year of creditable service, but limited to 60 percent of such salary. Average annual salary was defined to mean the average annual compensation earned over the highest three consecutive years of service.

After the plan had been in existence for ten years and the full current costs had been funded, the employer amended it to eliminate the limitation on distributions in the event of early termination of the plan or discontinuance of contributions thereunder, which had originally been included in the plan as required by section 1.401-4(c) of the Income Tax Regulations. Later the employer amended the plan to provide a normal retirement benefit of two percent of the average annual salary for each year of creditable service with the 60 percent maximum remaining. The employer did not include the restrictions contained in section 1.401-4(c) of the regulations in the amended plan.

The amendment will increase the annual benefits of employees who are not limited by the 60 percent maximum by $36 for each year of creditable service. The benefits for all but four of the 25 highest paid employees at the time of the amendment were already limited by the 60 percent maximum. Also, a large number of the lower-paid employees were nearer to retirement than the four highly-paid employees who were not already entitled to the maximum percentage allowed under the plan.

Section 401(a) of the Code sets out the requirements for the qualification of employees' pension plans. Section 401(a)(4) provides that the contributions or benefits under a plan must not discriminate in favor of employees who are officers, shareholders, supervisors, or highly compensated.

Section 1.401-4(c)(1) of the regulations provides that, although a qualified plan may provide for termination at will by the employer or discontinuance of contributions thereunder, this will not of itself prevent a trust from being a qualified trust. However, a qualified pension plan must expressly incorporate provisions which comply with the restrictions contained in section 1.401-4(c)(2). That subparagraph limits amounts that may be distributed to an employee who was among the 25 highest paid employees of the employer at the time the plan was established and whose anticipated annual pension under the plan will exceed $1,500, if (1) the plan is terminated within 10 years after its establishment, or (2) the benefits of such employee become payable within 10 years after establishment of the plan or (3) the benefits of such employee become payable after the plan has been in effect for 10 years and the full current costs of the plan for the first 10 years have not been funded.

Section 1.401-4(c)(5) of the regulations provides that if a plan has been changed so as to increase substantially the extent of possible discrimination as to contributions and as to benefits actually payable in event of the subsequent termination of the plan or the subsequent discontinuance of contributions thereunder, then the provision of section 1.401-4(c) shall be applied to the plan as so changed as if it were a new plan established on the date of such change.

In this case the amendment will affect the expected benefits of only four of the 25 highest-paid employees and will provide an increase that is proportionately greater for low-paid employees than for the four high-paid employees than for the four high-paid employees if all eligible employees actually receive the increased benefits. Furthermore, since a large number of the lower-paid employees are nearer to retirement than the four highly-paid employees who are not already entitled to the maximum plan benefit, discrimination in favor of highly-paid employees is unlikely in the event of termination of the plan, either before or after the four highly-paid employees have retired. Hence, the plan has not been changed so as to increase substantially the extent of possible discrimination for the purposes of section 1.401-4(c)(5) of the regulations.

Accordingly, the plan, as amended, still qualifies under section 401(a) of the Code.