Rev. Rul. 74-254

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

An employer established a noncontributory money purchase plan that permits distributions to be made to participants, to the extent their rights have vested, when they are transferred to job locations outside the area covered by the plan and, for that reason, become ineligible to participate in the plan. These participants are not considered to have terminated their service upon transfer and have no control as to the time and place of transfer.

Section 401(a) of the Code prescribes the requirements which must be met for qualification of a pension, profit-sharing, or stock bonus plan.

Section 1.401-1(b)(1)(i) of the Income Tax Regulations provides that a pension plan, within the meaning of section 401(a) of the Code, is a plan established and maintained by an employer primarily to provide systematically for the payment of definitely determinable benefits to his employees over a period of years, usually for life, after retirement. The regulations provide further, however, that a plan is not a pension plan if it provides for the payment of benefits not customarily included in a pension plan such as layoff benefits or benefits for sickness, accident, hospitalization, or medical expenses, except as described in section 401(h).

Disability and death benefits, although incidental to the primary purpose of providing benefits after normal retirement, are essentially a form of "retirement" benefits, since they are payable upon severance or termination of employment. Contingencies such as layoff, sickness, and accident generally do not involve a termination of employment, and payments for such contingencies from a qualified pension plan are prohibited by section 1.401-1(b)(1)(i) of the regulations.

Revenue Ruling 56-693, 1956-2 C.B. 282, as modified by Rev. Rul. 60-323, 1960-2 C.B. 148, holds that a pension plan fails to meet the requirements for qualification under section 401(a) of the Code if it permits employees to withdraw prior to normal retirement any part of the funds accumulated on their behalf which consist of employer contributions or increments thereon prior to the severance of employment or the termination of the plan. That Revenue Ruling deals with a situation in which withdrawals are at the option of, or subject to the control of, the employee and does not deal with the case in which an employee is being dropped from participation in the plan under conditions beyond his control.

In Revenue Ruling 56-213, 1956-1 C.B. 194, employees were dropped from participation under a qualified employees' retirement plan if they no longer met the minimum work period requirements or if they terminated their employment, and their vested interests under the plan could then be paid as an immediate annuity or cash settlement. Furthermore, such employees were later reinstated as participants in the plan upon meeting the minimum work period requirements or being reemployed. The Revenue Ruling holds that the qualification of the plan will not be adversely affected provided the terms of the plan are uniformly applied and the full actuarial equivalent of the amount already vested in the participant is deducted from the amount of pension or other settlement to be paid under the plan as a result of the service rendered after the reinstatement of the participants.

The primary holding in Rev. Rul. 56-213 deals with the conditions under which employees may be reinstated as participants in a qualified plan where they have received a distribution under the plan. However, the circumstances that rendered the employee ineligible to continue his participation in the plan were similar to those in this case and, as in this case, were beyond his control.

In this case, as well as in the plan underlying Rev. Rul. 56-213, the payment of an annuity or lump-sum distribution from employer contributions or increments thereon when an employee ceases his plan participation but continues his employment, is analogous to payments for contingencies such as layoff, sickness, and accident and does not satisfy the requirements of section 1.401-1(b)(1)(i) of the regulations. Therefore, a pension plan does not qualify if it permits distributions prior to normal retirement and prior to termination of employment or termination of the plan, and this requirement does not depend on whether withdrawals of employer contributions are at the discretion of the employee.

Accordingly, this plan does not qualify as a pension plan under section 401(a) of the Code since it permits distributions to be made to participants prior to normal retirement and prior to their termination of employment or the termination of the plan.

Rev. Rul. 56-213, 1956-1 C.B. 194, is hereby modified to remove therefrom the holding that the qualification of a pension plan is not adversely affected where it provides that a participant may receive his vested account balance in the form of an immediate annuity or cash settlement upon becoming ineligible to participate in the plan prior to his terminating employment or the plan being terminated.