Rev. Rul. 78-223

Section 1. Purpose

This Revenue Ruling provides rules concerning (a) determination of the required amount of contributions to a defined contribution pension plan for plan years following the plan year in which the minimum funding requirements are waived pursuant to section 412(d) of the Internal Revenue Code of 1954 and section 303 of the Employee Retirement Income Security Act of 1974 (ERISA), Pub.L. 93-406, 1974-3 C.B. 1, and (b) the allocation of waiver payments, which are the amortization amounts described in section 412(b)(2)(C) of the Code or section 302(b)(2)(C) of ERISA. This Revenue Ruling applies only until regulations on this subject are effective. The rules contained in this Revenue Ruling do not apply to multi-employer plans within the meaning of section 414(f) of the Code. However, similar principles apply for such plans.

Sec. 2. Background Information

.01 A defined contribution plan, described in section 412(a) of the Code, is subject to the minimum funding requirements of section 412 of the Code.

.02 A defined contribution plan, described in section 301 of ERISA, must satisfy the minimum funding requirements of section 302 of ERISA.

.03 Section 412(d) of the Code and section 303 of ERISA permit the Internal Revenue Service to waive, subject to certain limitations, the minimum funding requirements.

Sec. 3. General Rules

The following rules apply to a defined contribution plan for which the minimum funding requirement for a particular plan year has been waived in whole or in part. These rules are applicable until the total plan assets equal the sum of the adjusted account balances (described below).

.01 Adjusted Account Balances.--When the minimum funding requirement is waived in whole or in part with respect to a plan year under a defined contribution pension plan, those participants who would otherwise have received greater allocations to their individual accounts under the plan (hereafter referred to as "affected participants") must be, to the extent reasonably possible, restored to the position in which they would have been had the waived amount been contributed. There are several methods which satisfy this requirement. Each of the methods requires the maintenance of an adjusted account balance for each participant. The adjusted account balance is the account balance that a participant would have had, had the waived amount been contributed. The methods differ in the manner in which the adjusted account balance is computed. The plan must specify the method to be used. Two acceptable methods are described below.

Under one acceptable method, the actual yield method, the adjusted account balance is increased or decreased periodically at the actual rate of investment return experienced by the plan for such period. This method probably best approximates what the account balance would have been had the waived amount been contributed. Under this method, however, the employer assumes the investment risk of funding for the actual investment experience. If the fund has a high yield, the employer must fund more than if there is a low yield.

Under a second acceptable method, the 5% method, the excess of each affected participant's adjusted account balance over such participant's actual account balance is credited at a fixed rate of interest not less than 5% compounded annually. Although this method is more approximate than the actual yield method, this method is simpler. Furthermore, unlike the actual yield method, it provides a known level of costs.

.02 Waiver Payments.--The plan must specify how the amounts necessary to amortize the waived funding deficiency (the waiver payments) are to be determined. The waiver payments so specified should provide for an amortization of the waived funding deficiency over 15 years by level payments. A plan will not fail to satisfy the definitely determinable requirement described in section 1.401-1(b)(1)(i) of the Income Tax Regulations merely because such plan permits discretionary larger contributions, not to exceed the amount needed to make the sum of the account balances equal to the sum of the adjusted account balances. Furthermore, such larger contributions are currently deductible under section 404(a)(1) of the Code if the plan is qualified.

The interest rate used to determine the amortization schedule must be reasonable. The reasonableness of such interest rate depends on the method of determining the adjusted account balances under subsection .01.

If the actual yield method described in subsection .01 is used, the interest rate should be the best estimate of future investment experience. Unless the alternative method described in subsection .04 is used, the effect of deviations between the assumed interest rate and the actual investment yield are treated as experience gains or losses under subsection .03.

If the 5% method described in subsection .01 is used, the interest rate used to amortize the waived funding deficiency should be the same interest rate used to credit the excess of the adjusted account balances over the actual account balances. .03 Experience Gains or Losses.--Under the minimum funding standards, except to the extent that a plan is fully funded, experience gains or losses are to be amortized over 15 years rather than immediately and totally applied. Generally, in a defined contribution plan where forfeitures are not anticipated, a forfeiture is an experience gain. In a defined contribution plan that is fully funded, the effect of the full funding limitation is that such forfeitures immediately and totally reduce the required contribution. However, because a defined contribution plan for which a waiver is granted is not fully funded, only a 15-year amortization of such forfeitures may be applied to reduce the required contribution. The interest rate used to amortize experience gains or losses must be the same interest rate used in subsection .02. A plan for which a waiver is granted must specify the treatment of forfeitures.

.04 Alternative Computation of Waiver Payments and Experience Gains or Losses.--In lieu of the separate amortization of the items described in subsections .02 and .03, the following method may be used. In the year after the waiver is granted, the waiver payment adjusted for experience gains or losses equals the amount necessary to amortize over 15 years the excess of the sum of the adjusted account balances over the total plan assets. The interest rate used to determine the amortization must be the same rate that would be used under subsection .02 if subsection .02 applied. In the next year the excess for such subsequent year, if any, is amortized over 14 years. In each succeeding year the amortization period is reduced by one year. No other adjustments to the required contribution are made to take account of experience gains or losses.

.05 Interim Benefits/Allocation.--The plan must specify what benefit payments are available to participants before the total plan assets equal the sum of the adjusted account balances. There are many possible methods that may be employed to satisfy this subsection. Any method must not only define the benefits payable to participants but also include a mechanism for allocating the waiver payments (adjusted for experience gains or losses) to participants. Such method must be consistent with the benefit payout provisions. Paragraphs (1), (2), and (3) provide methods which satisfy this subsection. Paragraph (4) analyzes them. These methods are not an exclusive list of all possible methods. Furthermore, some of the methods may (a) not be appropriate in all cases or (b) be discriminatory within the meaning of section 401(a)(4) of the Code in certain situations:

(1) Immediate Allocation Method.--Under this method waiver payments adjusted for experience gains or losses are allocated immediately to the actual account balances of affected participants. The adjusted account balance of each affected participant may exceed that participant's actual account balance. The plan's distribution provisions limit the distribution of the nonforfeitable portion of the adjusted account balance to the actual account balance. Thus some affected participants may not be able to receive a total distribution of the nonforfeitable portion of their entire account balances; such participants would receive subsequent distributions derived from future waiver payments adjusted for experience gains or losses.

(2) Suspense Account Method.--Under this method, waiver payments adjusted for experience gains or losses are credited immediately to a suspense account. The adjusted account balance of each affected participant may exceed that participant's actual account balance. The plan provides that if the nonforfeitable portion of the participant's adjusted account balance exceeds that participant's actual account balance at the time of distribution, that participant will receive the largest amount to the extent that there are then funds in the unallocated suspense account to cover the excess. Thus some affected participants may not be able to receive a total distribution of the nonforfeitable portion of their entire adjusted account balances; such participants would receive subsequent distributions derived from future waiver payments adjusted for experience gains or losses. When the total plan assets equal the sum of the adjusted account balances, the suspense account is allocated to the affected participants so that the actual account balance of each affected participant equals that participant's adjusted account balance.

(3) Unrestricted Distribution Method.--Under this method, the waiver payments adjusted for experience gains or losses become part of the plan's general assets, and actual account balances are not maintained. When a participant is entitled to a distribution, that participant receives the entire nonforfeitable portion of that participant's adjusted account balance to the extent that the plan's assets are sufficient to make the payment. Thus some participants may not be able to receive a total distribution of the nonforfeitable portion of their entire adjusted account balances; such participants would receive subsequent distributions derived from future waiver payments adjusted for experience gains or losses.

(4) Analysis of Above Methods.--In deciding on a method to satisfy this subsection, two fundamental concerns are: the claim that each participant has to the plan assets, and the desire to have a minimal effect on the normal distribution rules of the plan.

Under the Immediate Allocation Method, each participant will receive precisely what that participant is entitled to. However, this method is the most disruptive to the plan's normal distribution rules (because an affected participant might not receive his entire adjusted account balance before the total plan assets equal the sum of the adjusted account balances).

Under the Suspense Account Method, distributions are not disrupted as much as under the Immediate Allocation Method, but those affected participants who are first entitled to distributions may deplete the suspense account so that other affected participants may not benefit from the waiver payments adjusted for experience gains or losses should the plan terminate.

Under the Unrestricted Distribution Method, the normal distribution provisions of the plan are virtually unaffected. However, this method may deplete the plan assets of all participants whether or not they are affected participants. In the event of a subsequent termination of the plan, certain participants may suffer as a result of this method. Accordingly, this method may not be acceptable unless there is a showing that such subsequent plan termination is extremely unlikely.