Rev. Rul. 60-33

Advice has been requested whether the accumulation of dividends earned on insurance and annuity contracts purchased by a trust under an employees' pension plan, in a case in which the employer pays the full premium charged by the insurer, will affect qualification of the plan under section 401(a) of the Internal Revenue Code of 1954, and whether such practice will affect the allowable deduction for the annual contribution by the employer under section 404(a) of the Code.

An employees' pension plan is funded by the use of a trust which purchases level annual premium retirement income and retirement annuity contracts. The employer pays the full premium charged by the insurer each year. Any dividends earned on these contracts are held by the insurer or the trustee, pursuant to the terms of the plan, and are to be applied to the premiums at some future date in the event the employer is unable to make all or part of the annual contribution necessary to pay the full premium. The earned dividends do not constitute a significant part of the fund. They can never revert to the employer, and they do not currently serve to reduce the premium charged by the insurer.

Section 1.404(a)-3(b) of the Income Tax Regulations provides, in effect, that the amount of deduction otherwise allowable for a taxable year shall be reduced by any decrease in liability which may arise from experience during the next preceding taxable year which is more favorable than that assumed in determining the costs. This decrease in liability is usually referred to as an actuarial gain. Further, any adjustment for such gain may be made in the current year, instead of the succeeding year, provided it is done consistently.

With respect to benefits funded under insurance and annuity contracts, a portion of the gain is accounted for by dividends, surrender values, cancellation credits, deferred retirement credits, and similar credits and returns which reduce the employer's cost. The subtraction of all such credits and returns in the current or succeeding taxable year from the unadjusted limit for that year is usually considered an adequate adjustment for gains.

It is clear from the foregoing that in determining the allowable deduction under section 404(a)(1) of the Code, the contract dividends, as well as any interest credited on accumulations thereof, must be used to reduce the current or the succeeding year's limitation, whichever method is consistently used.

The practice of contributing the full amount of annual premium without reduction for accumulated dividends and regardless of the amount of the allowable deduction limitation would result in the creation of a contingency or surplus reserve. If a significant part of a trust fund consists of such a contingency or surplus reserve, a plan's qualification under section 401(a) of the Code could be adversely affected. However, if the advance funding is minor in relation to the actuarial liability under a plan, if there is no possibility of the reversion of a substantial amount to the employer on termination of the plan, and if the advance funding is exclusively for the benefit of the employees or their beneficiaries, then such advance funding would not adversely affect qualification of the plan under section 401(a) of the Code.

Accordingly, it is held that the accumulation of dividends earned on insurance and annuity contracts held by a trust under an employees' pension plan, in a case in which the employer pays the full premium charged by the insurer, will not necessarily disqualify the plan under section 401(a) of the Code, but the deduction otherwise allowable for any taxable year, under section 404(a) of the Code, must be reduced by the amount of dividends earned, and interest credited on accumulations thereof, in the current or next preceding taxable year.