As you are no doubt aware, this Committee will shortly begin hearings on bills dealing with minimun standards for private pension plans. In the course of those hearings, members of this Committee will want to know the status of current requirements of vesting and funding under the Internal Revenue Code and regulations. Accordingly, I would appreciate it if you would confirm or correct my present understanding of the requirements imposed by the I.R.S., which are as follows: A. FUNDING It is my understanding that the Treasury, as part of the statutory requirement of "permanency" under Code section 401, generally requires that a pension fund receive contributions sufficier to cover current service costs, plus an amount equal to interest on any unfunded past service liability; but it is also my understanding that this funding requirement is merely a general standard, and need not be met in any particular year. It is also my understanding that there is an upper limit for contributions (I believe this is in the neighborhood of 10% of unfunded past service liabilities). Could you please inform me (1) whether my understanding, as set forth above, is correct, (2) if not, what corrections should be made, and (3) in any event, what is the authority (a) in the Code, (b) in the Treasury Regulations, and (3) in currently applicable Revenue Rulings, for the funding requirements and limits which are now in force? B. VESTING It is my understanding that as a general matter the Treasury does not require vesting in private pension plans qualified under section 401, except that (1) benefits must vest when the employee actually retires, and (2) there may be vesting requirements imposed by the Treasury upon small businesses where the work force is of such a nature that, without vesting, the plan would automatically discriminate in favor or higher-paid or owner-operator employees, in violation of 401. Isadore Goodman -2 June 8, 1972 Again, could you confirm or correct my understanding, as expressed above, and also cite me to the applicable provisions of the Code, Regulations, and Revenue Rulings? Many thanks for your help. With best wishes, Sincerely, foule Frank Cummings Minority General Counsel Mr. Isadore Goodman Chief, Pension Trust Branch Internal Revenue Service United States Department of the Treasury 82-079 072 pt. 3 - 2 In your letter of June 8, 1972, you request our confirmation of, or statements in regard to, your understanding relative to funding and vesting requirements for qualified private pension plans under the current provisions of the Internal Revenue Code of 1954 and the Income Tax Regulations thereunder. Such Your understanding of the requirements for adequate funding of pension plans is substantially in accord with existing rules if it recognizes that any suspension of contributions to such a plan may ripen into a discontinuance, if it affects the benefits to be paid or made available under the plan or if it permits the unfunded past service costs to exceed the unfunded past service costs as of the establishment of the plan, plus any additional past service or supplemental costs added by amendment. a discontinuance would require that employees' interests, to the extent then funded, be made nonforfeitable. See Revenue Ruling 56-596, C.B. 1956-2, 288. The upper limit for contributions of ten percent is basically a deduction limit, but does not limit the amount that may be contributed, and is one of several limits applicable to deductions. There is also a provision for carrying over to a subsequent year a contribution in excess of the deduction limit in the taxable year. See section 404(a)(1)(A), (B), (C), and (D) of the Code. In regard to the second area set forth in your letter, namely vesting requirements, section 401(a)(7) of the Code requires that upon termination of a plan, or complete discontinuance of contributions, the rights of all employees to benefits accrued to the date of such termination or discontinuance, to the extent then funded, or to the amounts - 2 Frank Cummings credited to the employees' accounts, must be nonforfeitable. In addition, section 401(a)(2)(A) of the Code requires that employees must have nonforfeitable rights to or derived from contributions at the time of contribution, where a qualified pension or profit-sharing plan provides contributions or benefits for owner-employees. In other situations, vesting is not required prior to attainment of normal retirement age and completion of the service and reasonable requirements set forth in the plan. See Rev. Rul. 68-302, C.B. 1968-1, 163. Furthermore, the vesting provisions in a plan must not result in prohibited discrimination. See Rev. Rul. 71-151, C.B. 1971-1, 123. Thus, as you mention, adequate vesting or other additional provisions may be necessary where the work force is such that, without such provisions, the plan will automatically discriminate in favor of employees in whose favor discrimination is prohibited. See Rev. Rul. 71-263, C.B. 1971-1, 125, for an example of such a situation. I hope that the above information has been of help to you. I am also enclosing a copy of I.R.S. Publication 778 dealing with guides for qualification of pension, profitsharing, and stock bonus plans. Note in particular the discussion of vested rights in Part 5(c) on page 17, and discontinuance or suspension of contributions or curtailments in Part 6(a) on pages 21 and 22. If I can be of further assistance please feel free to call on me. Sincerely yours, Enclosures Chief, ension Trust Branch Mr. CUMMINGS. Finally, Mr. Willis, you show on your table in the back of your testimony that the current average of supplements as a percent of wages is 13 percent of base wages. Are you familiar at all with the recent ruling of the Pay Board as to what a new employer is permitted to use as a base for setting up fringe benefit package? Mr. WILLIS. I have forgotten the figure. Mr. CUMMINGS. Perhaps Mr. Melgard is aware of that. Mr. MELGARD. I do not recall. Mr. CUMMINGS. Does this 13 percent represent an average industry. wide, including most people who have no pension plan at all or no other benefit plans at all, or is it just an average of those who have fringe benefit plans? Mr. WILLIS. This is an across-the-board figure. Mr. MELGARD. These figures were taken from the National Income Statistics which have been published by the U.S. Department of Commerce since 1929. They are across the board. I might point out that supplements to corporate wages and salaries are estimated to be about 60 percent of the cost of what are commonly considered employee benefits. The remaining 40 percent include items like paid vacation, paid holiday, paid sick leave, paid rest period. Mr. CUMMINGS. These are fringe benefits-supplements? Mr. MELGARD. This 40 percent of the costs for these benefits covers pay for time not worked. Mr. CUMMINGS. Would you favor a standard permitting a newly established employer to use a maximum base of either 5 or 7 percent of base wages? The Pay Board's limit of 5.5 percent of base wages is well below the standard, I think, and might be characterized as substandard? Mr. WILLIS. That is the increase in benefits, is it not? Mr. CUMMINGS. If a new employer that did not exist at all goes into business and wants to set up fringe benefit package today, my understanding is that he is limited, depending upon interpretations of PB 51, to something like 5.5 percent of base wages. Mr. WILLIS. They are on up to 7 percent now, more in line. I think probably as a starting employer, that is about all he can afford to start out with in this particular fringe benefit area, recognizing that vacations, holidays, and things of that sort are not in this figure nor in the percentage figure. Mr. CUMMINGS. Do you think that percentage is an adequate percentage? Mr. WILLIS. As a starter, it is probably all right. Ultimately as a going figure, it is low. Mr. CUMMINGS. You would not be able to compete with GE on the basis of 5 percent. Mr. WILLIS. He would probably sell his products pretty much lower. I think as a longrun operation, obviously 512 to 7 percent would be low, but as a one year thing, and then moving on it probably would work out. Mr. CUMMINGS. As to reinsurance, you say that you would oppose the application of this concept because, as you said on page 8, it insures assets which are not there. In other words, it insures a contingency which is not funded Mr. WILLIS. That is right. |