PLR 1349029: Transfers between disability and defined contribution plans are not taxable events

Plain-English summary

A state government maintained a defined benefit plan and a defined contribution plan for its employees. Under proposed disability procedures, a participant who became totally and permanently disabled would transfer the participant's account balance from the defined contribution plan to the defined benefit trust, and a later recovery could trigger a transfer back. The IRS ruled that these transfers would not be subject to Section 414(k), would not create taxable distributions or additional taxes under Sections 72(t), 401(k), 402, or 404, and would not create constructive receipt. The transfers also would not affect the participant's annual benefit limit under Section 415(b) or annual addition limit under Section 415(c). The ruling addressed only the requested facts and conclusions.

Ruling snapshot

• Question: Would transfers between the state's defined benefit and defined contribution plans on disability and recovery cause tax, constructive receipt, or changes to Section 415 limits?
• Outcome: Approved. The requested transfers receive the stated non-tax treatment and do not affect the Section 415(b) or 415(c) calculations.
• Key authorities: IRC §§ 72(t), 401(k), 402, 404, 414(k), 415(b), 415(c), and 4974(c); Rev. Rul. 67-213, 1967-2 C.B. 149

Full text (IRS public release)

Significant IndeX Nos. 72.20-00; 401.29-00; 402.00-00; 404.00.00; 415.00-00

\
DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE

WASHINGTON, D.C. 20224 201349029
TAX EXEMPT AND AUG 27 2013

GOVERNMENT ENTITIES
DIVISION

[illegible]

Taxpayer =

DB Plan =
DC Plan =

State = -
Dear —

This letter is in response to your request of June 5, 2003, as modified by your letters
of March 15, 2005, and June 20, 2008, for rulings concerning the federal tax
consequences of certain proposed transactions between the DB Plan and the DC
plan. In particular, you have requested rulings that:

(1) Amounts transferred upon disability retirement from the DC Plan to the DB
Plan under the disability provisions of the Plans are not subject to section
414(k) of the Internal Revenue Code (“Code”).

(2) The transfer of assets from the DC plan to the DB Plan (upon disability
retirement) or from the DB Plan to the DC Plan (upon recovery from disability)
are permissible plan transfers that will not result in taxation under sections
72(t), 401(k), 402, or 404 of the Code.

(3) The transfer of assets from the DC plan to the DB Plan (upon disability
retirement) or from the DB Plan to the DC Plan (upon recovery from disability)
will not result in constructive receipt to an affected participant or otherwise
subject the participant to taxes under sections 72(t) or 401(k) of the Code.

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(4) The transfer of assets from the DC plan to the DB Plan (upon disability
retirement) or from the DB Plan to the DC Plan (upon recovery from disability)
with respect to any affected participant will not affect the determination of
either the participant's annual benefit under section 415(b) of the Code or the
determination of the annual addition to the participant's account under section
415(c) of the Code.

Facts

The Taxpayer administers qualified government retirement plans for the State. The
State maintains a defined benefit plan and trust (the “DB Plan”) and a defined
contribution plan and trust (the “DC Plan”). The DB Plan and the DC Plan were
previously the subject of PLR 200130057.

State employees may actively participate in either the DB Plan or DC Plan. State
employees eligible to participate in the DB Plan are enrolled by default in the DB
Plan, but may at any time before the end of the fifth month following the employee’s
month of hire, elect to participate in the DC Plan. In addition, all employees have an
additional one-time opportunity, at the employee’s discretion, to switch from the DB
Plan to the DC Plan. Similarly, all employees have an additional one-time
opportunity, at the employee’s discretion, to switch from the DC Plan to the DB plan.

Subsequent to the issuance of PLR 200130057, State law was amended and
statutes were created to allow participants in the DC Plan who become totally and
permanently disabled’ to receive a disability benefit (“Disability Retirement’). In order
to receive disability benefits, a disabled DC Plan participant must transfer all monies
accumulated in his or her individual accounts to a ministerial account within the DB
Trust Fund (the “Disability Account’).

The amount of the Disability Retirement benefit of a DC Plan participant is generally
determined in the same manner as the Disability Retirement benefit of a participant
who was a participant in the DB Plan at the time of his or her disability.”

‘ The applicable laws of the State provide that “A participant shall be considered totally and
permanently disabled, if in the opinion of the division, he or she is prevented, by reason of a medically
determinable physical or mental impairment, from rendering useful or efficient service as an officer or
employee”.

2 in both cases the amount of each monthly payment is computed in the same manner as for a normal
retirement benefit under the DB Plan except that (1) disability option actuarial equivalency tables are
used, (2) average monthly compensation and creditable service are determined as of the date of
disability (as opposed to the date of retirement), and (3) the otherwise determined monthly payment
may not be less than certain specified percentages of average monthly compensation depending on
whether the participant was injured in the line of duty. For example, for participants injured in the line
of duty, the Disability Retirement benefit generally may not be less than forty-two percent of average
monthly compensation as of the date of disability. Retirement benefits under the DB Plan are
generally determined based on final average compensation and years of service.

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If a disabled DC Plan participant recovers from his disability, the net difference
between the amount transferred to the Disability Account, including earnings, and
the total disability benefits paid to the participant, is redeposited in individual
accounts within the DC Plan, as directed by the participant. (If the now recovered
participant does not return to covered employment, nonvested amounts are held in a
suspense account and forfeited if the participant does not return to covered
employment within five years).

In determining the net difference between the amount of a recovered participant’s
account balance transferred to the Disability Account and the total disability benefits
paid to the participant, paid disability benefits are first subtracted from the vested
portion of the transferred amounts and second from the nonvested portion of such
amounts.

A disabled DC Plan participant may elect, in lieu of receiving benefits under the
disability provisions of the DC Plan, to receive benefits under the normal benefit
provisions of the DC Plan (i.e., the benefit provisions available to a nondisabled
employee who terminates employment).

Law

Section 72(t) of the Code provides that if any taxpayer receives any amount from a
qualified retirement plan (as defined in section 4974(c)), the taxpayer’s tax under this
chapter for the taxable year in which such amount is received shall be increased by
an amount equal to 10 percent of the portion of such amount which is includible in
gross income.

Section 401(k) of the Code generally provides that a profit-sharing or stock bonus
plan, a pre-ERISA money purchase plan, or a rural cooperative plan shall not be
considered as not satisfying the requirements of subsection (a) merely because the
plan includes a qualified cash or deferred arrangement.

Section 402(a) of the Code provides that except as otherwise provided in that
section, any amount actually distributed to any distributee by any employees’ trust
described in section 401(a) which is exempt from tax under 501(a) shall be taxable to
the distributee in the taxable year of the distributee in which distributed under section
72 (relating to annuities).

Section 414(k) of the Code provides that a defined benefit plan which provides a
benefit derived from employer contributions which is based partly on the balance of
the separate account of a participant shall —

• For example, if $40,000 (consisting of $26,000 of vested amounts and $14,000 of nonvested
  amounts) was transferred from the DC Plan upon a participant’s disability and $10,000 was paid from
  the Disability Account prior to the participant's recovery, subsequent to the participant's recovery
  $30,000 would be transferred to the participant's individual account in the DC Plan (consisting of
  $16,000 of vested amounts and $14,000 of nonvested amounts).

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(1) for purposes of section 410 (relating to minimum participation standards), be
treated as a defined contribution plan,

(2) for purposes of section 72(d) (relating to treatment of employee contributions
as separate contract), 411(7)(A) (relating to minimum vesting standards), 415
(relating to limitations on benefits and contributions under qualified plans), and
401(m) (relating to nondiscrimination tests for matching requirements and
employee contributions, be treated as consisting of a defined contribution plan
to the extent benefits are based on the separate account of a participant and
as a defined benefit plan with respect to the remaining portion of benefits
under the plan, and

(3) for purposes of section 4975 (relating to tax on prohibited transactions), be
treated as defined benefit plan.

Section 404 of the Code provides, in part, that if contributions are paid by an -
employer to or under a stock bonus, pension, profit-sharing, or annuity plan, or if
compensation is paid or accrued on account of any employee compensation, such
contributions or compensation shall not be deductible, but if they would otherwise be
deductible, they shall be deductible under that section, subject to the limitations on
the amounts deductible in any year described therein.

Section 415(b)(1) of the Code provides that benefits with respect to a participant
exceed the limitation of that subsection if, when expressed as an annual benefit
(within the meaning of paragraph (2)), such annual benefit is greater than the lesser
of -----

(A) $160,000, or

(B) 100 percent of the participant's average compensation for his high three
years.

Section 415(b)(2)(A) of the Code provides that for purposes of paragraph (1), the
term “annual benefit” means a benefit payable annually in the form of a straight life
annuity (with no ancillary benefits) under a plan to which employees do not contribute
and under which no rollover contributions (as defined in sections 402(c), 403(a)(4),
403(b)(8), 408(d)(3), and 457(e)(16)) are made.

Section 415(c)(1) of the Code provides that contributions and other additions with
respect to a participant exceed the limitation of that subsection if, when expressed as
an annual addition (within the meaning of paragraph (2)) to the participant’s account,
such annual addition is greater than the lesser of -----

(A) $40,000, or

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(B) 100 percent of the participant's compensation

Section 415(c)(2) of the Code provides that for purposes of paragraph (1), the term
“annual addition” means the sum for any year of -----

(A) employer contributions,

(B) the employee contributions, and

(C) forfeitures
For purposes of that paragraph, employee contributions under subparagraph (B) are
determined without regard to any rollover contributions (as defined in sections 402(c),
403(a)(4), 403(b)(8), 408(d)(3), and 457(e)(16)) without regard to employee
contributions to a simplified employee pension which are excludable from gross
income under 408(k)(6). Subparagraph (B) of paragraph (1) shall not apply to any
contribution for medical benefits (within the meaning of section 419A(f)(2)) after
separation from service which is treated as an annual addition.

Section 4974(c) of the Code provides that for purposes of that section, the term
“qualified retirement plans” means ---

(1) a plan described in section 401(a), which includes a trust exempt from tax
under section 501(a),

(2) an annuity plan described in section 403(a),

(3) an annuity contract described in section 403(b),

(4) an individual retirement account described in section 408(a), or
(5) an individual retirement annuity described in section 408(b).

Such term includes any plan, contract, account, or annuity which, at any time, has
been determined by the Secretary to be such a plan, contract, account, or annuity.

Section 1.415(b)-1(c) of the regulations provides rules for adjusting a form of benefit
other than a straight life annuity to an actuarially equivalent straight life annuity.

Section 1.415(c)-1(b)(1)(i) of the regulations provides that the term annual addition
means, for purposes of that section, the sum, credited to a participant’s account for
any limitation year, of ----

(A) Employer contributions;

(B) Employee contributions; and

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(C) Forfeitures.

Section 1.415(c)-1(b)(1)(iii) of the regulations provides that the direct transfer of a
benefit or employee contribution from a qualified plan to a defined contribution plan
does not give rise to an annual addition.

Revenue Ruling 67-213, 1967-2 C. B. 149, involves the transfer of funds directly from
a trust forming part of a pension plan under section 401(a) of the Code to a trust
forming part of a stock bonus plan. The revenue ruling provides that if a participant’s
interest in a qualified plan is transferred from the trust of a qualified plan to the trust
of another qualified plan without being made available to the participant, no taxable
income will be recognized by such transfer.

Analysis

Ruling 4

Section 414(k) of the Code provides that a defined benefit plan which provides a
benefit derived from employer contributions which is based partly on the balance of
the separate account is treated as a defined benefit plan for certain purposes and a
defined contribution plan for certain other purposes. In this case, the disability
benefit of a disabled participant who was formerly a participant in the DC Plan is
determined in a similar manner to a disabled participant who was a participant in the
DB Plan at the time of his disability. That is, the disability benefit of disabled
participant who was formerly a participant in the DC Plan is determined without
regard to the balance of the participant's account in the DC Plan at the time of his
disability. Thus, the DB Plan is not a defined benefit plan. which provides a benefit
derived from employer contributions which is based partly on the balance of the
separate account. Accordingly, amounts transferred upon disability retirement from
the DC Plan to the DB Plan under the disability provisions of the Plans are not
subject to section 414(k) of the Code.

Rulings 2 and 3

Section 72(t) of the Code provides for an additional tax on any amount received from
a "qualified retirement plan" (as defined in section 4974(c), which includes plans
described in section 401(a)). The additional tax for the taxable year in which such
amount is received is equal to 10 percent of the portion of such amount which is
includible in gross income, except where such income is distributed on or after an
employee attains the age of 59½, or on account of one or more exceptions provided
for under section 72(t)(2) of the Code.

Section 72(t) does not apply in this case to the transfers because the transfers do not
result in any amounts being includible in the participant's gross income. Accordingly,
the transfers will not result in the trigger of an additional tax under section 72(t) and

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will not result in constructive receipt to an affected participant or otherwise subject the
participant to taxes under section 72(t) of the Code.

Section 401(k) of the Code provides that a plan shall not be considered as not
satisfying the requirements of section 401(a) merely because the plan includes a
qualified cash or deferred arrangement. In PLR 200130057 it was ruled that transfers
from the DB Plan to the DC Plan or from the DC Plan to the DB Plan did not
constitute cash or deferred arrangements within the meaning of Code section 401 (k).
In any event, distributions from plans that include cash or deferred arrangements are
generally taxed under section 402(a) of the Code, not section 401(k). Accordingly,
any transfers from the DB Plan to the DC Plan upon recovery from disability or from
the DC Plan to the DB Plan upon disability will not result in the trigger of an additional
tax under section 401(k) and will not result in constructive receipt to an affected
participant or otherwise subject the participant to taxes under section 401(k) of the
Code.

Section 402(a) of the Code provides, in effect, that contributions made by an
employer to a trust described in section 401(a) are not taxable to the employees on
whose behalf they are made until the year or years in which such contributions are
actually distributed to them.

Revenue Ruling 67-213, 1967-2 C.B. 149, involves the transfer of funds directly from
a trust forming part of a qualified plan under Code section 401(a) to a trust forming
part of another qualified plan. The revenue ruling provides that if a participant's
interest in a qualified plan is transferred from the trust of a qualified plan to the trust
of another qualified plan without being made available to the participant, no taxable
income will be recognized to the participant by reason of such transfer.

In this case, no benefits are made available or paid to the participant at the time of
the transfers. The transfers from the DC Plan to the DB Plan upon disability and
back to the DC Plan upon recovery and reemployment occur automatically based on
the type of retirement selected by the participant and the participants’ recovery, if
any, from disability. No participant or beneficiary of either of the plans will receive a
distribution of any assets at the time of the transfer, and the assets will remain in
trusts that are qualified under Code section 401(a) and exempt from tax under
section 501 (a). Accordingly, as was the case with the transfers considered by Rev.
Rul. 67-213, the transfer of assets from the DC Plan to the DB Plan (upon disability
retirement) and back to the DC Plan (upon recovery from disability) are plan transfers
that will not be a taxable event under section 402 and will not result in actual or
constructive receive of income.

Section 404 of the Code provides rules for determining the deduction for
contributions of an employer to an employee's trust or annuity plan. Distributions
from employee’s trusts or annuity plans are generally taxed under section 402 of the
Code, not section 404. Accordingly, any transfers from the DB Plan to the DC Plan

upon recovery from disability or from the DC Plan to the DB Plan upon disability will
not result in the trigger of an additional tax under section 404 of the Code.

Ruling 4

Section 415(b) of the Code and the regulations thereunder provide that a
participant's annual benefit generally means a benefit payable in the form of a
Straight life annuity (or the actuarial equivalent thereof). In this case because neither
the transfers of assets from the DC plan to the DB Plan or the transfer of assets from
the DB Plan to the DC Plan are benefits payable or made available to participants,
the transfers do not affect the determination participants’ annual benefits.
Accordingly, neither the transfers of assets from the DC plan to the DB Plan upon
disability or the transfer of assets from the DB Plan to the DC Plan upon recovery
affect the determination of a participant’s annual benefit under section 415(b) of the
Code.

Section 415(c) of the Code and the regulations thereunder provide that an annual
addition to a participant's account is the sum of employer contributions, employee
contributions, and forfeitures credited to a participant's account for any year. Section
1.415(c)-1(b)(1)(iii) of the regulations provides that transfers of a benefit or a
employee contribution from a qualified plan to a defined contribution plan does not
give rise to an annual addition.

Thus, because the transfer of assets from the DB Plan to the DC Plan is the transfer
from a qualified plan to a defined contribution plan no annual addition arises.
Similarly, because there are no participants’ accounts in the DB Plan, the transfer of
assets from the DC Plan to the DB Plan is also not an annual addition. Accordingly,
neither the transfers of assets from the DC plan to the DB Plan upon disability or the
transfer of assets from the DB Plan to the DC Plan upon recovery affect the
determination of the annual addition to a participant’s account under section 415(c) of
the Code.

Conclusions

(1) Amounts transferred upon disability retirement from the DC Plan to the DB
Plan under the disability provisions of the Plans are not subject to section
414(k) of the Code.

(2) The transfer of assets from the DC plan to the DB Plan (upon Disability
Retirement) or from the DB Plan to the DC Plan (upon recovery from disability)
will not result in taxation under sections 72(t), 401(k), 402, or 404 of the Code.

(3) The transfer of assets from the DC plan to the DB Plan (upon Disability
Retirement) or from the DB Plan to the DC Plan (upon recovery from disability)

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will not result in constructive receipt to an affected participant or otherwise
subject the participant to taxes under sections 72(t) or 401(k) of the Code.

(4) The transfer of assets from the DC plan to the DB Plan (upon Disability
Retirement) or from the DB Plan to the DC Plan (upon recovery from disability)
with respect to any affected participant will not affect the determination of
either the participant's annual benefit under section 415(b) of the Code or the
determination of the annual addition to the participant's account under section
415(c) of the Code.

This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) of the
Internal Revenue Code provides that it may not be used or cited by others as
precedent.

We are furnishing a copy of this letter to the enrolled actuary for the plan in accordance with a
power of attorney (Form 2848) on file.

If you have any questions on this ruling letter, please contact [illegible]

Sincerely,

David M. Ziegler, Manager
Employee Plans Actuarial Group 2