IRS PERMITS
PARTICIPANT CHOICE
BETWEEN
DEFINED BENEFIT
Prepared by: Debra L. Mackey
Johnston Barton Proctor & Powell LLP
Birmingham, AL
In Private Letter Ruling 200213029 issued December 31, 2001, the Internal Revenue Service ruled that permitting employees to elect between participating in a defined contribution plan and participating in a defined benefit plan is not a cash or deferred election within the meaning of § 401(k) of the Internal Revenue Code.
The ruling request involved an employer who sponsored a defined benefit plan and a defined contribution plan for its employees. The employer proposed to amend both plans to provide a one time irrevocable election for employees to cease participation in the defined benefit plan and to receive an enhanced contribution to the defined contribution plan. Participants who did not make the election would continue to participate in both plans, but would not receive the enhanced contribution in the defined contribution plan. Additionally, participation in the defined benefit plan would be frozen (new hires would not be eligible to participate in the defined benefit plan).
The election at issue was simply between continuing benefit accruals under the defined benefit plan or receiving additional contributions in the defined contribution plan. This is a choice between two non-taxable benefits. Because there is no option to receive cash or a taxable benefit, the one-time irrevocable election is not a cash or deferred arrangement.
Comment: Allowing employees to choose between plans is common in the public sector. In fact, several states (Florida, Montana, Vermont, and Washington) require that state employees be given a choice between a defined benefit plan and a defined contribution plan. In conversions to a cash balance plan, offering a choice between the traditional formula and the cash balance formula is fairly common. In fact, pending legislation may require such a choice in the future.