Rev. Rul. 60-337

Advice has been requested whether a trusteed pension plan involving integration with social security benefits will meet the requirements for integration, if the plan contains no limitation on the amount of excess earnings of the trust which may be credited to a participant's account.

An employer established a self-insured, trusteed pension plan. The plan provides for a normal retirement benefit, payable for ten years certain and life thereafter, equal to 35 percent of compensation (averaged over the period of participation in the plan, but not taking into account changes in compensation occurring after attaining age 55), offset by 90 percent of the primary social security benefit. Normal retirement is at age 65, or the tenth anniversary of becoming a participant, if later. The amount in an employee's account will be paid in the event of death before retirement.

In case of early retirement, disability retirement, or other termination of employment prior to normal retirement date, the benefit paid will be that which can be provided by a stated percentage (not to exceed 100 percent) of the amount in the employee's account. The employees do not contribute to the plan.

The employer's contributions are made on the assumption that the trust will earn a return of three percent per year. However, the plan will provide `variable' benefits, since the actual earnings (realized and unrealized) of the trust will be credited proportionately to the individual accounts, whether such earnings are greater or less than three percent.

Section 401(a) of the Internal Revenue Code of 1954 provides, in part, that a trust created or organized in the United States and forming part of a stock bonus, pension, or profit-sharing plan of an employer for the exclusive benefit of his employees or their beneficiaries shall constitute a qualified trust if the trust does not discriminate in favor of employees who are officers, shareholders, persons whose principal duties consist in supervising the work of other employees, or highly compensated employees.

Section 401(a)(5) of the Code provides, however, that a classification shall not be considered discriminatory merely because all employees whose annual remuneration constitutes `wages' under section 3121(a)(1) (for purposes of the Federal Insurance Contributions Act) are excluded from the plan. This provision is intended to permit the qualification of plans which supplement the old-age and survivors insurance benefits under the Social Security Act, as amended.

Section 1.401-3(e) of the Income Tax Regulations establishes the general basis for integration of pension, annuity, profit-sharing, and stock bonus plans, which limit participation to employees earning in excess of $4800 a year, or which base contributions or benefits only on compensation in excess of that amount, with the benefits provided by the Social Security Act, as amended.

Section 1.401-3(e)(2) of the regulations provides that in determining whether a plan is properly integrated with the Social Security Act, the total old-age and survivor insurance benefits with respect to an employee are considered to be 150 percent of the employee's old-age insurance benefits under such Act, and the proportion of such total benefits which is attributable to employee contributions is considered to be approximately 22 percent of such total benefits.

It follows from this provision of the regulations that the part of the total benefits under the Social Security Act not attributable to employee contributions is deemed to be equivalent in value to a straight-life annuity beginning at age 65 (or subsequent retirement) equal to 117 percent (78 percent of 150 percent) of the primary old-age insurance benefit. In a plan providing death benefits before retirement equal to the reserve, and a ten-year certain and life annuity, such as in the instant case, the 117 percent limit should be reduced to 93.6 percent (117 percent times 8/9 times 90 percent), in accordance with the rules set forth in Mimeograph 6641, C.B. 1951-1, 41.

The operation of the variable feature (i.e., crediting excess earnings to the employees' accounts) of this plan can result in the 93.6 percent limit being exceeded.

In view of this, it is held that the pension plan in the instant case does not meet the requirements for integration with Social Security Act benefits.

However, such a plan may meet the requirements for integration if it is amended so as to contain limits to insure that the crediting of the amount of excess earnings of the trust fund will not cause the actual benefits paid to exceed integration limits. This may be done by providing that in no case will the amount to be credited to a participant's account at any time exceed 104 percent (93.6 percent divided by 90 percent) of the amount that would have been credited to such account had the earnings of the fund (realized or unrealized) always been at the assumed rate of three percent. Any excess earnings which, in any year, cannot be credited to a participant's account because of such limitation, should be used to reduce the employer's contributions for that year.

As an alternative to limiting the amount of earnings that may be credited to a participant's account, it would be acceptable to amend the plan to provide that any earnings in excess of three percent will be allocated on a basis which does not involve integration with Social Security, for example, by allocating such excess earnings in proportion to `compensation' as defined in the plan or in proportion to total `compensation' since becoming a participant. (See Rev. Rul. 185, C.B. 1953-2, 202.)