IRS disqualifies plans when investment options offered only to prohibited group.

• Author: Walker, Deborah
• Position: Discriminatory control of investment fund

Many plans currently offer investment direction options to only specified participants - usually officers, shareholders or highly compensated participants. The rank-and-file employees' accounts are invested in a "safe" investment, such as U.S. Treasury notes or savings accounts, with a low rate of interest. The final regulations under Sec. 401(a)(4) specify that the opportunity to direct investment is an "other right or feature" of a plan that must be nondiscriminatory as to current and effective availability. Moreover, the IRS has issued a technical advice memorandum indicating that the same is true for plan years before the effective date of the Sec. 401(a)(4) final regulations - and that the result of noncompliance is plan disqualification (Letter Ruling (TAM) 9137001).

The facts

The plan sponsor was a corporation of eight doctors, each of whom was incorporated and whose professional corporations (PCs) were shareholders in the plan sponsor. The arrangement constituted an affiliated service group under Sec. 414(m). The plans, a profit-sharing and a money purchase pension plan, covered the doctors and six rank-and-file employees. Three of the doctors served as the plans' trustees.

The plans provided for directed investments by each "adopting employer" - that is, each participating PC. During the years at issue (pre-1989 plan years), each PC would direct the trustees - through an "investment committee" composed of some of the doctors - to invest its contribution in particular investments. These investments earned between 11% and 41% in the pension plan, and between 8% and 23% in the profit-sharing plan. For the same years, the investment committee directed the investment of contributions on behalf of the rank-and-file employees. Those investments showed only a 6% rate of return.

Law and rationale

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