QUALIFICATION REQUIREMENTS
FOR GOVERNMENTAL PLANS

Bruce B. Barth

Robinson & Cole LLP
March 14, 2001

I.          General Rules

A. Governmental Plans are exempt from the provisions of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”).

B. Governmental Plans must generally meet some of the requirements of Section 401(a) of the Internal Revenue Code of 1986, as amended (“Code”).

1. Tax-Exempt status of qualified plans not relevant, as government monies are generally exempt from taxation.
2. Deferred taxability for participants is very important – absent meeting the requirements of Section 401(a) of the Code a participant in a funded governmental plan would be taxed as the participant became vested under Sections 402(b), 61 and 83 of the Code.
3. If Section 401(a) requirements are met, then participants are not taxed until monies are received from the governmental plan and these monies, if eligible, could be rolled over upon distribution.

II.         What is a governmental plan?

A. Code Section 414(d)-“The term ‘governmental plan’ means a plan established and maintained for its employees by the Government of the Unites States, by the government of any State or political subdivision thereof, or by any agency or instrumentality of any of the foregoing.”

B.  Governmental Plans cannot cover more than a deminimis number of non-government employees.

1. Facts and circumstances test.
2. If not met, then the plan is subject to the requirements of Section 401(a) of the Code applicable to non-governmental plans and is subject to ERISA.

C. Factors to be considered.

1. Does a governmental entity control or maintain the plan?
2. Does the governmental entity fund the plan?
3. Are only governmental employees covered by the plan.

D. Volunteer plans are generally not considered governmental plans as they do not cover employees – Section 401(a) is inapplicable.

III.           Mandatory Requirements-Although governmental plans are exempt from many qualification requirements, they must satisfy the following requirements generally applicable to qualified plans:

A.         Code Section 401(a)(1)-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 under this section-if contributions are made to the trust by such employer, or employees, or both, for the purpose of distributing to such employees or their beneficiaries the corpus and income of the fund accumulated by the trust in accordance with such plan.  This provision provides the basis in the regulations for requiring a written plan document.

B.         Code Section 401(a)(2)-Exclusive benefit rule-Under the trust instrument it is impossible, at any time prior to the satisfaction of all liabilities with respect to employees and their beneficiaries, for any part of the corpus or income to be used for, or diverted to, purposes other than for the exclusive benefit of employees or their beneficiaries.

C.         Code Section 401(a)(3)-Minimum coverage standards of section 410(b) (401(a)(3) as in effect prior to the adoption of ERISA applies to governmental plans.) *Please note that Section 410 (relating to minimum participation standards) does not apply to governmental plans* However, under Notice 2001-9, nondiscrimination rules are still scheduled to go into effect for governmental plans other than state and local government plans (e.g., federal governmental agencies, international organizations, and Indian tribes) for the first plan year beginning on or after January 1, 2002. 

D.         Code Section 401(a)(4)-General nondiscrimination rules-The contribution or benefits provided under the plan must not discriminate in favor of highly compensated employees. *Please note for taxable years beginning on or after August 5, 1997, any governmental plan is exempt from the general nondiscrimination requirements of Code Section 401(a)(4).

E.         Code Section 401(a)(5) Discussing special rules relating to nondiscrimination requirements (Exceptions to general nondiscrimination rules)-*Please note section 401(a)(5) is inapplicable to state and local governmental plans; however, it is applicable to other governmental plans subject to a delayed effective date (for the first plan year beginning on or after January 1, 2002).

F.         Code Section 401(a)(7)-Minimum Vesting Standards of section 411--The plan of which such trust is a part must satisfy the requirements of section 411. *Please note that governmental plans are exempt from section 411 (relating to minimum vesting standards; however, governmental plans must satisfy Code section 401(a)(7) as in effect prior to the enactment of ERISA)

1.  Section 401(a)(7) pre-ERISA required full vesting at normal retirement age or plan termination.  The Section also required vesting that did not discriminate in favor of the “prohibited group”.

G.         Code Section 401(a)(8)-Use of forfeitures-A trust forming part of a defined benefit plan shall not constitute a qualified trust unless the plan provides that forfeitures must not be applied to increase the benefits any employee would otherwise receive under the plan.

H.         Code Section 401(a)(9)-Minimum required distributions-Applicable to governmental plans for plan years beginning after December 31, 1986.  A governmental plan must contain language setting forth the distribution requirements of section 401(a)(9), which apply beginning on:

1.  the later of the April 1 of the calendar year following the calendar year in which the employee attains age 701/2 or the April 1 of the calendar following the calendar year in which the employee retires, or

       2 . the employee’s death.

I.          Code Section 401(a)(16) and Section 415-Relating to maximum benefits and pre-Tax Reform Act of 1986 rules for limits for early and late retirement-Section 401(a)(16)-A trust shall not constitute a qualified trust if the plan of which such trust is a part provides for benefits or contributions which exceed the limitations of section 415.  * Please note that in the context of a governmental plan, after-tax employee contributions are treated as annual additions under section 415(c), but the benefit generated by them is excluded in applying the maximum benefit limitations of section 415(b).  Picked-up contributions under section 414(h)(2) are treated as if they were not part of the employee’s compensation for purposes of the section 415 limits, and they are not part of the annual addition.  However, benefits generated by picked-up contributions are subject to the limits of section 415(b).  Furthermore, it is important to note that section 415 neither supersedes nor invalidates contract provisions, which provide for the payment of pension benefits in excess of section 415 limits.  If payments are made in excess of the limitations imposed by the Code, the plan loses its favorable tax status (e.g. participants become taxed as they are vested).

Although governmental plans have limitations on the maximum benefit that can be provided to a participant, the limitations are more generous than the limitations under private sector plans.  If benefits begin before Social Security retirement age, for private sector plans the maximum benefit limit under Code Section 415 ($90,000 as adjusted for inflation) must be adjusted actuVerdanaly.  However, governmental plans generally remain subject to the maximum annual benefit limits that applied before enactment of the Tax Equity and Fiscal Responsibility Act of 1982.   Note* If benefits begin between the ages of 55 and 62, the $90,000 limit is actuVerdanaly adjusted but cannot be reduced below $75,000 (not indexed).  If benefits begin before age 55, the $90,000 limit is actuVerdanaly adjusted using an actuVerdana equivalent of $75,000 at age 55.

J.          Code Section 401(a)(17)-Maximum recognized compensations rules-.  Became applicable to governmental plans, effective for the first plan year beginning on or after January 1, 1996, or 90 days after the opening of the first legislative session beginning on or after January 1, 1996 of the governing body with authority to amend the plan if that body did not meet continuously.  Under the plan, the annual compensation of each employee taken into account under the plan for any year cannot exceed $150,000.  *Please note that the IRS adjusts the $150,000 amount for increases in the cost-of-living at the same time and manner as adjustments under section 415(d); except the base period shall be the calendar quarter beginning October 1, 1993, and any increase which is not a multiple of $10,000 shall be rounded to the next lowest multiple of $10,000.

K.         Code Section 401(a)(25)-Specified actuVerdana assumptions-A defined benefit plan shall not be treated as providing definitely determinable benefits unless, whenever the amount of any benefit is to be determined on the basis of actuVerdana assumptions, such assumptions are specified in the plan in a way which precludes employer discretion  *Please note that this rule has a reduced effect on governmental plans, since such plans can change their actuVerdana assumptions without regard to the limitations in section 411.

L.         Code Section 401(a)(26)-Minimum participation requirements *Please note that this section is not applicable to state and local governmental plans.  However, there may be a question as to whether it applies to other governmental plans.  To the extent applicable, subject to several rules for the exclusion of certain employees, a plan must benefit on each day of the plan year, the lesser of 50 employees of the employer, or 40% or more of all employees of the employer.

M.        Code Section 401(a)(31)-Direct rollover rules-The plan must provide that if the distributee of any eligible rollover distribution-

1.           elects to have such distribution paid directly to an eligible retirement plan, and

2.           specifies the eligible retirement plan to which such distribution is to be paid such distribution is to be paid

3.         such distribution shall be made in the form of a direct trustee-to-trustee transfer to the eligible retirement plan so specified.

N.         Code Section 401(b)-Retroactive amendments-Time for amending a plan to comply with qualification requirements- According to Notice 89-8, 1989-3 I.R.B.15. for governmental plans, this time normally expires on the last day of the seventh month following the end of the plan year.  However, amendments necessary to comply with the Tax Reform Act of 1986 and later statutes (including GUST) and regulations can be adopted as late as the last day of the last plan year beginning before January 1, 2001 or the last day of the first plan year beginning on or after the 2000 legislative date (the 90^th day after the opening of the first legislative session beginning after December 31, 1999 of the governing body with authority to amend the plan).  Rev. Proc. 2000-27.

O.            Code Section 3405-Income tax withholding on benefit payments.

P.         Code Section 6652(i)-Rollover notices required with respect to lump sum distributions.

IV.        Non Applicable Code Provisions -Governmental plans are exempt from the following    Code requirements applicable to private sector plans:

A.    Code Sections 401(a)(10) and 416-Top-heavy rules.

B.    Code Sections 401(a)(11) and 417-Requirments of Joint and Survivor Annuity.

C.    Code Sections 401(a)(12 and 414(l)-Merger and Consolidation rules.

D.    Code Section 401(a)(13)-Prohibition of Assignment and Alienation of benefit rules.

E.    Code Section 401(a)(14)-Commencement of Benefits.

F.    Code Section 401(a)(15)-Requirement that plan not decrease plan benefits on account of certain Social Security increases.

G.    Code Section 401(a)(19)-Requirement that certain benefits not be forfeited on account of participant withdrawals.

H.    Code Section 401(a)(20)-Requirements with respect to PBGC notices on qualified total distributions.

I.     Code Section 401(a)(29)-Security required upon adoption of amendment resulting in significant underfunding.

J.     Code Section 412-ERISA funding requirements and benefit commitments.

K.    Code Section 414(p)-Qualified domestic relations orders.

L.     Code Section 4975-Excise tax on prohibited transactions.

M.    Code Section 4980-Excise tax on reversion of plan assets.

N.    Code Sections 6057-Requirement to file Schedule SSA; 6058-Requirement to file Form 5500; and 6059-Requirement to file actuVerdana report.

V.        Special Rules

A. As noted, governmental plans are exempt from most filing requirements.  However, a governmental plan must file a request for a determination of qualification with the IRS if a determination is desired.  Most governmental plans do not request a determination letter.  Furthermore, a governmental plan must file appropriate forms with the IRS regarding plan distributions, as well as a Form 990-T to report any unrelated business taxable income.

B. What information must governmental plans provide to participants?

1. A governmental plan must provide recipients of certain distributions with information regarding rollover rights;
2. The plan must also notify a participant of withholding rights;
3. The plan must provide participants with information regarding tax reporting on distribution on IRS Form 1099R; and
4. If a determination letter is requested, advance notice of the filing must be provided to all interested parties.