IRS proposal moves the deduction line on retroactive benefit increases

The proposed regulations that the Treasury Department and IRS published on Aug. 20 at 91 Fed. Reg. 53803 update the minimum funding rules for single-employer defined benefit plans, catching Section 430 up to statutory changes from WRERA, the SECURE Act, and SECURE 2.0 that had not yet made it into the existing rules, and they also reach technical issues that have since arisen.

Section 430 sets how much an employer must contribute to a defined benefit plan each year to avoid excise-tax penalties and satisfy related funding requirements, and it supplies the framework actuaries use to tell a sponsor what it owes and what it can deduct. The proposed regulations bring into it pieces of law that have been sitting on the shelf and settle at least one question that practice has wrestled with for years.

Plan sponsors will want to read the retroactive-amendment section first, where the SECURE Act and SECURE 2.0 already allow an employer to adopt a new plan or a retroactive amendment increasing accrued benefits after the plan year closes, provided the adoption happens no later than the employer's tax filing deadline, with extensions. Under the proposal, those retroactive provisions would count in the plan year being measured, feeding the funding target and target normal cost, as long as certain statutory elections are made and the amendment is effective no later than the date it is adopted.

Reflecting the increased benefits in the year they are effective increases the sponsor's deductible contribution limit for that year. Groom Law, which flagged the proposal in its Benefits Brief, walks through the standard case: an employer that adopts a retroactive benefit increase under Internal Revenue Code section 401(b)(3) after the plan year has closed would generally be able to include it in that year's funding calculations if the election requirements are met, and the firm notes the option may be particularly attractive to smaller employers.

The election is not a loophole; it is a timing decision. The same calculation that lifts the deductible contribution limit also pushes the added benefits into the plan's funding target and target normal cost, so the sponsor is taking credit for obligations it will have to fund. For an employer that already intends to increase benefits, the proposed rule makes the deduction line move in the same year as the obligation, and the IRS says facilitating benefit increases is the point.

The statute has allowed the amendment all along, but under the existing regulations the funding calculation had no clear place for it, and the IRS has now drawn the map that changes the calculus. Run the actuarial projection under the proposal's assumptions now; the deduction benefit is visible before the final rule is written.

The second half of the proposal settles the long-open question of which plan expenses belong inside target normal cost, defining "plan-related expenses" to include amounts expected to be paid from plan assets other than benefit payments and investment-related expenses—actuarial, legal, audit, administrative, and PBGC premium expenses.

The definition matters for the same reason the retroactive-amendment rule does: it moves money into the funding calculation, where it becomes part of the plan's minimum funding obligations and, in turn, shapes the deduction limit available to the sponsor. Groom describes the question as longstanding, which suggests plans and their actuaries have had to hand-build their answers from plan to plan, so a uniform definition is welcome—but sponsors should check the latest valuation report against the list before the rule is finalized.

Sponsors should trace their administrative and premium payments through the latest valuation report, because any payment that sits outside target normal cost today is likely to move inside it under the proposal, and every dollar that moves raises the minimum contribution requirement while also raising the deduction ceiling. The trade is symmetrical with the retroactive-amendment rule: both provisions make the funding calculation reflect more of the plan's actual cost and make the deduction limit a better proxy for that cost, so a plan that does both should expect a larger minimum contribution and a larger deduction room.

A sponsor that uses the retroactive-amendment election will carry more benefits into the funding target, and a sponsor that pays administrative expenses from plan assets will carry more expense into the target normal cost; both push the minimum contribution in the same direction, so the combined effect deserves a single projection rather than treating the proposal as two unrelated rule changes. The sponsors who get the most out of this rulemaking will decide before the final version arrives whether they want the earlier deduction, the higher funding obligation, and the cleaner expense line, and will run the numbers accordingly.