501(c)18 Plan: What it Means, How it Works, Examples

What Is a 501(c)18 Plan?

The term 501(c)18 refers to a type of trust created before June 25, 1959, for the purposes of paying benefits to employees under pension plan rules. A 501(c)18 plan designation confers a tax-exempt status to these pension trusts, which are funded solely by member contributions. The money held inside a 501(c)18 trust can only be used for the payment of benefits.

The designation 501(c)18 should not be confused with other tax-exempt categories, such as 501(c)8, which applies to fraternal beneficiary societies, or 501(c)11, which applies to teachers’ retirement fund associations.

Understanding a 501(c)18 Plan

A 501(c)18 plan is a special type of trust that’s used specifically for funding employee pension benefits. The Internal Revenue Code (IRC) spells out the requirements for 501(c)18 plans. In order to qualify for tax-exempt status, these trusts must:

• Have been created before June 25, 1959
• Be a valid, existing trust under local law
• Be evidenced by an executed written document
• Rely on funding solely from employee contributors who are members of the plan

If any one of these conditions is not met, then the trust doesn’t qualify for 501(c)18 plan status. There’s an exception to this rule if a trust created before June 25, 1959, is merged with a trust created after that date. The Internal Revenue Service (IRS) doesn’t consider this to be a fundamental change in the character of the original trust if the merged trusts are used for the benefit of employees in the same or related industries.

Special Considerations

A 501(c)18 plan is funded solely through the contributions of employees who are members of the plan. Money contributed to it can only be used to pay pension or retirement benefits to its beneficiaries, including customary retirement benefits as well as incidental and death benefits.

The income of the trust can’t be used for anything else other than paying out benefits. Again, the IRS does allow for one exception to this rule. Any payment of expenses associated with administering the plan or payout of benefits to employees doesn’t affect the trust’s qualification status as a 501(c)18 plan.

The IRS also imposes a rule against discrimination. Specifically, the trust of a 501(c)18 plan can’t discriminate in favor of certain employees, including:

• Officers
• Shareholders
• Highly compensated employees
• Supervisory employees

Benefits offered to highly paid employees may be more than those paid to employees who earn less, but whether this occurs can depend on the method used for determining benefits. The IRS specifies that trusts inside a 501(c)18 plan must use an objective method to determine how benefits should be paid out. For instance, they may follow the method used by traditional pension plans, which base benefits on years of service and highest earnings.

501(c)18 Plan Examples

The IRS provides two examples of situations that may or may not affect the nature of a 501(c)18 plan and its tax-exempt status. These examples offer insight into how these plans work.

Example No. 1

In the first IRS example, we assume that a 501(c)18 trust is established for the members of participating locals of a national union. This trust was created in 1950 and adopted by 29 locals before June 25, 1959. Additional locals adopt the trust in 1962, but this does not affect the fundamental character of the trust because the adoption is by employees in a related industry.

Example No. 2

In this example, we use the same set of facts that apply to the first example but with one change. We assume that in 1965, the union that initially adopted the 501(c)18 trust merges with another union. Members of both unions are engaged in similar trades, and the second union’s pension plan is rolled into the first union’s 501(c)18 plan. As the trust is still used for the benefit of both unions’ employees, the merger doesn’t affect its tax-exempt status.

In either example, the trust and its associated 501(c)18 plan would still meet the requirements specified by the IRS.

501(c)18 Plans vs. Other Retirement Plans

Though 501(c)18 plans allow employees to set aside money for retirement, they’re not the same as other retirement plans, including:

• Defined-benefit pension plans
• 401(k) plans
• 403(b) plans
• 457 plans
• Profit-sharing plans
• Employee stock ownership plans (ESOPs)
• SEP IRAs
• SIMPLE IRAs
• Cash balance plans

Depending on your employer, it’s more likely that you have access to one of these plans rather than a 501(c)18 plan. Each of these plans can vary in terms of annual contribution limits, how they’re funded (through employer contributions, employee contributions, or a mix of both), and their tax treatment.

Defined-contribution plans, such as 401(k)s, leave you in control of how much you contribute, while defined-benefit plans pay out a set amount of money to you in retirement. With most of these plans, withdrawals are taxed as ordinary income, though there are exceptions if you opt for a Roth 401(k). If you’re unsure which type of retirement plan you have access to at work, your human resources department should be able to explain your options in more detail.