Client terminating Pension Plan and closing office, and intends to pay 2 clerical employees severance pay. He would prefer not to include this severance as "compensation" when computing required pension contribution. Is this permitted? Thanks for all input...

If the plan is frozen, it might not matter what you call it.

You should first review the plan document to determine if the definition of "compensation" excludes "severance pay." Even plans that use the "safe harbor" definition of compensation may exclude this form of compensation. Reg. sec. 1.414(s)-1(B)(3).

Or, client could amend plan to exclude such compensation (might throw them out of a safe harbor comp definition, though).

Alternatively, client could reduce the intended severance pay by the increased value of the pension benefit. This is sometimes done with large companies undergoing layoffs.

Delete "might throw them out of a safe harbor comp definition, though" from my previous comment.

Technically, I think that it will depend on when the severance is paid. I know the IRS position is that severance is not paid to an "employee" or for services rendered "on account of employment," so it shouldn't be taken into account under a qualified retirement plan. It is an unworkable standard, so I have heard that a safe approach is to count it (assuming that the plan doesn't exclude it) if it is included in a final paycheck or received (in advance) while the person is still an employee. Once the person leaves employment, amounts paid as severance shouldn't be included in plan compensation even if the plan definition includes it because it is not being paid to employees for services rendered.

So, in response to the last message, suppose a pension plan is amended so that the period of severance which follows active employment (i.e. the participant receives only severance payments, and is considered inactive for all other purposes such as vaction, etc.) counts towards pension service. In other words, pension vesting and accrued service includes the period of severance. This amendment is supposed to become a permanent feature of both the pension and severance plans, and not merely an early retirement window feature. Any issues? If so, regulation cites?