Vesting upon plan termination

[Blinky the 3-eyed Fish]

A participant terminates 12/31/01 and the plan eventually terminates 12/31/03. He was 20% vested upon termination and his vested benefit was only worth a few hundred dollars. He didn't respond to attempts to pay him out (in hindsight it appears the client may have had a bad address), so he was cashed out. However, the check came back for a bad address and he was never paid out. The plan termination came and he is suddenly 100% vested.

Does anyone know of a precedent in this situation that would allow for the client to argue he still should only be paid his 20% vested amount?

[AndyH]

Not me. We always 100% vest in such situation.

[Blinky the 3-eyed Fish]

I ended up telling the client in so many words that you can take my advice or not, but don't come crying to me if it's discovered upon audit.

[mwyatt]

Assuming you filed for a DL, this payment would be disclosed in the 5-year lookback schedule for partial/non-vested terms. Are you filing for a letter? I wouldn't think that the IRS would go for 20% vesting if he never received the funds.

[Effen]

I don't see why they person should be treated as 100% vested just because he wasn't paid out 2 years ago. He clearly had a break-in-service and his termination was not related to the plan's termination. Many plans that don't pay lump sums have lots of partially vested terminated participants. Just because you terminate the plan doesn't make them all 100% vested.

From TREATISE, PENSION-ANSWER-BOOK, Q 25:4 What is the effect of a plan termination on a participant's accrued benefit?

... Generally, a participant who is partially vested need not become 100 percent vested upon termination of the plan if the participant separates from service and is paid the vested accrued benefit prior to the date of termination. However, a partially vested participant who terminates service, is not paid the vested accrued benefit, and does not incur a one-year break in service (see Q 5:10) prior to the date of termination must become 100 percent vested upon termination of the plan. Some IRS district offices have interpreted the above rule to require that all nonvested former participants with breaks in service of less than five years who have not been paid their vested accrued benefits be fully vested (see Q 9:16). [iRC §§ 411(a)(6)(B), 411(a)(6)©; Penn v Howe-Baker Eng'rs, Inc, No. 89-2257 (5th Cir 1990); GCM 39310 (Nov 29, 1984)]

[AndyH]

Some IRS district offices have interpreted the above rule to require that all nonvested former participants with breaks in service of less than five years who have not been paid their vested accrued benefits ......

How is a non-vested participant paid their vested benefits? Should that say partially vested participants?

And, I am told that it is the 5 year lookback schedule that mwyatt mentions that causes the IRS reviewer to focus on this issue. But then again, we are in the same IRS district.

[Belgarath]

I looked into this a while back. I believe this is due to 1.411(a)-7(d)(4)(ii)(D) - it appears to say that a distribution will be deemed to be made on account of termination of participation ONLY if it is made not later than the close of the second plan year following the plan year in which such termination occurs. In other words, by definition if the payout takes place after this period, it is not "on account of" termination of employment, and is therefore deemed to be on account of PLAN termination, and therefore 100% vested.

If the timing is such that the payout is made within the requisite period, then I think you have a good argument for not 100% vesting, but if after that, then I think the IRS will insist upon the 100% vesting.

[KJohnson]

For what it is worth, this was in the Fall 2002 of the IRS' Employee Plan News.

Vesting of Separated Participants upon Plan Termination

Despite a 1984 General Counsel Memorandum (GCM), there remains some confusion on the issue of full vesting for participants – who have yet to incur a forfeiture in accordance with plan terms – as a result of plan termination. This topic is a recurring determination letter issue, a potential examination issue and also tends to show up during plan termination sessions at various benefits conferences.

When a complete or partial plan termination happens, the result is full vesting for affected participants. In April 1984, the Service concluded in GCM 39310 that a partially vested participant who separates from service and would not incur a forfeiture of their benefit under the terms of a qualified plan must be vested in their accrued benefit (to the extent funded) at plan termination.

A defined contribution (DC) plan may provide for acceleration of forfeitures under the cash-out rules of Internal Revenue Code section 411. Except in the case of a non-vested participant, forfeiture cannot precede distribution under the cash-out rules. If a DC plan does not use the cash-out provisions, it may provide that forfeiture will still occur through use of the break-in-service rules of section 411 (at the end of the applicable break-in-service period).

In a plan that uses the break-in-service rules to determine when forfeiture occurs, if the plan terminates before forfeiture occurs, partially vested separated participants are affected employees who must become fully vested. This is regardless of whether they received a prior distribution. Conversely, in the case of a plan that uses the cash-out rules, a participant who separates from service and is paid their vested accrued benefit has no years left for purposes of accruing benefits. In a plan that uses years of service to determine accrued benefits, a cashed-out employee has no accrued benefit and nothing in which to fully vest at plan termination. The rationale in GCM 39310 applies to defined benefit plans as well as DC plans.■

[AndyH]

Thanks, Ken. Now would you kindly tell us what it means?

[mwyatt]

The 1984 GCM basically stated that due to the new REA rules, which provided for the increase to 5 years before you could disregard prior service, a plan that is terminating must provide for full vesting for those terminated participants who were still within this time frame. The logic employed by the IRS author here was that these former participants still could return to work and reclaim this service at the time of termination, and henceforth this hypothetical ability must be protected as part of the termination. If I recall, this even phased in from 8/23/1984 (REA enactment date) so that the 5-years grew from that date forward.

Of course on the DB side of things, the logical extension of the 1984 GCM, due to the fact that you don't really have the same 5 year wipeout of past service, was that any partially vested terminated participant still in the Plan at the time of termination would have to be fully vested since you never wipe out the past service. Fortunately the IRS didn't climb all the way out to the end of this particular logical limb.

Obviously this was a source of consternation among many (the old standard usually being full vesting for those who terminated in the year of term and possibly the prior year - otherwise you'd fire everybody, then terminate the plan). IRS did backtrack a bit and introduced the cashout exception, including the $0 deemed cashout (which now leads to the peculiar interpretation that the only folks you need to fully vest at termination are partially vested participants in the 5 year window - nonvested terms are out of luck).

[Blinky the 3-eyed Fish]

IRS did backtrack a bit and introduced the cashout exception, including the $0 deemed cashout (which now leads to the peculiar interpretation that the only folks you need to fully vest at termination are partially vested participants in the 5 year window - nonvested terms are out of luck).

Why do you find this peculiar? My understanding is that the 100% vesting is to apply to those that haven't forfeited their balances in a DC plan. Those who still have balances in a DC plan don't forfeit until 5 BIS, hence the 5-year window. If the plan has a 0% cash out rule, then upon termination, a 0% vested participant will forfeit their balance immediately. Now for DB plans, they are informally treated in a like manner to DC plans even though there isn't the 5-year BIS forfeiture rule.

It all seems consistent to me.

Also, in response to your question mwyatt, yes, a DL was filed for. This person was included on the schedule as someone who terminated with less than 100% vesting, but his distribution information was left blank in the attachment because he hadn't received it yet. We will see if that combination gets questioned.

[Guest Partly Cloudy]

1. In GCM 39310, the lookback was one year. After REA, if 5 years was the new lookback standard for plan terminations they should have released another GCM.

2. GCM 39310 is not binding on third parties, it is an internal document regarding a specific case.

3. The specific case was a DC plan.

I have heard on a number of occassions of using a one year from DOPT lookback for 100% vesting.

[AndyH]

Blinky, what do you mean by saying that "there isn't the 5 year break in service forfeiture rule" for DB plans?

[Effen]

FWIW, we have terminated several plans where the Plan only provided full vesting for those who didn't have a ONE year break. We disclosed all this on the 5310 and sometimes the IRS asks a question and sometimes they dont, but I don't recall them ever making the Plan provide full vesting to those who incured a at least of one year break.

[Blinky the 3-eyed Fish]

I mean in a DB plan a participant doesn't forfeit their unvested accrued benefit after 5 BIS, while a DC plan can (and most often does) have this rule.

[mwyatt]

I think this thread points out the whole problem with this issue, in that the IRS has never formally codified the standard for "looking back" on plan termination. Blinky's observation about the 5-year forfeiture not applying to DB plans is correct if you read the Code carefully, and points out the fallacy in the original GCM. Using the logic that full vesting is required for those who still retain the right to return and have their service reinstated at the time of termination ala DC plans would in turn lead one to conclude in the DB situation that all remaining partially vested participants in a DB plan should in turn be fully vested. This is due to the fact that they could theoretically return at some point in the future and reclaim their service. As I previously stated, the IRS author didn't go down this illogical (but consistent with his argument) path.

Having been involved in DB terminations since 1983, I watched the evolution of this IRS "standard". Perhaps the best tack is to fully disclose on the attachment to the 5310 who you are contemplating fully vesting/not fully vesting and rely on the blessing of the agent.

[Blinky the 3-eyed Fish]

Well said.

P.S. Andy, I have you by 3 posts. Get busy.

[Guest EmpBen]

I have recently been dealing with this issue as well. I agree with the previous posts that this is certainly a grey area. The regs do not set-out a clear answer to the required timing of forfeitures. In reviewing caselaw, it seems that the courts have come down on both sides of the issue as well. The GCM is not binding. In fact, there is a case where a party tried to use that GCM to advance their argument and the court not only found that it did not apply, but went on to acknowledge that even if it had, it was not binding. The issue is whether the plan is administered in a way consistent with the plan documents and not contrary to binding law. If it is, and if the plan contains the magic "arbitrary and capricious" language, then forfeiting the balances of partially-vested former employees works. The arbitrary and capricious standard would be applied to the actions of the plan's trustees (or administrators, or whomever dictated the forfeitures in this case) and if the forfeitures were done pursuant to the plan language or based upon previous caselaw, for example, it should pass muster. (See the 6th circuit court of appeals case Borda v. Hardy et. al.)

[Guest flogger]

We have twice successfully argued, upon audit of the DB termination, that those with at least 1 yr break in service should not receive additional vesting. Because the IRS's "logic" to the 5-yr look back is that the employer could rehire before 5 yrs is up, we have had the employer sign an statement that he promises not to rehire the terminated person(s).

[Guest flogger]

Interesting language you present AndyH. The statement that promised not to rehire was an affidavit and not an amendment to the plan. But what it most important is that the approach worked for the client.

[KJohnson]

I have always thought that the 510 discrimination issue was interesting on this issue. The Third Circuit in Mack Trucks determined it was not a 510 violation to refuse to rehire somone based on the additional pension liability that would create as opposed to a new hire. I don't recall if other Circuits have signed on to this reasoning If anyone is interested the Mack Trucks decision is here:

http://laws.lp.findlaw.com/3rd/004414.html

[mbozek]

Under the employment at will doctrine an employer isn't required to hire any former employee. There have been several case where cts have held that employees cant maintain a 510 claim because they are fired before they accrue maximum benefits at normal retirement age or become vested under the plan.

[KJohnson]

There have been several case where cts have held that employees cant maintain a 510 claim because they are fired before they accrue maximum benefits at normal retirement age or become vested under the plan

At least in a rehire, the argument is that the failure to rehire does not fall within the prohibited conduct of "discharge, fine, suspend, expel, discipline, or discriminate against a participant " for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan." Whether other Circuits that don't require a current employment nexus for "discrimination" would adopt the Third Circuit's reasoning, will, I guess, be decided sometime in the future.

However, firing someone to prevent them from accuring benefits or becoming vested under the plan is the heart of a 510 action and participants surely could "maintain" such an action if they alleged that that is the reason they were fired. Whether the employee could make a prima facie case that this was the reason for the discharge and whether the employer could rebut this prima facie case with a non-disciriminatory reason would go to the merits.

I agree that under the employment at will doctrine you are not required to rehire anyone, but that doesn't mean that you can refuse to rehire someone for a discriminatory reason (age, sex, race etc.) Of course at least in the Third Circuit it is not considered "discriminatory" to refuse to rehire someone because of potential implications on the employer's ERISA plan.

[mbozek]

There are cases upholding an employer's right to amend a plan to reduce benefit costs or exclude active employees from a plan. So why is it discriminatory to refuse to rehire an employee because of benefit costs.

To maintain a 510 claim on the merits the employee has to present more than a conclusory allegation that employer action prevented the employee from accruing or a exercising a benefit right. There must be evidence that the interference with ERISA rights was a motivating factor, not just that loss of benefits occurred as a consequence of the employer action. Ali v. Chelsea Catering, 910 FSupp 338. Otherise the case will be dismissed on summary judgement. Fed cts can and do impose penalties on attorneys and clients who file frivilous lawsuits that have no factual basis.

[KJohnson]

There are cases upholding an employer's right to amend a plan to reduce benefit costs or exclude active employees from a plan.

Agreed. The Supreme Court in Inter-modal said exactly that.

So why is it discriminatory to refuse to rehire an employee because of benefit costs

.

In the Third Circuit it would not be, but the argument woudl be that it is for the same reason that you cannot discharge an employee for purposes of preventing him or her from attaining a benefit right. An employer could eliminate retiree health benefits as a settlor decision but an employer coud not discharge an employee solely for the purposes of preventing that employee from obtaining the years of service neccessary to obtain that retiree benefit. As the Supreme Court said in Inter-Modal if you want this settlor "out" you have to formally amend the plan and they were not going to accept an argument that an employer was really informally amending the plan one participant at a time.

To maintain a 510 claim on the merits the employee has to present more than a conclusory allegation that employer action prevented the employee from accruing or a exercising a benefit right.

I never indicated that this was the standard. I said: However, firing someone to prevent them from accuring benefits or becoming vested under the plan is the heart of a 510 action and participants surely could "maintain" such an action if they alleged that that is the reason they were fired.