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Must An HCE's Distribution Be Restricted In An Underfunded Plan If All Participants Are HCEs?


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A plan has 3 participants who are all family members and HCEs. There have never been and will never be any other employees. The plan is underfunded for 417e purposes and one of the HCEs is due a distribution.

The Treasury Regulations say that in most cases an HCE's distribution must be limited to an amount that would leave behind enough assets in the plan to at least equal 110% of the plan's remaining current liabilities. Treas. Reg. 1.401(a)(4)-5(b) states that the 110% restriction does not apply “if the Commissioner determines that such provisions are not necessary to prevent the prohibited discrimination that may occur in the event of an early termination of the plan” – do you think it would be reasonable to believe that “the Commissioner” would consider an unrestricted distribution to be nondiscriminatory since all of the participants are HCEs?

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Interesting question. I'm neither a "DB" person nor am I an EA, but although your argument seems reasonable, I wonder if your plan language would back it up? (Even if the Commissioner does agree with you) The DB documents I've seen don't delve into it to such a detailed level. They merely, flat out, prohibit a distribution to a "restricted employee" when assets are below the 110% as you mention, subject to certain exceptions which don't apply to your question - and the "restricted employee" is defined. Example below:

Definition of Restricted Employee. For purposes of this Section, "Restricted Employee" means any Highly Compensated Employee or former Highly Compensated Employee. However, a Highly Compensated Employee or former Highly Compensated Employee need not be treated as a "Restricted Employee" in the current year if the Highly Compensated Employee or former Highly Compensated Employee is not one of the twenty-five (25) (or larger number chosen by the Employer) nonexcludable Employees and former Employees of the Employer with the largest amount of compensation in the current or any prior year.

Assume your plan permits the "payment if security provided" route? That might be a better option.

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Only considering rules applicable to defined benefit plans, since how else could there be any underfunding at all?

It depends on the way benefits are to be distributed. Any kind of lifetime payout would not be subject to restriction (as long as no annuities are purchased), only payouts more rapid than under a straight life annuity.

Assuming that the AFTAP is at least 80%, nothing beyond the usual security set-up should be required.

Does the plan have any language limiting the 25-high restrictions to situations where discrimination in favor of HCEs could be an issue or is the language the standard language? Is it worth seeking a PLR?

Always check with your actuary first!

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Thank you both for your responses. The doc does not elaborate on the topic - it basically just reprints the treas reg. Reading through the 'adequate security' provision, however, I'm having difficulty understanding its merits if eventually the beneficiary would have to repay the restricted amount back to the plan with interest. Is the sole advantage that it's a loan that can have flexible terms such as balloon or interest-only payments and whose maturity can be set to be a very long time from now?

I suppose the beneficiary could take the 'safe' route and opt for the SLA, but that could be a hard sell when they know the plan can pay out a lump sum - once the final numbers have been determined we can present the risk/reward scenario, Would the SLA be based on the participant's or the non-spouse beneficiary's lifetime? The participant was in his 90's, so the periodic payment amounts could be vastly different.

I'm not familiar with what's involved in requesting a PLR - does anyone know the approximate amount of user fees or time frame that would be needed to obtain one?

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