Guest Article

(From the July 12, 2004 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Federal Government Garnishments of Qualified Plan Benefits

---

Some of a plan sponsor's most difficult quandaries arise when various parties other than employees lodge claims against pension plans. Whether these are divorcing spouses, state escheat officers, or successful litigants, including state or federal governments, the plan is almost immediately involved in a legal dispute that can be costly and which has virtually nothing to do with the plan.

Fortunately, a recently issued private letter ruling addresses some of the issues that arise when the United States government is the litigant seeking to enforce a court judgment against a "debtor" who is a plan participant. As always, PLRs apply only to the party seeking the ruling and cannot be used as precedent. Nevertheless they are valuable guidance for those in similar fact situations.

Background of the Plans

PLR 200426027, dated March 30, 2004, addresses several issues involving federal government garnishments of benefits held in defined benefit and defined contribution plans. These issues cover whether such payments would be subject to the 10 percent early withdrawal penalty and whether such payments would be subject to rollover notice requirements and 20 percent withholding.

The employer seeking the PLR offered both a collectively bargained defined benefit plan and a collectively bargained defined contribution plan. At least three plan participants or beneficiaries were convicted of federal crimes and were ordered to pay fines or restitution to the federal government. One participant was receiving pension benefits as a surviving spouse; one was a retiree receiving pension benefits; and one was not yet eligible to receive distributions from the defined contribution plan. The government served the plans with notices of garnishment under the Federal Debt Collection Procedures Act (FDCPA) and the Mandatory Victims Restitution Act, laws outlining how the federal government can enforce judgments it has received. The employer acting on behalf of the plans refused to pay. The employer placed the disputed amounts in escrow and then challenged the garnishments in court.

At the time the PLR was issued, two of the challenges were being appealed. Clearly, the employer-- or its plans-- was spending significant amounts on litigation to "defend" the plans' assets. During the lengthy litigation between the employer and the federal government, the employer filed a PLR request seeking five rulings on behalf of the plans:

paying the amounts would not violate the anti-alienation provisions under IRC sec. 401(a)(13); paying the amounts would not violate the "exclusive benefit" rule under IRC sec. 401(a)(2), regardless of whether the amounts were deemed to be fines or criminal restitution payable to the U.S. for U.S. agencies, for private parties, or for state or local governments; the lien created under the Mandatory Victims Restitution Act attaches immediately, but that the U.S. government (i) cannot collect from the plan until the participant or beneficiary has a right to a distribution under the plan, (ii) steps into the shoes of either the participant or the beneficiary and can elect distribution on behalf of that person when that person could elect a distribution, regardless of whether that individual has made such an election; and (iii) is subject to the joint and survivor annuity rules and other plan provisions to the same extent as either the participant or the beneficiary; payments are not subject to the 10 percent early withdrawal penalty tax under IRC section 72(t); and details on the extent to which payments from either the defined benefit or the defined contribution plan will be (i) treated as "eligible rollover distributions," requiring written notice to plan participants or beneficiaries on rollover options and tax consequences and (ii) subject to the 20 percent federal income tax withholding applicable to rollover payments.

The PLR first discusses the relevant statutes, noting that the FDCPA permits writs of garnishment to be lodged against property in which the debtor has a significant interest, even when such property is held by a third party, including a retirement plan. Fines imposed as part of a criminal action are subject to the same rights of enforcement as tax liabilities assessed under the Internal Revenue Code. The PLR also cites two recent cases upholding the enforcement of restitution orders against pension plans, U.S. v. Tyson, 265 F. Supp. 2d 788 (E.D. Mich. 2003) and U.S. v. Clark, No. -02-X-74827 (E.D. Mich, June 11, 2003).

Anti-Alienation and Exclusive Benefit Rules

The PLR concludes that the anti-alienation provision does not prevent garnishments of retirement plan distributions to collect a criminal fine or restitution, regardless of whether such restitution will be received by the federal government or by the federal government on behalf of an individual or a state government. The exclusive benefit rule is not violated by such garnishments, because the distributions are being used to satisfy a debt of the participant or the beneficiary of the plan. (PLR 200342007 reached a similar conclusion.)

Timing of the Levy on the Retirement Plan

On the issue of the timing of the distribution from the pension plan, the IRS held that the lien on the account of the beneficiary or the participant attaches immediately. However, the distribution cannot occur until the participant or beneficiary has a right to distribution under the terms of the plan. At that time the U.S. government may elect to take the distribution, regardless of whether the participant or the beneficiary has elected such a distribution. However, any applicable qualified joint and survivor rules would also continue to apply.

Early Withdrawal Penalties

Based on the Tax Court ruling in Murillo v. Commissioner, T. C. Memo 1998-13, acq. 1999-1 C.B. 332, the PLR holds the 10 percent early withdrawal penalty will not apply when the government triggers an early withdrawal from the plan.

Notices and Withholding

Whether the information notice and the mandatory 20 percent withholding applicable to eligible lump sum distributions not rolled over will apply to distributions triggered by the government will depend on whether the distributions are eligible rollover distributions. A lump sum distribution to the government will be subject to the ordinary rules for lump sums, including the applicable notice outlining payment options and the consequences of failure to rollover, as well as the mandatory 20 percent withholding. If the garnishment payments are paid as periodic distributions they are not subject to notice or withholding rules.

---

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Tom Brisendine 202.879.5365, Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Taina Edlund 202.879.4956, Mike Haberman 202.879.4963, Stephen LaGarde 202.879.5608, J. D. Lutz 202.879.5366, Bart Massey 202.220.2104, Diane McGowan 202.220.2077, Martha Priddy Patterson 202.879.5634, Tom Pevarnik 202.879.5324, Tom Veal 312.946.2595, or Deborah Walker 202.879.4955. Copyright 2004, Deloitte.

---

BenefitsLink is an independent national employee benefits information provider, not formally affiliated with the firms and companies who kindly provide much of the content and advertisements published on this Web site, including the article shown above.