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Guest MMBest

cash balance plans & reversions

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Guest MMBest

If an employer with an overfunded DB plan converts it to a cash balance plan, hwat happens to the overfunded amount?

I do not believe tha plan is terminated so there should not be a reversion.

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I don't think there would be a reversion in the scenario you described as all you are doing is amending the benefit formula under the Plan, hence no termination. The only way a reversion could occur is if an Employer terminated the existing plan and then established a new cash balance plan (with some form of offset feature to account for accruals under the prior terminated plan).

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I agree, there would be no reversion as long as the traditional DB plan is amended into a cash balance DB plan.

And, it would be silly to terminate the traditional DB plan to get the reversion, and then start a new cash balance plan. That is because all accured benefits in the traditional DB plan would have to be fully vested and there is an excise tax on the reversion.

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Guest Harry O

This is not as simple as it appears.

A "horizontal" partial termination may occur when a DB plan is amended to decrease the rate of future accruals and a result of such decrease the potential amount of reversion to the employer is increased. Reg. 1.411(d)-2(B)(2).

Many cash balance conversions operate to reduce the rate of future accruals (isn't that the beauty of these plans!). If the plan is overfunded at the time of conversion, the IRS may argue that a partial termination has occurred and current employees should be vested in their pre-cash balance accrued benefits.

This is a nettlesome but unresolved issue and may be fertile ground for plaintiffs' lawyers . . .

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I concur with the horizontal termination issue after looking at the regs. However, it appears that the only impact is the full vesting of accrued benefits as of the date of conversion. The regs don't provide for any further sanction or remedies other than vesting.

Taken from RIA'S Pension and Benefits Expert (my apologies if I'm breaking any copyright laws here)

"A horizontal partial termination affects current employees through the cessation or decrease in future benefit accruals. The remedy is to vest these employees in their then-accrued benefits. No additional plan contributions or damages are required, nor must the plan be disqualified. Other remedies may be available under the plan itself. 43

43 Gulf Pension Litigation In re, (1991, DC TX) 764 F.Supp. 1149, 13 EBC 1873, affd on other issue sub nom Borst v. Chevron Corp, (1994, CA5) 36 F3d 1308, 18 EBC 2217."

The Employer could not currently get at the excess assets at conversion as the Plan has not yet terminated, so they stay in the plan for funding purposes. However, it also appears that no reallocation of the excess assets is required at conversion.

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As an aside, MMBest, that is usually the point to a cash balance conversion. It provides a mechanism for "using up" some excess, either indefinitely, or temporarily as a precursor to freezing the plan. That is, sometimes a cash balance plan is used as a bridge from a traditional DB environment to a DC environment.

Personal opinion: It can be good or bad. Much depends on the company demographics, philosophy of management, and the future of the plan sponsor. In many cases, the cash balance approach is done simply to cut current costs, without any analysis or regard for the underlying philosophy about the level of benefits and what the plan sponsor wants.

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More on the "horizontal termination" issue:

According to Harry O and 1.411(d)-2(B)(2), "a horizontal partial termination may occur when a DB plan is amended to decrease the rate of future accruals and a result of such decrease THE POTENTIAL AMOUNT OF REVERSION TO THE EMPLOYER IS INCREASED." (emphasis added)

Not all conversions from tradition DB plans to cash balance DB plans are designed to save the company money. Some are designed to provide the same level of benefits, but to provide them with a career pay - lump sum orientation.

So, switching from an X% final average pay plan to a Y% cash balance plan might cost the employer the same amount (either measured as a per cent of payroll or as the present value of total benefits promised).

In this case, the potential reversion is not increased, so a partial plan termination shouldn't occur.

Now, some will say that some employees are helped (will have higher future benefits) and some employees are hurt (will have lower future benefits) due to the switch to a cash balance plan, so there is a partial plan termination (at least with respect to the employees who are hurt).

If that were the case, then ANY change in plan formula could potentially be ruled as a partial plan termination. That would include the following changes that are intended to be "cost-neutral" - (1) changes from a 1.0%/1.5% integrated plan to a 1.2% nonintegrated plan, (2) changes from a 1.0% final pay plan to a 2.0% career pay plan.

Unless the benefit formula were clearly a reduction in overall projected benefits, I believe a strong argument against a partial plan termination can be made --- IMHO of course.

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