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Guest Jae

Participation in DC plan by participant in frozen, overfunded DB plan.

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Well, I suppose somebody invented the first 401(k). We'll have to come up with a name for this new animal.

Now accepting nominations..... How about the anti-415, the 514 plan.

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My two cents without looking at anything (which makes for the best comments): A frozen db plan must satisfy 401(a)(26) by satisfying prior benefit structure test. So 401(a)(26) could be an issue. A saving factor (when there are enough former employees) is that former employee can be used in the alternative test. A plan termination does not excuse compliance with 411, 417, and the consent rules would require a participant's election of a lump sum. Nor is it that easy to circumvent the 415 issues. Title IV would require an annuity purchase for the termination of a 25+ participant professional plan, subject to participant election of a lump sum.

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This is 1.401(a)26)-2(B):

Frozen plans. A plan under which no employee or former employee benefits (within the meaning of §1.401(a)(26)-5(a) or (B)), is a frozen plan for purposes of this section and satisfies paragraph (a) of this section automatically. Thus, a frozen defined contribution plan satisfies section 401(a)(26) automatically and a frozen defined benefit plan satisfies section 401(a)(26) for a plan year by satisfying the prior benefit structure requirements in §1.401(a)(26)-3. For purposes of the rule in this paragraph (B), a defined benefit plan that provides only the minimum benefits for non-key employees required by section 416 is a frozen defined benefit plan.

The first sentence says it all. The second sentence tells how and states "a fronzen db plan satisfies 401a26 by satsifying prior benefit structure.." Therefore no 401a26 problem. Ever.

As for my second contention I have already stated there is nothing which specifically states it can be done. It is that there is nothing which specifically prohibits the distribution under the conditions given. (at least I have never found anything)

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Megga dittos, RTK. I don't listen to Rush Limbaugh anymore, but I've always liked the phrase. Thanks for the help.

Reid (we've never met but somebody important on these boards speaks highly of you personally), this is waaay out there.

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Alex B:

The real reason why the IRS won't attack anybody on the indirect reversion has nothing to do with the legal arguments you raised.

It has to do with the fact that the PBGC wants to foster these mergers, because they help to eliminate underfunded plans.

If the IRS prevailed on the indirect reversion theory, it would discourage these mergers, leaving more underfunded plans that the PBGC might have to takeover some day.

The PBGC's policy arguments prevailed.

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Kirk:

Interesting insight. Of course, with the changes in EGTRRA allowing for the deduction of "terminal funding", isn't this a little less of an argument for this type of scheme, since the funds available to lessen over funding must be readily available by the sponsor (as they are being applied to the purchase of the over funded plans' assets, albeit at some discount, but not too much or the deal wouldn't be financially attractive).

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Guest Alex B

Kirk:

Your point is well taken. The fact that the PBGC wants to encourage these mergers in order to reduce the burden of underfunded plans is a good policy reason for the IRS not to challenge the transactions. However, what give me (and my clients) more comfort is the legal hurdles the IRS would have to overcome in order to succeed with an indirect reverion theory.

mwyatt:

The "terminal funding" deduction provided by EGTRRA will not impact the value of these mergers for companies with underfunded plans that do not benefit from such a tax dedcution, e.g. non-profits and companies with large NOLs carryforward.

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I guess what I was trying to get at (ignoring tax considerations - I was bringing up the EGTRRA change as plans previously had to deduct over 10 years the additional funds added, with uncertain application of the 10% nondeductible excise tax rate) was that real hard cash would be on hand outside of the underfunded plan, either to add to the Plan directly (in the terminal funding standpoint), or by the purchase price of the excess assets. So the real savings for the acquiring entities is the spread between purchase price and the excess assets acquired in the transaction. What sort of discounts are typically offered on the excess assets in these transactions?

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Guest Alex B

Discounts to buying companies with underfunding are typically 20% of the overfunding acquired. The sellers can expect to receive 75% and up to as much as 80%. With the proceeds taxed at long-term capital gains, this is a good result for both sellers and buyers.

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Let me hop back in with a couple of more comments.

No doubt that a frozen db plan satisfies 401(a)(26) if it satisfies the prior benefit structure requirements. The question is how is this applied to a frozen plan: Is it enough for the plan to satisfy the prior benefit structure when it is frozen? Or must the plan continue to satisfy the prior benefit structure in subsequent plan years?

A general reading of 1.401(a)(26)-1 and -7 indicates that a plan must satisfy 401(a)(26) each plan year. I would be reluctant to conclude that this does not apply to a frozen plan. First, the prior benefit structure has a test for plans without any current benefit accrual (i.e., a frozen plan), under which a frozen plan satisfies the requirements by providing meaningful benefits to the required number (50 or 40%) or former employees. Second, the regulations (1.401(a)(26)-3©(2)) state that a plan does not satisfy the prior benefit structure requirements if it exists primarily to preserve accrued benefits for a small group of employees and functions more like an individual plan for the employees or employer. Somehow you think this would have been resolved in the past 15 years or so.

Regarding the lump sum distribution of a 100% j&s annuity at plan termination: (1) the consent regulations provide that the requirements apply before, on or after a plan termination (1.411(a)-11(e)(1)); and the j&s regulations provide that benefits provided under a plan subject to the 401(a)(11) and 417 annuity requirements must be provided in accordance with those requirements even if the plan is terminated (1.401(a)-20, Q&A 6). Therefore plan termination by itself would not permit the distribution of a lump sum in lieu of the 100% j&s annuity without the participant's consent (i.e. election) or the spouse's consent.

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To RTK - Your reading of the 401a26 regs are correct as far as it goes, but you cannot forget the -2b regs quoted earlier.

Of course consent is required to change the J & S annuity into a LS on plan termination, but that is not the question. The question is whether the lump sum of life annuity restriction is 'lifted' if the participant has already elected the J & S and is now merely consenting to LS, not choosing LS. As was noted this idea is 'way out there' (GGG), but so was reducing LS values upon conversion to GATT!!!

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