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Distributions to active employees done without plan termination


Jakyasar

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I was approached for consulting on the following - never saw this before:

Sponsor has a PS plan.

Sponsor intended to merge (or terminate the existing plan and join - not clear) with another group of plans and add 401k feature.

Sponsor, without taking any formal action, provides distributions to all participants, mostly active employees. All happened in May of 2021

Sponsor decides not to join the other group and continue with his PS plan and also amend for 2022 by adding 401k feature.

What can be done here to correct all?

Thank you

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Thank you for the cite as I was not searching using "overpayment".

Section 5.01(3)(c) clearly provides the explanation of what is an overpayment is.

Section 6.06(4) provides reference to Appendix B, section 2.04(c)(2) provides reference to Appendix B section 2.04(1)(c)

Just confirming the sections.

Very clear.

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Jakyasar, there's a lot you are not saying here. You are not saying what the rules are for allocation of a profit sharing contribution under the plan. Is it fixed or discretionary? What have you told participants about this year's profit sharing allocation (if anything)?  Is the plan top heavy? Has the profit sharing plan been around for at least 5 years? 

Assuming around at least 5 years and not top heavy....

If your profit sharing plan provides for a discretionary allocation for 2021, why not just tell the sponsor to terminate profit sharing plan now (effective retroactively) without allocating discretionary contribution for 2021, and then start a new 401(k)/profit sharing plan next year?  Admittedly, there is probably an issue with terminating effective retroactively, but if you treat the earlier distributions as advanced payments, I don't see what the harm would be.  

If your profit sharing plan provides for an allocation that is fixed not discretionary for 2021 and some participants already have earned it (so that it can't be cancelled without violating the anti-cutback rule), freeze the plan allocations and resolve to terminate the plan and distribute all assets, allocate the final contributions. Then treat the amounts previously distributed in error as advance payments, and issue residual checks for everyone with a balance after the 2021 allocation is done. Then start a new 401(k)/profit sharing plan next year.  

Regardless of the situation, you may want to submit a VCP to make sure IRS is on board with allowing you to distribute the plan assets in-service before the plan termination was formally adopted (and treating those distributions as advance payments as a remedy). 

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Just stream of consciousness thoughts:

Did the sponsor get distribution instructions from the participants?  Or did they just pay people out?

Even if you allow a retro-active amendment for in-service withdrawals of PS money, it seems like these distributions were coerced, and not voluntary.

How was vesting handled?  Everyone 100%?  If so, IF you do the in-service amendment, then you may need to amend vesting, too, if the source was not originally immediately vested.

That in-service withdrawal provision would be a protected benefit.

Could they terminate this plan, and adopt a new plan for 2021 with only PS and the 401(k) option available effective 1/1/22?

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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Bito'money, thank you for comments. I am not saying because what I posted is all the information given to me.

All I know/told (as of yesterday) is that now they want to make the plan whole again i.e. fix it one way or another and have all the participants return their monies to the plan. 

I pointed them to rev proc 2021-30 and it is in their hands now.

As an update, I was informed yesterday that not all participants have received their balances and also a termination resolution was put in place in August.

In my humble opinion, best approach is to rescind the termination, have everyone return their monies to the plan, the sponsor provide additional earning based on rev proc 2021-30, all to be completed/deposited prior to 12/31/2021.

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Who is paying if the funds have lost money since distribution, but would have gained money in left in the plan.

For example, my distribution was $10,000 and I rolled it into my IRA.  I was invested in Fund A in the plan.  When the money hit my IRA, I put it all into some stock.

I get a letter from the Plan Administrator that I have to return the money.  But the stock sank, and is only worth $8,800 now.  But if I kept it in the plan, Fund A was up 5% since I took it out.

Who is compensating me for the loss in principal and loss of earnings in the plan?

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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9 hours ago, BG5150 said:

Who is paying if the funds have lost money since distribution, but would have gained money in left in the plan.

For example, my distribution was $10,000 and I rolled it into my IRA.  I was invested in Fund A in the plan.  When the money hit my IRA, I put it all into some stock.

I get a letter from the Plan Administrator that I have to return the money.  But the stock sank, and is only worth $8,800 now.  But if I kept it in the plan, Fund A was up 5% since I took it out.

Who is compensating me for the loss in principal and loss of earnings in the plan?

BG5150, I'm not sure you would have a case. The fiduciary duties run to plan assets. While the funds were outside the plan, they were not a plan asset. I know they should have been in the plan, therefore should have been a plan asset, but I don't think that sort of "but for" causation analysis that sometimes works in state court would work in federal court under ERISA.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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Luke, are you saying, if they took out 10k and now it 7k in the IRA, they can only return 7k and accept the losses, even though if the monies stayed in the plan they would have been worth 12k?

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Luke's position seems reasonable to me. The participant voluntarily took the distribution, and then invested it in highly speculative stocks. If they hit a home run and the stocks quadruple in value, they get to keep the gain. If they lose, why should the Plan Fiduciary be liable? (This is my general thought, NOT a valid legal argument - I leave that to the attorneys!)

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1 hour ago, Jakyasar said:

Luke, are you saying, if they took out 10k and now it 7k in the IRA, they can only return 7k and accept the losses, even though if the monies stayed in the plan they would have been worth 12k?

Jakyasar, absent other bad facts and circumstances, I think you could probably get that correction in VCP.

If you're under self-correction, I think Rev. Proc. 2021-30, Section 6.06(4), which as Belgarath previously pointed out, provides the rule for correction of overpayments, is somewhat ambiguous, or more accurately, confusing. On the one hand, 6.06(4)(c) says the plan administrator must take reasonable steps to get the money back from the distributee, with earnings at the plan's earnings rate. Two problems. First, generally, what is the plan's earnings rate if the overpayment was the entire balance of a self-directed account, as was probably the case here, although I am just guessing as to that fact? Second, specific to your case, if the plan distributed all of its accounts, it had no earnings rate, right? Anyway, to deepen the confusion, note that the second sentence of of 6.06(4)(b) seems to say that the requirement to get the money back, with earnings, has no teeth (i.e., the employer or a third party does not need to make up whatever the employee does not return) if the only problem was that the amount should not have been distributed. So I don't see why they would have to require the earnings if they don't even have to get the principal. I guess the point is per the IRS, the employer is supposed to take reasonable steps to get the principal and earnings. I would say that in a case where it goes from a self-directed account in a plan to an IRA, it would be unreasonable to try to get back from the employee more than the current balance of the IRA, again assuming 100% was rolled over. (Interesting question that does not seem to be addressed in 2021-30 as to what happens if the employee's IRA out-earned the plan. Will leave that for another day.)

Switching subjects, Jakyasar, since the plan was only a profit sharing plan, not a 401(k), I would closely review the steps that were taken to terminate it. Could the employees take the position it actually was terminated, so they don't have to give the money back and the employer essentially started a new plan? Alternatively, should the employer maybe backfill the termination with paperwork and move on? Just things to consider. Of course, your facts will have details that will greatly affect the appropriate outcome for all of these issues, but you might want to examine them closely.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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