Freezing/terminating a money-purchase plan; timing and penalties

[Guest Gerritsen]

My small company has two employees who each own 1/2 of the company. We have an MPPP in place, using a standard prototype plan, from Vanguard in our case. We would like to freeze the plan, terminate the plan or otherwise reduce the required contribution to 0%. My understanding is that this is not a problem for FY 2001 (for us same as calendar 2001) if it is done prior to 3/15/2001. If possible, we would like to also do this retroactively for 2000. We have not yet filed our 2000 tax return, and have not yet made any contributions for 2000.

From looking at other threads on this site, it appears that maybe the only penalty associated with this kind of "retroactive" termination is that it triggers 100% vesting. In our case, that's not a problem since we have both been 100% vested since the start of the plan.

Am I right that this would be the only "penalty" associated with what would essentially be a retroactive freeze/termination?

(In retrospect, setting things up initially as a combo MP and Profit-Sharing plan, might have been better as it would have given us greater contribution flexibility.)

[AndyH]

You cannot do it retroactively to 2000. That would be an impermissable cutback in benefits. The consequences would be that the contribution would still be owed, but the plan would be disqualified.

A decrease in the formula cannot be effective prior to 15 days after the plan has been amended and participants have been formally notified. The 3/15/01 date is probably the date that participants have earned 501 hours and the contribution would be locked in for 2001, so it may have the same result as being retroactive to 1/1/2001, but technically it is not.

[KJohnson]

I think you are stuck for 2000. Since this is a MPPP you are subject to minimum funding standards which basically means you are obligated to put in whatever the plan says is required. Not making the 2000 contribution would subject you to an excise tax under section 4971 of the Code. This excise tax can grow to 100% of the defficiency. In addition a "retroactive" termination would be a "cut-back" in benefits that is not allowed under the Code or ERISA.

Whether you are stuck for 2001 depends on the terms of the Plan and whether someone has "accrued" a benefit for the year and the extent of the accrual. Under a standarized prototype the 3/15 date may be a guesstimate on the date when someone would have accrued 500 hours and be entitled to a contribution for the year.

Finally, you need to watch out for 204(h) notice issues. I believe that practitioners are divided on whether a 204(h) notice is required for a termination. A 204(h) notice basically means you have to give "advance notice" of any reduction in benefit accruals.

[wmyer]

My understanding is, additionally, that if you terminate the plan effective 3/31/2001, you are going to have to prorate the 501 hour condition for contributions, 500x3/12=125 hours. Anyone working more than 125 hours in that period, I think, would have to get a contribution.

[Guest Mr. X]

Wmyer, I disagree with your post. Terminating a plan does not cause the hours requirement to be prorated.

[Guest Gerritsen]

Thank you all for the useful, informative and speedy responses!

[PMC]

What if they amended the plan to have a short plan year for 2001 ending 3-31-01. Wouldn't they only be on the hook for contributions based on compensation for the plan year (now short)?

[AndyH]

Why would that be better than freezing the plan and having no contribution for 2001?

[PMC]

Right - freezing or terminating as of 3-31 (or 3-15) ends the plan year as of that date anyway.

[Guest Mr. X]

A plan year is changed by a specific amendment to it or if the final plan assets are distributed. It does not changes merely because the plan was frozen or terminated.

[AndyH]

True of course.

Also, I think there would be complications to the hours requirement if a short year were to somehow be created. I recall reading that in the case of vesting a short year would result in the same hour computation (e.g. 1000 hours), but for the 12 months ending in the short year. So, what I'm trying to say is that somehow running a short year may require that the 501 hours be deemed satisfied. I'm not 100% certain of this, but I do seem to recall reading that somewhere, and it merits caution.

[KJohnson]

I still think all of this still depends on when a participant is entitled to an "allocation" for the year. If there is a 500 hour requirement in the plan for an allocation and you terminate prior to anyone accruing 500 hours no contribution is owed. If you terminate afterword, you owe a contribution for anyone who has earned 500 hours based on comp up through the termination. If there is no hours requirement at all, then a contribution must be made based on comp earned through the date of the termination of the Plan.

The following is from the Reish and Luftman Technical Tips column (as reprinted from the 1998 ASPA conference Q&As with the IRS).

Tip 16: The following question and answer were from the IRS Q&A Session at the 1998 ASPA Annual Conference:

Revenue Ruling 79-237 and PLRs 8329098 and 9109067 state the IRS position that amendments (with proper notice) prior to a money purchase pension plan's contribution Allocation Date can reduce or eliminate the contribution requirement for the Plan Year. The positions taken in the Revenue Ruling and PLRs do not depend on the Plan having a separate 1,000 hour and last day contribution eligibility requirement. While some standardized prototypes have, in essence, a daily contribution Allocation Date, others have a contribution Allocation Date as of the last day of the Plan year.

Please confirm that the IRS position is still that amendments (with proper notice) prior to a money purchase pension plan's contribution Allocation Date can reduce or eliminate the contribution requirement for the Plan Year. If not, please state the IRS revenue ruling which changed the position taken in Revenue Ruling 79-237.

IRS Response: The position of the Service can be more accurately stated as holding that the Allocation Date is the date when the requirements for the allocation have been satisfied, not necessarily the specific "Allocation Date" stated in the Plan document. We believe proposed Reg. 1.412(B)-4©(3) and (4) should be examined for a better understanding of how we see the definition of Allocation Date.

Comment: The cited proposed regulations states:

"(3) Due date of contributions. For the purposes of paragraphs ©(1) and (2) of this section, a contribution is due as of the earlier of--

(i) The date specified in the plan, or

(ii) The date as of which the contribution is required to be allocated.

(4) Date for allocation of contribution. For purposes of paragraph ©(3)(ii) of this section, a contributions is required to be allocated as of a date if all the requirements for the allocation have been satisfied as of that date."

For example, a money purchase pension plan which requires only that a participant work 1,000 hours to receive an allocation cannot be amended to reduce the contribution requirement once a participant has worked 1,000 hours during the plan year.

Technical Tip 13: The following question and answer were from the IRS Q&A Session at the 1998 ASPA Annual Conference:

A calendar year 10% MP [that is, money purchase pension] plan has no last day employment condition, no hours requirement for receiving a contribution, and defines compensation as compensation paid during the plan year. It terminates on 6/30/98 with all participants having accrued 1,000 hours of service in the plan year to that date. On the same day, the sole NHCE [nonhighly compensated employee] terminates employment. The sole HCE [highly compensated employee] continues in employment through the end of the year and beyond. The participating NHCE had $10K in compensation to the date of termination; the participating HCE had $50K in comp to date of plan termination and a total of $100K in compensation for the entire plan year.

Is the contribution required to satisfy 411(d)(6) (and 412):

a) $0 [applying RR 79-237];

b) $6,000 counting compensation to date of plan termination; or

c) $11,000 counting all compensation for all participants for the entire plan year.

IRS Response: B is the correct answer.

[Guest Tara Curran]

We have read many of the messages from the message board regarding whether an MPP contribution must be made in year of plan termination/merger. However, we are not sure we fully agree with the analysis of a standardize plan. Our standardized prototype says if you terminate, you must work 500 hours to receive a contribution. This would mean then that someone who received a contribution last year, is eligible in the current year, employed on the last day of the current year and worked only 300 hours would receive a current year contribution.

Therefore, under our standardized plan, if we terminate the MPP after the first of the year, we feel that an MPP contribution will need to be made based on compensation up until the termination date even though participants haven't worked 500 hours.

Is this correct?