IRC401

I am beginning to see cash balance plans which permit employees to rollover DC plan account balances to the cash balance plan. The rolled over amount is converted into a cash balance and credited with "interest" as if it were a benefit accrual. Companies apparently want this feature in their plans because they expect the plan to earn a greater return than the "interest" that is being credited; so, the plan makes a profit off of the transaction, which could boost corporate earnings. I can't figure out why an employee would go for this unless he is terrified of investing, and the plan is offering a higher rate of return than a money market fund. I wonder whether any one has considered whether this sort of plan provision creates a prohibited transaction. What is happening as a matter of economic reality is that the pension plan is selling annuities to participants in the DC plan. If the DB were to sell annutities directly, wouldn't it need to become a state regulated insurance company? Therefore, I wonder if this sort of provision subjects the plan trustees to regulation by the state insurance commissioner. I assume that the conventional wisdom is that the DC account is being converted into a DB accrued benefit. If that is the case, does anyone have any authority that such a presto-chango conversion is permissible? If it is permissible, then it seems to me that IRC 414(i) and 414(j) have no meaning, and why isn't the reverse permissible? Other questions: - Are the rollover amounts subject to the PBGC insurance program? There doesn't appear to be any policy reason why the PBGC should start to insure DC accounts. - May a plan give a higher rate of interest to HCEs than non-HCEs? Why not? The rollover amounts are not subject to IRC 401(a)(4). It seems to me that the only limit should be the point at which the IRS asserts that the interest rate is so high that the HCE is in fact accruing a benefit. Therefore, if this sort of DB to DC conversion is permissible, there are all sorts of planning opportunities. - May a 401(k) plan make a pre-59 1/2 inservice (non-hardship) transfer to a DB plan (getting around IRC 401(k)(2)(B))? [NOTE: I understand that Bank of America did put such a provision in its 401(k) plan. Does anyone have any inside information on the Bank of America plan?] - Is there a point at which the rollover assets are so large that the DB plan is no longer a DB plan? Does anyone know of any authority to permit DC rollovers to DB plans (without keeping the rollovers as separate DC accounts)? Am I missing something? Thank you.

There is a pre-ERISA revenue ruling that states (in effect) that the forfeitures have to be allocated for the year of forfeiture. (The Service's writing wasn't any better 25+ years ago.) As far as I know, the rule is still in effect. On the other hand, I have seen insurance company prototype documents (with IRS approval) that explicitly allow forfeitures to be allocated in the following year. As long as the forfeitures are being allocated promptly (for example, using December's forfeitures as part of January's match), I doubt that the IRS will bother you. I strongly recommend NOT allocating in a subsequent year UNLESS your plan document so permits and the plan has a current determination letter. Furthermore, be careful that your plan administrator does not allow forfeitures to build up for several years.

A significant percentage of DC plans give employees the right to take an in service distribution at a specified age, usually 59 1/2 or normal retirement age. There would be no qualification or constructive receipt problem letting or requiring employees to take distributions at 70 1/2. (Ok, you could in theory have a 411(d)(6) problem.) Consider the plan administration issues with a DB plan. Do you want to start making monthly payments while a participant is still accruing benefits? My advice is KISS (Keep it simple, stupid.)

You stated that 40% of the stock was distributed and 40% was in trust. Does that mean that 40% of the stock is in a suspense account to be allocated as an ESOP loan is paid off? I once asked a speaker at an ALI-ABA program if an ESOP trustee ever had a fiduciary duty to default on an ESOP loan because the company was going downhill, and he responded "Very interesting question". If your company is no longer a good investment, consider defaulting on the loan. That will get someone's attention. By the way, it is one thing to assert that there are problems, but is the stock price going down? Look at the methodology that the appraiser has used to value the stock and try to determine whether you would anticipate a significant decline in share price. If the stock price isn't going down, is there really a problem? Finally, for a situation such as the one you described, it is very dangerous to rely on advice from a computer screen. Good Luck.

You stated that 40% of the stock was distributed and 40% was in trust. Does that mean that 40% of the stock is in a suspense account to be allocated as an ESOP loan is paid off? I once asked a speaker at an ALI-ABA program if an ESOP trustee ever had a fiduciary duty to default on an ESOP loan because the company was going downhill, and he responded "Very interesting question". If your company is no longer a good investment, consider defaulting on the loan. That will get someone's attention. By the way, it is one thing to assert that there are problems, but is the stock price going down? Look at the methodology that the appraiser has used to value the stock and try to determine whether you would anticipate a significant decline in share price. If the stock price isn't going down, is there really a problem? Finally, for a situation such as the one you described, it is very dangerous to rely on advice from a computer screen. Good Luck.

Deloitte & Touche LLP is selling the idea; I don't know who else is. The idea is at least ten years old and runs directly contrary to the IRS' position in Rev. Rul 90-105 (which is not a well reasoned rev.rul.). Big Five accounting firms can't obtain patents or copyrights on, or claim trade secret status for, the Code, regs , and rulings. Therefore, they try to develope some secret methodology, the secret status of which they may be able to protect. It is highly unlikely that whoever is selling the idea really has a secret methodology. It is more likely that your client has been approached by someone who doesn't understand what he is selling and has a sales script.

<> My two underlying assumptions were that: (1) your firm has a different retirement plan (or benefit structure) for the partners (or shareholders) than the associates, which is a common practice, and (2) your second year associates earn enough to be HCEs. Are those assumptions wrong? I don't have the statistics to back me up, but I'm reasonably confident that very few law firms are paying second year associates over $80,000. I'm not aware of any 500 attorney firms paying less than that (although it is possible that they exist) . Maybe your recruitment problem is with your salary scale. If you change the benefits, it affects your nondiscrimination testing, maybe for better, maybe for worse. You shouldn't be looking to change the plan without considering the impact on the testing.

<> My two underlying assumptions were that: (1) your firm has a different retirement plan (or benefit structure) for the partners (or shareholders) than the associates, which is a common practice, and (2) your second year associates earn enough to be HCEs. Are those assumptions wrong? I don't have the statistics to back me up, but I'm reasonably confident that very few law firms are paying second year associates over $80,000. I'm not aware of any 500 attorney firms paying less than that (although it is possible that they exist) . Maybe your recruitment problem is with your salary scale. If you change the benefits, it affects your nondiscrimination testing, maybe for better, maybe for worse. You shouldn't be looking to change the plan without considering the impact on the testing.

The major differences between a multiple employer plan and a single employer plan are: 1. You probably won't be able to use a prototype document. 2. ADP and ACP testing are done on an employer (per IRC sec 414) basis ( and your recordkeeper may not know how to do the testing). 3. The 5500 reporting is a little different. The differences are significant enough that you should not set up a multiple employer plan unless you have a good reason to do so and are being advised by someone who understands the rules. NOTE that a multiple employer plan is not the same as a multiemployer plan.

If I understand your facts, you have a very serious situation that may involve criminal activity. I recommend that you get legal advice ASAP.

If you manage to pull this off, keep in mind that you will have turned your capital gains on the IPO into ordinary income inside of the IRA, and if the company goes belly-up, there will be no deduction.

I hope that you realize that you will need to pay all expenses out of the IRA. If you personally pay any of the expenses, it will be treated as a contribution to the IRA. Do your cash flow planning carefully. If the IRA needs to borrow money, it could owe UDFI tax (IRC sec 514).

I should have stated that she has both a problem and an opportunity that most law firms don't have. I assumed that the partners had a profit-sharing plan and that they wanted the associates to be HCEs to improve the test results. There are a lot of possibilities, and a professional services firm of that size should be willing to pay for advice.

Qualified retirement plans can and do invest in futures and options. If you do your homework, you'll find some PLRs discussing whether these investments generate UDFI. (IRC 514.) I assume that your contemplated investments do not include anything that could be an impermissible type of employer security, such as an option on the employer's stock. When you are making your investment decisions, don't forget to allow for the cost of explaining what you are doing to your plan's auditors or to your accountants for figuring out your IRC 514 issues.

<< The company is considering changing to an all defined contribution approach but to provide benefits at the same accounting cost as the cash balance contribution credits (for which the employees get a fixed rate of return that's fairly modest), it would have to halve approximately the level of the stated contributions. Hence, giving investment direction to the employees doesn't just shift the investment risk for better or worse but also significantly decreases the level of contributions.>> If I understand what you are proposing, you are drawing the wrong conclusion. Let's assume for example, that your cash balance plan credits 6% of compensation each year and credits "interest" at 4%. The actual company contribution each year is not 6% of compensation but whatever amount is needed under IRC 412 to fund the plan. If the plan is changed to have a 3% "contribution" plus an "interest rate" equal to directed investment results, the actual company contribution could go up or down depending on what the actuaries assume, but it does not automatically get cut in half. What gets cut in half is the amount of "contribution" allocated to accounts each year. If your client uses "directed investments", how will the actuaries perform the 401(a)(4) test? What kind of rate of return will they use to project benefits to the testing age? Is it permissible (or reasonable) to assume the same rate of return for everyone? It seems to me that if one of the HCEs is the best investor, you have a 401(a)(4) problem.

From an IRS perspective: Someone who has terminated employment cannot run his COBRA premiums through a 125 plan because he has no compensation that can be reduced. From a DoL perspective: COBRA premiums may be run through a 125 plan so that if an employer is self-insured it can avoid the requirement to put the premiums in trust. This position was stated to me at an ALI-ABA program; I've never seen it in writing.

The problem that you have that 99% of the law firms in the country don't have is that your second year associates are HCEs.

If the broker is deciding where money will be invested, it is a fiduciary, and it seems to me that it would be a breach of fidicuary duty to invest the money in a non-interest bearing checking account. (It may be a breach to put it in an interest bearing checking account.) If the plan trustee (who is the legal owner of the account) directs the broker where to invest the money, I don't see how NASD has any basis for a complaint (although that is not my area of expertise). If the trustee directs how the money will be invested, there would be no ERISA 404© protection (which may be meaningless anyway). If the client wants the plan to comply with 404©, it should not deposit any money for the participant until the forms are completed, and if the borker has taken it upon it self to help the sponsor comply with 404©, it should refuse to accept any contribution for a participant who has not filled out the forms.

I'm no SEC guru. Nevertheless, I can assure you that there is no requirement for a participant to sign anything in order to have an account with profit-sharing contributions. (He needs to sign a salary deferral agreement top make 401(k) contributions.) The account should be in the name of the plan trustee, not the employee. The trustee can set up the account and direct the investment of money allocated to the account (and may be committing a breach of fiduciary duty by putting money in a non-interest bearing checking account). On the other hand, the employer may require an employee to complete forms as a condition of participation, in which case no money should be allocated to the account of the participant before the forms are completed.

Sort of... I believe that the case is Hickerson v. Velsicol Chemical. The employer started crediting "interest" on DC accounts, in effect converting a DC plan to a cash balance plan (This action preceded the creation of cash balance plans). After the stock market took off in the early 80s, the employees sued in order to obtain actual investment returns (as in how a DC plan is supposed to operate). The Circuit Court of Appeals (I forget which one.) decided for the company. This opinion has not been overturned. The IRS has since issued regulations which, if valid, would prohibit employers from doing this sort of thing. Why did you ask?

The IRS position as stated last week atr the ALI-ABA program: The notice must be given in accordance with IRS rules. There is no exception for a plan that adds a 401(k) feature in the middle of a year. The employer needs to set up a new 401(k) plan and give a timely notice. The employer could merge the 401(k) plan into the profit-sharing plan the following year.

If VEBA funds are used to purchase a policy, the VEBA should own the policy. Why not get stop loss insurance to limit the VEBA's liability?

<< I would like to approach the school system to help them rationalize this process of selecting vendors>> Are you trying to sell an engagement or help a client? If you are trying to help a client, I recommend that you tell her to pick whom she would like to invest with and then start working her way up the command to find out what is involved with adding a new vendor to the list (keeping your name private). My cynical guess is that the vendor list was chosen because of relationships with union shop stewards and that you will have a hard time adding to the list and a close to impossible time getting a vendor dropped.

If the IRS attempts to disqualify one of your plans for excluding key employees, please let us all know. If you go in under CAP with a proposed correction of giving special allocations to the family that owns the business, please let us know how the IRS reacts. If you are dealing with MP or P/S contributions, as opposed to 401(k) contributions, try excluding key employees in the allocation section.

You need to have a trust document in order to have a master trust. Did anyone create a trust? How is the annuity policy titled? I'd want to see the documents before determining what you have>