Kirk Maldonado

Your pain is about to get much worse. The legislation pending before Congress will compound your funding problems.

QDROphile: Thanks for pointing that out. I had focused on the person paying the insurance premium for the new coverage. Now I understand that wasn't the issue that everyone else was addressing. I think my point is still valid; just not germane to the discussion thread.

Belgarath: To be hyper-technical, the language you cited only specifically relates to the taxability of the loan; not to whether or not it is a prohibited transaction. But I agree that it is a prohibited transaction in these circumstances and that language is indirect support for that position. Here is the language you referenced: Q-17. What are the income tax consequences if an amount is transferred from a qualified employer plan to a participant or beneficiary as a loan, but there is an express or tacit understanding that the loan will not be repaid? A-17. If there is an express or tacit understanding that the loan will not be repaid or, for any reason, the transaction does not create a debtor-creditor relationship or is otherwise not a bona fide loan, then the amount transferred is treated as an actual distribution from the plan for purposes of the Internal Revenue Code, and is not treated as a loan or as a deemed distribution under section 72(p).

Did you check the regulations under section 416 to see if they provide any guidance?

The issue about FSAs is not relevant. You can't pay premiums out of an FSA anyway. What you want to do is to pay the insurance premiums through a premium only plan, which is not subject to the FSA rules.

I analyze the situation in a slightly different manner than either mjb or QDROphile, so I'm actively soliciting the reaction of both of you as to whether you agree with my approach, which may aid in the resolution of this interesting issue. If the disability benefit were completely unrelated to the pension benefit (say it was provided under a LTD plan), the court decisions that I've seen seem to indicate that the former spouse has no right to any portion of the disability benefit if the basis for the person's disability (e.g., a car accident) occurred after the divorce, despite the existence of a QDRO. On the other hand, I've seen decisions that say that if the participant's disability just affect when the benefit under the tax-qualified retirement plan becomes payable (and maybe whether there is an actuarially subsidized benefit), then the former spouse does share in the disability benefits pursuant to the QDRO. Do you both agree that these are the applicable principles of law? If you do, then that may make reaching the determination as to what is the correct conclusion much easier.

mjb: Do you agree that if there was any such rule (and I don't believe there is one), it would probably be contained in the section 414(l) regulations? While I agree that Revenue Ruling 2002-42 does support your position, I think even stronger authority is Revenue Ruling 94-76, which was amplified by Revenue Ruling 2002-42. Rev. Rul. 94-76 is set forth below: Rev. Rul. 94-76, 1994-2 CB 46, 11/29/1994 Headnote: The IRS has ruled on the effect on plan qualification of merging part of a qualified purchase-money pension plan with a profit-sharing plan that allows the withdrawal of accrued benefits after two years. It also ruled on the same issue with respect to a direct rollover to a profit-sharing plan of a distribution from a terminated pension plan. Full Text: Issue Whether, in the situations described below, changes in the plan provisions governing amounts transferred (Situation 1) or directly rolled over (Situation 2) from a qualified money purchase pension plan to an otherwise qualified profit-sharing plan will cause the profit-sharing plan to fail to satisfy the requirements of section 401(a) of the Internal Revenue Code. Facts Situation 1: Employer X maintains a money purchase pension plan (“Plan A”) that is qualified under section 401(a). Plan A provides that distribution of accrued benefits may be made to employees only upon retirement, death, disability, severance of employment, and termination of the plan. Plan A covers all of the employees of X. Plan A does not permit voluntary employee contributions. The employees of X are organized into 2 divisions, Division 1 and Division 2. In 1994, X establishes a discretionary profit-sharing plan (“Plan B”) for the benefit of employees in Division 2 only. Plan B provides for all of the optional forms of benefit provided under Plan A, including the joint and survivor annuity option. However, unlike Plan A, Plan B also permits employees to elect to receive a distribution of any portion of their nonforfeitable accrued benefit after the amount has been in the employee's account for at least two years. X amends Plan A and Plan B to provide that the Plan A assets and liabilities of the employees of Division 2 will be transferred from Plan A to Plan B in a spinoff of Plan A and merger with Plan B that satisfies the requirements of section 414(l). The provisions of Plan B, including its distribution provisions, remain in effect without modification after the transfer, and apply to the assets and liabilities transferred from Plan A. All applicable notice requirements are satisfied with respect to the transfer. Situation 2: Employer Y maintains a money purchase pension plan (“Plan C”) that is qualified under section 401(a). Plan C provides that distribution of accrued benefits may be made to employees only upon retirement, death, disability, severance of employment, and termination of the plan. In 1994, Y terminates Plan C and establishes a profit-sharing plan (“Plan D”). Plan D permits employees to elect, at any time, a distribution of accrued benefits that are attributable to any amount rolled over to Plan D. Upon termination, Plan C is amended to provide employees the additional distribution option of electing an immediate single-sum distribution equal to the employee's account balance. If an employee elects distribution in a single sum, the employee may also elect to have the distribution paid to Plan D in a direct rollover to the extent the distribution is an eligible rollover distribution. Employee S elects a single-sum distribution consisting of S's entire account balance from Plan C and elects to have the distribution paid directly to Plan D in a direct rollover that satisfies the requirements of section 401(a)(31). The applicable requirements of sections 411(a)(11) and 417 and the notice requirements of section 402(f) are satisfied with respect to the distribution before it is paid in a direct rollover. Law Section 401(a) provides that a trust created or organized in the United States and forming a part of a qualified stock bonus, pension, or profit-sharing plan of an employer constitutes a qualified trust only if the various requirements set out in section 401(a) are met. Section 1.401-1(b)(1)(i) of the Income Tax Regulations provides the definition of a pension plan. This section provides, in part, that a pension plan is a plan established and maintained by an employer primarily to provide for the payment of definitely determinable benefits to employees over a period of years, usually for life, after retirement. This section also provides that a pension plan may provide for the payment of a pension due to disability, and may also provide for incidental death benefits. Rev. Rul. 56-693, 1956-2 C.B. 282, as modified by Rev. Rul. 60- 323, 1960-2 C.B. 148, provides that a pension plan fails to meet the requirements of section 401(a) if it permits an employee to withdraw any part of the employee's accrued benefit (other than a benefit attributable to voluntary employee contributions) prior to certain distributable events; e.g., retirement, death, disability, severance of employment, or termination of the plan. Section 1.401-1(b)(1)(ii) provides the definition of a profit- sharing plan. This section provides, in part, that a profit-sharing plan is a plan established and maintained by an employer to provide for the participation in its profits by its employees. This section also provides that a profit-sharing plan may provide for the distribution of funds accumulated under the plan after a fixed number of years. Rev. Rul. 71-295, 1971-2 C.B. 184, provides that the term “fixed number of years” as used in section 1.401-1(b)(1)(ii) is considered to mean at least two years. Section 401(a)(31) requires a qualified plan to permit a distributee of any eligible rollover distribution to elect (in such form and at such time as the plan administrator may prescribe) to have the distribution paid directly to an eligible retirement plan as a direct rollover. Section 1.401(a)(31)-1T, Q&A-14 provides that for purposes of applying the qualification requirements of section 401(a), a direct rollover is a distribution and rollover of the eligible rollover distribution and not a transfer of assets and liabilities. Section 402©(8)(B) defines an eligible retirement plan to include a qualified trust under section 401(a). Section 402© defines an eligible rollover distribution as the taxable portion of any distribution to an employee of all or any portion of the balance to the credit of the employee in a qualified trust except for minimum distributions required under section 401(a)(9) and certain periodic annuities. Section 414(l) provides, in part, that a plan will not qualify under section 401(a), in the case of any transfer of assets or liabilities of such plan to any other plan, unless each employee in the plan would (if the plan then terminated) receive a benefit immediately after the transfer that is equal to or greater than the benefit the employee would have been entitled to receive immediately before the transfer (if the plan had then terminated). Section 1.414(l)-1(o) provides that any transfer of assets or liabilities will, for purposes of section 414(l), be considered as a combination of spinoffs and mergers. Section 1.414(l)-1(b)(4) defines a spinoff as the splitting of a single plan into two or more plans. Section 1.414(l)-1(b)(2) defines a merger as the combining of two or more plans into a single plan. Section 411(d)(6)(A) provides that a plan will not be a qualified plan if an employee's accrued benefit is decreased by any amendment of the plan (with exceptions not here relevant). Section 411(d)(6)(B) provides that a plan amendment that has the effect of eliminating an optional form of benefit with respect to benefits attributable to service before the amendment is treated as reducing accrued benefits. Section 1.411(d)-4, Q&A-2(b) provides that the Commissioner may provide that certain plan amendments that otherwise would be treated as not satisfying section 411 because of section 411(d)(6) will satisfy section 411(d)(6) to the extent the amendments are necessary to enable a plan to comply with other requirements of section 401(a). Analysis Situation 1: Under section 414(l), the transfer of certain assets and liabilities from Plan A to Plan B is considered a spinoff of those assets and liabilities from Plan A and the merger of those assets and liabilities with the assets and liabilities of Plan B. The merged entity consists of both the assets and liabilities transferred from Plan A and the assets and liabilities of Plan B. A merger of assets and liabilities of a qualified money purchase pension plan with the assets and liabilities of a qualified profit-sharing plan does not divest the assets and liabilities of the money purchase pension plan of their attributes as pension plan assets and liabilities. Therefore, to satisfy section 401(a), the assets and liabilities transferred from Plan A to Plan B must remain subject to the restrictions on distributions applicable to a qualified money purchase pension plan. In order to remain qualified, any plan provision applicable to the accrued benefits derived from Plan A must not permit distributions prior to retirement, death, disability, severance of employment, or termination of the plan. Plan B's distribution provisions permit distribution of an employee's accrued benefit after two years. The application of these distribution provisions to the accrued benefits transferred from Plan A therefore causes the merged plan to fail to satisfy section 401(a). In order for Plan B to remain qualified, Plan B must be amended to provide that on and after the transfer, the accrued benefits attributable to the assets and liabilities transferred from Plan A to Plan B (i.e., the account balances including the post-transfer earnings thereon) will be distributable only on or after events that are permissible under qualified pension plans. In order to avoid a violation of the provisions of section 411(d)(6), the amendment to Plan B must be adopted on or before the date of the transfer from Plan A to Plan B. This is because the right to take a distribution of an employee's accrued benefit after two years is an optional form of benefit. Accordingly, if Plan B were amended to eliminate that right with respect to benefits that have accrued, that amendment would be eliminating a section 411(d)(6) protected benefit. See section 1.411(d)-4, Q&A-1, 2. Furthermore, in order to implement the Plan B amendment that imposes the pension plan distribution restrictions on the Plan B assets and liabilities that were transferred from Plan A to Plan B and not on the other Plan B assets and liabilities, there must be an acceptable separate accounting between the accrued benefits attributable to the transferred assets and liabilities and all other benefits under Plan B. See, section 1.401(a)-20, Q&A-5(b) for a description of an acceptable method of separate accounting. The result in this revenue ruling will be the same whether or not the transfer in situation 1 constitutes a partial termination under section 411(d)(3). In addition, the result in this revenue ruling would be the same if, instead of transferring the assets and liabilities of all of the employees of Division 2 from Plan A to Plan B, Employer X had transferred from Plan A to Plan B the assets and liabilities of some, but not all, of the employees in Division 2. Similarly, the result in this revenue ruling would not differ if, instead of transferring only some of the assets and liabilities of Plan A from Plan A to Plan B, Employer X had merged Plan A with Plan B and extended Plan B's distribution provisions to the accrued benefits under the merged plan that were attributable to benefits from Plan A. Furthermore, the result in this revenue ruling would not differ if Plan B had been a stock bonus plan, instead of a profit- sharing plan. Situation 2: Pursuant to Q&A-14 of section 1.401(a)(31)-1T, for purposes of applying the qualification requirements of section 401(a), the direct rollover of the entire amount of Employee S's account balance to Plan D is a distribution and rollover of the amount and not a transfer of assets and liabilities under section 414(l). Once assets are properly distributed from a qualified plan in accordance with its terms, the liabilities of the plan with respect to the distributed plan assets are discharged and the amounts distributed are no longer assets of a qualified plan. Therefore, in order to remain qualified, an eligible retirement plan is not required to provide, with respect to amounts paid to it in a direct rollover, the same optional forms of benefit that were provided under the plan that made the direct rollover. In addition, the application of the immediate distribution provisions of Plan D to benefits attributable to rollover contributions does not cause Plan D to fail to satisfy the requirements of section 401(a) on or after the date Plan D accepts a rollover contribution in the form of a distribution paid in a direct rollover by Plan C. Holdings Situation 1: The provision of Plan B that permits employees to elect a distribution of any amount of an employee's nonforfeitable accrued benefit, including benefits transferred from Plan A, to be made after the amount has been in the employee's account for at least two years will cause Plan B to fail to satisfy the requirements of section 401(a). Situation 2: The provision of Plan D that permits employees to elect a distribution of accrued benefits that are attributable to rollover contributions from a qualified plan (including benefits from Plan C that are received in a direct rollover) does not cause Plan D to fail to satisfy the requirements of section 401(a). Corrective Plan Amendments Pursuant to the authority contained in section 1.411(d)-4, Q&A- 2(b), the Commissioner has determined that a profit-sharing plan or stock bonus plan is permitted to be amended to eliminate an optional form of benefit provided for in the plan on or before December 12, 1994, solely with respect to benefits attributable to assets and liabilities (other than any portion of those assets and liabilities attributable to voluntary employee contributions) that are transferred within the meaning of section 414(l) from a money purchase pension plan (i.e., the transferred money purchase plan account balances including the post-transfer earnings thereon), to the extent that the optional form permits distribution of those benefits prior to the employee's retirement, death, disability, or severance from employment, or plan termination, provided that the plan amendment eliminating the optional form of benefit is adopted by the last day of the first plan year beginning on or after December 12, 1994, and is made effective not later than the first day of that plan year, or, if later, 90 days after December 12, 1994. In addition, pursuant to the authority contained in section 7805(b) and section 301.7805-1, the Commissioner has determined that a profit- sharing plan or stock bonus plan will not fail to be qualified merely because the plan (i) contained a provision on or before December 12, 1994, that otherwise satisfied the requirements of section 401(a) and permits the distribution of any portion of an employee's nonforfeitable accrued benefit prior to the employee's retirement, death, disability, or severance of employment, or plan termination, and (ii) applies those provisions to benefits attributable to the assets and liabilities transferred within the meaning of section 414 from a qualified money purchase pension plan, provided that the profit-sharing or stock bonus plan is amended by the end of the first plan year beginning on or after December 12, 1994, to preclude distribution options that are not permissible under qualified pension plans from applying to benefits attributable to the assets and liabilities transferred from the money purchase pension plan, and the amendment is made effective not later than the first day of that plan year, or, if later, 90 days after December 12, 1994. A plan entitled to extend reliance under Rev. Proc. 89-9, 1989-1 C.B. 780, Rev. Proc. 89-13, 1989-1C.B. 801 (both as modified by Rev. Proc. 93-9, 1993-1 C.B. 474), or Rev. Proc. 93-39, 1993-2 C.B. 513 (relating to master or prototype plans, regional prototype plans, and individually designed plans), will not fail to be entitled to the relief set forth in the preceding paragraph merely because the plan is amended after the date set forth in the preceding paragraph, provided that the following three requirements are satisfied: (i) the plan is amended no later than the last day of the first plan year following the year in which the extended reliance period applicable to the plan ends, (ii) the amendments are made effective no later than the first day of that plan year and no earlier than the first day of the plan year in which the amendments are adopted, and (iii) no transfer of assets and liabilities to the plan from a money purchase pension plan occurred or occurs after the date of the most recent determination letter and prior to the date that the amendments are adopted. This relief from section 401(a) shall not apply to, or extend any relief otherwise applicable to, any otherwise eligible profit-sharing or stock bonus plan with respect to which the Service has notified the employer(s) (or any authorized agent(s)) prior to December 12, 1994, that the plan did not satisfy the requirements for a qualified plan because it provided for an impermissible distribution of accrued benefits attributable to assets and liabilities transferred from a money purchase pension plan prior to an employee's retirement, death, disability, or severance of employment, or plain termination.

There were some message threads in the past that contained some very creative and I think possibly viable solutions to this problem. Try using the search function to find them.

Belgarath: Am I interpreting your post as indicating that you believe if the person had no intention of repaying the loan when he or see obtained the funds from the plan, then it would be a prohibited transaction? (That is my position, without doing any research on this point.)

If you have a plan that provides coverage in that state, I think you would have to offer it to that person who relocated there. But I'm stating that without doing any research to back up my instinctive reaction. So if somebody has actually looked into this issue, please chime in.

JanetM: But remember that the exclusive benefit rule is applied on a controlled group basis and they are all part of the same plan and same controlled group. I recently did a deal where this was a negotiated issue between the parties, so I never had to research this point, but my gut reaction is the opposite of yours. This comes up so frequently in deals that you would think that if the IRS thought that the forfeitures could only be allocated to the participants in the plan that generated them, we would have heard about it by now. In that regard, my recollection is that the exclusive benefit rule predates ERISA.

The DOL website has a lot of very useful information on many topics, most of which is written in "plain English." I reccomend that people look on the DOL website for basic overviews of topics.

My recollection is that the IRS has some internal memos that apply the controlled group rules to non-profit entities. Because there are no ownership interests in non-profits, I seem to recall that the IRS looked at other factors, such as whether there were overlapping boards of directors (meaning the same persons sat on both boards). I don't remember if those rules applied if one of the entities was a for-profit business.

mjb: You just brought up another very good point, which is that the disclaimer apparently must satisfy both the rules in the IRC to be effective for federal tax purposes, but must also satisfy the state law rules to be effective for purposes of the income tax laws of the state in which the taxpayer resides (assuming that state imposes an income tax). This message thread has been very illuminating for me.

leevena: If the employer "encourages" people to elect Medicare in lieu of participating in the plan, the employer could possibly get hit with an ERISA section 510 claim, an age discrimination claim, or an audit by a governmental entity. I think that the employer better retain knowledgeable counsel to advise it before it starts doing something like that. Absent obtaining sound legal advice, I think that the employer should remain silent on this topic.

PGBenefitsL You better check out the facts more before you go to the insurance commissioner. As a general rule, the only reason you have a trust is if the plan is self-funded. No plan with less than 20 employees should be self-funded. That means that you might be part of a MEWA. Some states consider MEWAs to be unlicensed insurance companies and will shut them down. A number of MEWAs have turned out to be Ponzi schemes. My recommendation is that you need to hire competent ERISA counsel.

Janet M: Those arrangements were common many moons ago. That's why Congress enacted the limitations on plan loans that are contained in IRC section 72(p) as part of TEFRA 1982.

MJB: Thanks for the citations. I don't recommend anybody reading the Nickel case unless they enjoy doing some extremely complicated mental gymnastics. The court analyzed the wording of the plan in excruciating detail. The moral of the case is that the disclaimer language in the plan document needs to be drafted with extreme precision, or it may not achieve the desired result. QDROphile: You must get a higher quality of plans to review than I do. Given all of the due diligence that I've done on M&A transactions over the past 25 years, I estimate that I've reviewed at least 1,000 plans, and I've never seen one yet that had disclaimer language. But that could be due to the fact that I tend to work on larger, corporate plans rather than plans for professional corporations where the plan is used as a tax shelter technique. The drafters of those plans are often quite sensitive to estate planning considerations; whereas I am blissfully ignorant of those issues. Do you think that, in the absence of enabling language in the plan document, allowing a disclaimer would disqualify the plan (using the IRS analysis that actions not authorized by the plan document would disqualify the plan), or would that be something that you think could be handled by action of the plan's administrative committee? For what it is worth, my belief is that it is beter to be safe than sorry, so I'm going to add such language to my plans.

My point is that violations of the law do not invalidate the law. The fact that most people drive faster than 65 does not mean that the speed limit isn't 65. I admit that there is exceedingly little enforcement of the rules against the UPL, but to say that because there are no prosecutions that such conduct is not the UPL is intellectual dishonesty, to say the least. To say that no prosecutions mean that it is settled law that it is not the UPL is an absurdity.

This is dealth with in Rev. Proc. 2003-44.

Given that the regulations are expected in July, wouldn't it make sense to wait to see what they say? It might make for poor client relations if they take a course of conduct now that is less beneficial to them than as allowed by the final regulations.

Unfortunately, this is an area that I've spent a lot of time researching. You have Form 5500 filing obligations both under ERISA and the IRC. With respect to ERISA, the question is whether the tribal organization is a governmental entity (and therefore exempt from ERISA). That boils down to whether the tribal entity is performing a governmental function. Clearly, operating a gambling casino is not a governmental function. On the other hand, maintaining a police force is a governmental function. With respect to the IRC, Rev. Proc. 2002-64, 2002-2 CB 717, lists the Indian tribal governments that are treated as states for purposes of certain provisions in the IRC. If the entity you are working with is on that list, then you’re probably OK.

Lame Duck: Upon further reconsideration, I must sadly admit that you are right. (I'm not sad about being wrong; I'm sad that so many frivolous lawsuits are filed.) I hereby withdraw my remark.

I had exactly the same problem. In my case, the plan document was the source of source of the problem because it required coverage of all employees, and there was no exclusion for non-resident aliens with no US source income. Thus, there was a failure to operate the plan in accordance with its terms (becuase the plan wasn't extended to non-resident aliens). However, I had two in-depth discussions with IRS officials about my case, and they were both very accomodating. Part of that may have been due to the fact that in because in my client's situation the cost of trying to fix the problem would be much more than the cost of disqualification. Thus, the employer would rather opt for disqualification than to fix the plan. My recommendation is call the IRS to discuss your case with them ahead of time, and then submit it to them via EPCRS.

Mal: I realize that I did a dreadful job of trying to explain my two points. My first point was implicit; the multiemployer plan may not ever even spot this issue, so that if the employer didn't voluntarily bring it to the attention of the plan, it may never surface. I was more explicit about the second point; the employer faces a deck that is stacked against the employer in the arbitration. When you consider both of those points, my guess is that few employers would elect to voluntarily bring this issue to the attention of the plan. But I want to make it very clear that I don't always believe in "hiding the ball" from the plan. My experience has been that if you know that the plan will eventually uncover the problem, you are much better off if you approach them first. I've found that they generally appreciate your coming to talk to them ahead of time to try to work something out that works for both of you, rather than being in an adversial position after the fact. I've had uniformly positive interactions with the plans where we approached them before the problem actually occurred.