Underfunded DB Plan/Payment of Unrestricted Amount

[Guest]

I have a client with an underfunded DB plan. The oldest HCE wants to retire and take a lump sum. After explaining the restriction he is willing to take payment of the unrestricted amount.What election forms does he have to be given? Is he in fact electing a single-life annuity? He would have taken a lump sum if it could have been paid.The plan's normal form of benefit is 10c&l,plus there's the QJSA requirement.What happens if he dies?

[AndyH]

This is a tough one. I have the same situation. I look forward to some discussion on this.

It appears to me that the client must elect one of the annuity options available under the plan, with whatever death benefit that option provides for. Or the lump sum can be collateralized, escrowed, or bonded.

One question is what happens when/if the restriction is removed due to improved funding. Can another election then be made, and if so would a lump sum then qualify for rollover treatment (I think so).

[Lorraine Dorsa]

I have a client who came close, but did not get caught by this on the distribution to an HCE last year. However, since several other HCEs will retire in the next 5 years, it is likely that this will come up in the future so the attorney did some research.

The attorney's position was that the participant had to elect the form in which he would receive his benefits (in accordance with the terms of the plan document) and could not later re-elect to receive a different form. Therefore, the HCE could not elect an annuity now and then elect a lump sum later.

My suggestion to the attorney was why not have the HCE elect a lump sum if that's what he wants and then have the plan limit his payment to the maximum allowable amount (=amount of a life annuity payment) each year and then, if at some time the restriction no longer applied, pay him his remaining amount in a lump sum. This distribution would not be an annuity (no life guarantee), but simply a string of lump sum payments.

Attorney does not see anything wrong with this legally, but he's uncomfortable with the practicalities of this--he would like to be able to tell the participant for sure how much he would get each year, when he would get the balance of the lump sum and is worried about the participant getting used to the annual distributions and assuming they were guaranteed for life and then having the money run out.

This is still an open issue for this plan since the other HCEs are not at retirement age yet, but it's coming up in the next year or so.

[Guest]

I think this has potential,but...what happens if the plan does terminate in an underfunded state? If your HCE had really taken a lump sum and posted the appropriate security the Plan Administrator could collect and refund the remaining restricted amount to the plan.How do you address this issue within the plan? My HCE is one of four owners, so he could conceivably be asked to bear his share of any shortfall.Would this apply to your guy?

Also,for what it's worth ,I don't think much of the attorney's concerns.First,the amount should stay constant from one year to the next, except for any actuarial increase,no?Nobody ever complains about getting more money.Second,if the plan runs out of money and they can't pay his benefit,they probably have a lot more and bigger problems.Lastly,as for him "getting used to " the payment,so what? In addition to whatever plan amendment is necessary there should probably be additional documentation in place spelling out everybody's responsibilities.If he has to give something up,so be it.

[Lorraine Dorsa]

If the HCE takes the series of lump sums noted above, he would still have a significant remaining benefit in the plan any some reasonably soon after he began taking payment (less, of course, as time goes on). So if the plan terminated in an underfunded status, he could be made to share the hit for the underfunding.

I think attorney's concern re 'getting used to' a specific dollar amount each year is really a concern re the client thinking he had elected an annuity with a life guarantee rather than a series of lump sums. I agree that documentation would have to be most clear, but the employer in question is a law firm and the HCE in question is a senior attorney and the pension attorney wants to make sure that there are no loopholes that he'll have to deal with later.

[Everett Moreland]

I'm drafting a defined benefit plan and need to decide whether to deal with the restricted employee rules by (1) providing a term annuity with month payments equal to those under a straight life annuity or (2) following Ms. Dorsa's suggestion by providing that a restricted HCE who elects a lump sum will receive monthly payments equal to those under a straight life annuity until the restrictions cease to apply and then will be cashed out. My questions are: (1) would following Ms. Dorsa's suggestion violate the 1.401(a)(4)-4 availability rules because it makes available to restricted HCEs a payment form not available to NHCEs and (2) should I be asking other questions?

[mwyatt]

From a practical standpoint, I would say that your HCEs are the ones who are being restricted, not the NHCEs (remember, your HCEs, if given the chance, would take the full lump sum immediately if not for the Early Termination restrictions). I wouldn't think that you would have a BRF issue in this circumstance.

[Guest jgroves]

I've come across this issue as well and reading all the post (past and previous) have been very enlightening. Now, here's a catch that I know must be wrong but I can't think how.

Since this issue only affects HCE in a non-bargaining unit position, what's to stop the employer from putting that individual into a bargaining unit position for a month and then paying out the whole lump sum amount? There would be the safe harbor since he/she is covered under a CBA. Thoughts?

[david rigby]

How about "form over substance"?

[Guest Brian4]

Another issue. Part of the benefit was accrued while a non-bargained employee, the other part while a bargained employee. In the above situation, to attribute all of the employees benefit to non-bargained service, one would need to use the rule in regulation 1.410(B)-7©(4)(i)©(2):

(2) Attribution Of Benefits To Current Disaggregation Population.

If employees benefiting under a plan change from one disaggregation population to another disaggregation population, benefits they accrue while members of the first disaggregation population may be treated as provided to them in their current status and thus included in the portion of the plan benefiting employees of the disaggregation population of which they are currently members. This special treatment is available only if it is applied on a consistent basis and if it does not result in significant discrimination in favor of highly compensated employees.

The last condition appears difficult to satisfy in practice.

[MGB]

Where did you find a reference that this only applies to nonbargained employees? It is my understanding that such a distinction does not exist.

[Guest Brian4]

Interesting comment. This point was originally made by other posters. However, here is one possible explanation. The restriction on distribution rules are now in the non-discrimination rules. And, the non-discrimination rules are satisfied by collectively bargained plans. See Regulation 1.401(a)(4)-1©(5).