Treatment of rank and file if plan is disqualifed

[Guest BobParks]

If a plan were disqualified. That is all plan assets were to be distributed, no further contributions could be made; I assume all participants are fully vested but what happens to plan assets.

Are they distributed directly to the participants or are they rolled over into IRAs?

If they are distributed to participants is their a time period where they must either roll over or pay tax.

Are they allowed to roll over.

[BFree]

Since the "qualified" part of "disqualified" refers to tax qualificatioin, I doubt that the assets from a disqualified plan would be eligible for rollover. I have no first-hand experience with it, though.

[Erik Read]

BFree is correct - if a plan is "disqualified" then the assets become taxable to the participants, and the employer loses any deduction status for contributions to the plan as well - VERY UGLY - don't recommend anyone try it.

Pretty rare that a plan would actually be disqualified, the IRS and DOL prefer to have the plan file for what's call CAP, and levy some fines but maintain the qualified status of the plan.

[KJohnson]

I think the majority of the courts that have looked at this have stated that it is the status of the plan at the time of attempted rollover (i.e. if it is disqualified you can't roll over) that governs.

However, when the IRS disqualifies a plan it usually does so for only specified years for either operational defects or because the plan is a non-amender. (e.g. a non TRA '86 amender would not neccessarily be disqualified prior to that date). I believe that there are a few court decisions that "pro-rated" the distribution between amounts attributable to disqualified years and amounts attributable to years that the plan was not disqualified. My recollection is that there is a discussion of these cases in the BNA portfolio on Plan disqualificaiton.

[david rigby]

Let's be careful about the original post. It implied that disqualification means all asset would be distributed. Maybe. Depends on the terms of the plan.

Another caution is timing. The question might be refering to a new plan. Most new plans contain language that states its existence is contingent upon attaining initial qualified status. If such qualification is denied (rather than a disqualification), then the plan provisions will probably dictate what to do, such as "reverse" all payments made to the trust.

[KJohnson]

I think that the "typical" result of disqualification is for the plan to be treated as a non-qualified plan funded by a secular trust--generally not a good thing. What I think this means is that all contributions during the disqualified period would be taxable to the participant and the trust itself would be taxed at trust rates on earnings.

I also believe that under Code §402(B)(4) a highly compensated participant in such a plan will be taxed on the earnings in a secular trust (in addition to the trust being taxed) if one of the reasons that the plan is not qualified is its failure to meet the minimum coverage requirements of Code §410(B) [or §401(a)(26).]