Underfunded Plan Spinoff

[Guest Scott McHenry]

Consider a small, single employer sponsored Defined Benefit Plan that was frozen a number of years ago. The Plan is subject to PBGC. The Plan is substantially underfunded due to terrible investment return. PBGC premiums have increased to a significant level for a small employer:

Termination Basis

PVAB

Substantial Owner 1,100,000

10 other participants 700,000

Total 1,800,000

Current assets are 700,000.

What are some potential pitfalls with the following idea:

Spin-off the 10 other participants into a new plan and transfer the 700,000 in assets to this new Plan. This Plan could then terminate under Standard Termination.

The only participant in the remaining plan would be the Substantial Owner. The Plan would remain frozen so 401(a)(26), 401(a)(4), and 410(B) should not be ongoing concerns. The Plan would no longer be covered by PBGC and as such would not have the significant PBGC premiums. The company could then fund the Substantial Owner’s benefit and then terminate this Plan when sufficiently funded.

[MGB]

But, doesn't ERISA require the spin-off transaction to put EACH participant in the same funded status as before the spin-off? Therefore, only a pro rata portion may be spun off. It is only when you have excess assets that you can manipulate how much goes to each plan.

[Guest Scott McHenry]

Thanks for the response. I appreciate your help.

I see now in 1.414(l) that each participant receive benefits on a termination basis from the plan immediately after the transfer which are equal to or greater then the benefits the participant would receive on a termination basis immediately before the transfer.

The key issue being that benefits on a termination basis are benefits that would be provided exclusively by the plan assets pursuant to ERISA 4044 allocation.

[david rigby]

Can the sponsor fund the difference now?

[Guest Scott McHenry]

The sponsor wants to fund the difference over a period of 3-4 years. They do not want to do it in one year due to bank loan covenants (expanding store locations) and operating income concerns.

The goal of the idea was to save on PBGC premiums for the next few years until fully funded.

The 4044 allocation of assets may actually help somewhat since a quick look at it shows about 300,000 of the liability as Priority Class 3 (none to Substantial Owner) with the rest PC 4 and 5. It may actually look something like this:

4044

Allocation

S/O 200,000

Others 500,000

Total 700,000

The sponsor could then fund the remaining 200,00 (700,000 liability - 500,000 allocation) for the other participants in the Plan with the other participants in a year or two and then terminate that Plan.

That would save on PBGC Premiums for at least years 3 and 4 and would save on the Premium for the unfunded portion related to the S/O since this would be in a separate plan not subject to PBGC.

[Guest Keith N]

Seems like a lot of effort for a 10 life plan. Creating two plans creates the need for two documents ($$), two actuarial valuations ($$), two 5500's ($$), two PBGC filings ($$).

I agree that the PBGC premiums are excessive on small plans, but it seems like a lot of work for a little reward. Even if your $1,000,000 short, that's a $9,000 premium. Maybe you can get things done cheaper with prototypes, but I would image your additional expenses would be at least $4,000 or $5,000 before your all done.