Distribution of vested benefit, directly from employer checking accoun

[Moe Howard]

A profit sharing plan's assets are in investments that are not easily convertible into cash. The plan must distribute a former participant's $25,000 vested benefit to him within the next 30 days. The plan's regular discretionary PSP contribution for the current year will be $100,000.

My Question:

Can the employer (rather than the plan), directly pay the former participant the $ 25,000 ? .... Or must the $25,000 be paid directly from plan assets?

I would think that the employer could give the former participant an employer check for $25,000 and then the employer could deposit $75,000 to the plan (but employer would get credit for a $100,000 contribution, rather than just $75,000).

[E as in ERISA]

This is potentially a lending of money from the employer to the plan. See PTE 80-26 and related materials.

[david rigby]

Does the plan have a checking account, or cash account? If so, the ER can make a payment to that account, which is part of its $100K contribution. Then the participant can be paid from that account. Much better audit trail.

P.S. If the plan does not currently have such an account, this would be a good time to create one.

[E as in ERISA]

Yes. That would remove any question of whether you have met the 3-day requirement of PTE 80-26.

[Moe Howard]

Katherine --- when you said "YES" (in above reply) .... are you saying that employer can do what I described ?

[E as in ERISA]

I was agreeing with pax's idea about running it through the plan.

[Kirk Maldonado]

I believe that there are major problems associated with the employer paying the amount. For example, it wouldn't be a payment from a plan. Therefore, it couldn't be rolled over, etc.

[Moe Howard]

Does PTE 80-26 define the word "loan" ?

In other words ---If employer pays the plan's debt ($25,000) directly to a third party (the former participant) .... does that create a loan under PTE 80-26 ? If so, then a $ 25,000 loan (due by plan to employer) arose without the plan ever having possession of the $25,000 that employer paid.

As far as repayment by the plan (of the $ 25,000) to the employer.... wouldn't such repayment arise when the employer informs the plan that the employer wishes to contribute $100,000 to the plan for the current year, but since the plan already owes the employer $25,000 -- then the plan should retain such $25,000 and apply it toward the employer's current year contribution. Then employer would pay the plan $75,000 and thus, the $100,000 contrinution would have been made.

If all the above is done within 3 days .... then the 3-day execption of PTE 80-26 says that such a loan is exempt from PTE 80-26.

It all depends on how PTE 80-26 defines the word "loan".

[Kirk Maldonado]

I don't think that the PTE issue affects my concern about what entity actually pays the benefit.

For the loan to work, the employer would have to loan the funds directly to the plan, with the plan using those funds to pay the participant.

[IRC401]

I agree with Kirk. Do not make payments out of a corporate account.

I have vague memories of a PLR dealing with a situation in which an employer terminated a plan, transferred the plan assets to a corporate checking account, and paid the participants out of the corporate aco****. The IRS disqualified the plan.

[E as in ERISA]

It was my understanding that some sponsors use PTE 80-26 as the basis for paying benefits out of corporate accounts and then reimbursing themselves with a payment from the plan (e.g., in a small plan without an outside trustee where the plan is invested in mutual funds and they won't cut checks to participants).

Here is a link to PTE 80-26:

http://www.dol.gov/pwba/programs/oed/80-26admend.htm

The requirements of the PTE, as amended, are as follows:

(a) No interest or other fee is charged to the plan, and no discount for payment in cash is relinquished by the plan, in connection with the loan or extension of credit;

(B) The proceeds of the loan or extension of credit are used only--

(1) for the payment of ordinary operating expenses of the plan, including the payment of benefits in accordance with the terms of the plan and periodic premiums under an insurance or annuity contract, or

(2) for a period of no more than three business days, for a purpose incidental to the ordinary operation of the plan;

© The loan or extension of credit is unsecured; and

(d) The loan or extension of credit is not directly or indirectly made by an employee benefit plan.

[Kirk Maldonado]

The fact that some plan sponsors do something does not make it right. Hell, some employers steal money from plans, and that doesn't make it right.

[E as in ERISA]

But there isn't a PTE that even remotely allows stealing!

This PTE appears allow an employer to extend credit to the plan through "payment of benefits in accordance with the terms of the plan."

[Kirk Maldonado]

The existence of the PTE is completely irrelevant.

The issue is whether the participant received a distribution from a plan. If the benefit is paid out of the company's checking account, then, by definition, it isn't being paid out of a plan.

If it isn't paid out of a plan, it can't be rolled over into an IRA or otherwise qualify for favorable income tax treatment.

The simple solution is for the employer to lend the plan the money and have the plan use those funds to pay the participant.

[mbozek]

I see three separate issues here:

1. the PT issue both on the DOL and IRS 15% pt tax by paying the benefits from the employers corporate account instead of plan assets. Obviously the PT issues is an audit matter but it would be real painful if the employer has to p ay the tax and reimburse the plan for use of Assets-- I guess it up to counsel to determine if the PTE can apply here but why pay for a legal opinion when it is cheaper to open a checking account for the plan. Paying benefits from the employer's account is non uncommon where the plan assets are held by a custoidan who does not have payment authoirty-- The Er trays to save expenses by having the distribitions paid from the employer's general account and then having the custodian pay the distribition to the er. which leads to issue No. 2.

2. Distribution issue: If the Er cuts the check from its own account is this a distribution from the plan eligible for a tax free rollover? Who prepares the 1099 and whose tax ID number is used on the 1099? If the er cuts the check from its own acoo**** I dont think the distribution qualifies for rollover treatment because the benefits are not paid from the plan. This means the employee could be taxed on the distribution at least until the s/l expires after 3 or 6 years. This leaves the er with a big exposure for ee taxes. The employee would be subject to the 6% ecess contribution tax for each year the amount is kept in an IRA.

3. Benefit claim. If the payment is made by the er, cant the employee sue the plan for his /her accrued vested benefits on the grounds that employee has never received payment of the accrued benefits from the plan. How would the plan admin defend against such a claim. By using a fraudlent 1099 from the plan as proof of payment? The employee could also claim that the transfer of assets to the ER was a PT which would be running the pt issue up the flagpole.

I dont think the er can make payments from its general accounts under the PTE cited above without an ERISA / IRS violation. If the ER dosent want to pay for a checking account from the plan then the er should use a SEP or simple plan where the contributions are placed in the employees IRA and there is no need to make a distribution from the plan. Of course the er doesnt get the option to use forfeitures for contributions and has to cover part timers but is is a better way to adminsiter the plan.

[Kirk Maldonado]

Although I wouldn't have phrased it in the same manner as MBozek, I concur in his reasoning.

[Belgarath]

I was doing a search due to a similar question, and wondered how you felt about the following solution:

Employer simply writes a check to the Trustee of the plan for 25,000. Now it is a plan asset. Trustee simply turns around and endorses the check to the First National Bank of East Overshoe FBO John Doe IRA, or whatever. Plan properly reports the distribution, employer deducts the contribution, and everyone is happy.

If there's no rollover and 20% withholding is required, do it with 2 checks insted of one.

Only potential hole in this that I can see might be the plan language on how a contribution is allocated - this 25,000 isn't really being "allocated."

On the other hand, it seems like a reasonable accomodation, particularly where this preserves plan assets for the remaining participants by not forcing a liquidaton of assets at a loss. Hard to see how the Regulatory Powers would get upset over this?

[mbozek]

I thought that contributions are made to the Plan trustee, not to individual participants. Participants receive an allocation of contributions to their account. I dont think that an endorsed check is a plan asset until the check is deposited to the plan's account.

[david rigby]

I agree. Why would the plan and/or plan sponsor want to do something that created an ambiguous (at best) audit trail, especially when it is so simple to do it right.

[KJohnson]

I have talked with DOL about the situation that is common for some small plans where the brokerage house does not agree to perform any withholding or 1099’s and therefore pays the distribution to the trustee of the Plan. The Trustee then deposits it in a checking account for the Plan and makes the distribution to the participant and applicable withholding. However, the employer is constantly given grief by the bank or charged fees because this bank account typically only has assets for a few weeks each year (especially for those plans that only allow distributions after the end of the plan year).

I asked whether under PTE 80-26 the employer could “seed” the account as an interest free loan in a sufficient amount so that the account would not be subject to closure by the bank if there was no balance or be subject to fees if the balance was below a certain minimum. The person I spoke with at DOL said that he believed that this should work under PTE 80-26 and would fall under the “payment of ordinary operating expenses of the plan including the payment of benefits in accordance with the terms of the plan” You would just book the seed money as an asset and reflect the repayment obligation as a corresponding liability. That way your plan assets and account balances should still match.

He also indicated that although it was not certain, he thought it very likely that there would be an amendment to 80-26 in the near future which would remove the three day limit for an interest free loan incidental to the ordinary operation of the plan. This would then remove, in his words, “all doubt” on the subject.

[Locust]

KJohnson - I think the seed money idea complicates the asset accounting unnecessarily and should be avoided because:

1. The documentation for the seed money - "it's a loan but it's exempt, it's not an asset that is to be allocated, it's not a suspense account, etc." - will be more expensive than just paying the bank fees. It is much cleaner not to have these issues.

2. You still have the issues with loans and reimbursement of expenses paid by the company. I'm not convinced that this works under the rules. I could be wrong, but I'm an experienced person and my doubts are reasonable. Why have this sort of issue that must be explained to the IRS or DOL or participants if it is ever reviewed? In my experience asset issues are the first ones that a DOL auditor reviews - and if he or she sees a suspense fund like this, it is an issue.

3. The Plan has to account for this seed money every year. This would be another quirk in administration that has to be explained to everyone who works with the plan every year.

4. Why doesn't the employer just pay the bank fees?

5. IMO - Brokerage houses that don't have a reasonable way to handle payments should not be given the business.

L.

[Guest RBlaine]

5. IMO - Brokerage houses that don't have a reasonable way to handle payments should not be given the business.

Couldn't agree more!!!

[mbozek]

Brokerages are not banks and legally cannot provide banking services for clients. Even banks do not want checking accounts for occasional use customers, for example irrevocable trusts which hold life insurance policies and write one check a year to the ins co. cannot find a bank that will open a checking account in the name of the trust. If you are paying $5-10 a trade dont expect to get ancillary services.

[KJohnson]

Locust,

I agree that it is not the greatest solution, but I have been told by two small plan sponsors that they could not find a brokerage house that would provide the 1099R/941 service for a reasonable fee for a small account, or a bank that would keep the account open or not charge fees. I did not go out and test this on the market myself, but assuming this is true this seemed like one solution that would work, there might be others. As to your points:

5. IMO - Brokerage houses that don't have a reasonable way to handle payments should not be given the business.

I agree but I am told that for some small accounts, brokerage firms won't provide these services or they come with ridiculous fees. Also, my first suggestion when this came up was to change banks, but was again told that you could not find a bank that would hold open an account like this one that has a $0 balance for most of the year. Mbozeks comments seem to confirm this

4. Why doesn't the employer just pay the bank fees?

I agree that this is the best solution if you can get the bank to bill the employer directly but: a) I have dealt with one plan sponsor who indicated its a plan expense and they are not going to pay it; b) It doesn't deal with the issue of the account being closed for a $0 balance and c) Typically the fees are deducted from the account directly. If the account is in the plan's name and you have the employer then reimbursing the fees and you have more of an accounting headache than the no-interest loan. Is it a contribution, does it have to be allocated.

3. The Plan has to account for this seed money every year. This would be another quirk in administration that has to be explained to everyone who works with the plan every year.

It would be a static asset and liability. I agree it would have to be on the balance sheet etc. but I don't really see this as a big deal.

2. You still have the issues with loans and reimbursement of expenses paid by the company. I'm not convinced that this works under the rules. I could be wrong, but I'm an experienced person and my doubts are reasonable. Why have this sort of issue that must be explained to the IRS or DOL or participants if it is ever reviewed? In my experience asset issues are the first ones that a DOL auditor reviews - and if he or she sees a suspense fund like this, it is an issue.

Why don't you think this works under the PTE? What are your doubts? I would be the first to agree its not the best way to handle this, and the two situations I reviewed it was already in place and I wanted to make sure that there was no PT. Finding a different brokerage house or bank is the best solusiton assuming you can get the services for a reasonable sum. That said, I think the explanation to the regulatory authories is fairly simple-- the employer wants to save the plan fees and expenses. I would think DOL audtor would appreciate the concern

1. The documentation for the seed money - "it's a loan but it's exempt, it's not an asset that is to be allocated, it's not a suspense account, etc." - will be more expensive than just paying the bank fees. It is much cleaner not to have these issues.

The asset is completely offset by the liabiltiy so I am not sure that there is really anything to allocate. It is also not a contribution or earnings. So I am not sure this is an issue. The documentation issues of 80-26 are not really that cumbersome.