Demutualization Proceeds

[Disco Stu]

I'm dealing with a 401(k) plan that has received proceeds from the demutualization of the insurace company that holds the plan's investments. The trust now holds common stock which will shortly be sold for cash.

The question at issue is the basis for allocating the proceeds to participant accounts.

Based on information provided to the insurance company, policy holders in 12/2001 are the ones who received demutualization proceeds. However, the demtualization was not approved, and the proceeds were not issued until 10/2002.

Obviously, neither my firm (recordkeeping) nor the client is overjoyed by the prospect of allocating these earnings to participant accounts based on their positions in 12/2001. Everyone involved would be much happier allocating the earnings based on the positions at 10/2002.

Is this an issue where the trustee can exercise some discretion? The trustee is going to get the opinion of their attorney, but I am curious about the experience of others on these message boards. Is there any published guidance?

[mbozek]

Proceeds from demutulaization are generally regarded as a dividend which accrues to all participants who benefitted under the insurance policy before the company was demutualized. Therefore the participants who had accounts on the record date would be the correct parties for receiving the demutualization proceeds based upon their account balances as of the record date.

[Kirk Maldonado]

Be aware that if you get demutualization proceeds, you may very well get audited by the DOL (so that they can see how you treated those amounts). Accordingly, you may want to take that into account in determining how to allocate the funds.

[KJohnson]

If this is Principal or Prudential both put out fairly extensive demutualization manuals that presented (but did not really endorse) varioius methods of allocation of demutualization proceeds for both DB and DC Plans.

Of course you have to follow your plan document but it is probably silent on this.

I generally agree that MBOZEK's methodology reprepresents a good compromise and I believe it is the "default" methodology used by the Principal. Of course even under this method if there is an individual who participated for years under the contract but received a complete distribution shortly prior to the demutaliztion date that person may argue that they too were part of the contract during the period that the 'surplus" being distributed was created.

Usng the proceeds for legitimate plan expenses is another possible option, but you don't want the proceeds to sit unallocated in an "supsense" account at the end of the plan year. Also, make sure your document supports this use.

I don't think there is a perfect answer and I think DOL recognizes this.

Also, there are issues in a participant directed plan where the GAC is the basis of some investment options but not all investment options.

[MWeddell]

MetLife also put out a brochure on the same topic too.

There is no clear answer how to allocate it. It's a fiduciary decision.

To give a sense of the range of possible answers, I worked with a Prudential client who allocated demutualization proceeds based on current balances in all investment funds. The rationale was that the proceeds were due to the historical relationship with Prudential, not just who happened to be invested in the guaranteed account on a particular date. They then amended their plan document to clarify that this allocation method would be followed.

[KJohnson]

MWEDDELL--Obviously DOL takes the position it is a fiduciary decision. However, if you amend your plan document is it actually a fiduciary decision?

Typically amending a plan document is a settlor decision and then a fiduciary's duty is to abide by the terms of that Plan document.

If you specifially amend you document to provide a speicfic allocation formula (and assuming you don't run afoul of any vesting/accrual provisions of ERISA or the Code with that formula) have you, in fact, insulated yourself from fiduciary attack on the allocation formula?

[KJohnson]

Here is another issue.

A D.C. Plan was terminated in the late 1970's Several participants selected an annuity option from the plan. The annuities were purchased under a single group annuity contract. The terminated DC plan has now received demutualization proceeds from the insurance company based on this contract.

The former trustee has decided to allocate these proceeds based on the original purchase price of each participant's annuity for all participants (or their beneficiaries) who were still receiving annuity payments on the demutualization date.

The trustee has set up a checking account in the old trust's EIN.

Will these distributions to the former participants be eligible rollover distribuitons?

[mbozek]

I think the answer is yes provided that the plan is amended and brought into compliance with all applicable provisions of the IRC. The proceeds are a dividend under the contract and an asset to be allocated among the plan's participants.

[Kirk Maldonado]

I agree with MBozek. There are some rulings in analogous situations that seem to support that conclusion.

[MWeddell]

KJohnson,

I would guess that the DOL still would regard it as a fiduciary decision. Possibly amending the plan to state how the demutualization proceeds are handled might create the presumption under ERISA 404(a) that fiduciaries should follow the plan document unless they conclude that doing so would be imprudent.

Our motivation for amending the plan was to better insulate us from any participant challenges.

[KJohnson]

I thought that while your document must be updated for current law at the time of termination, it does not have to be updated for subsequent law as long as assets are distributed as soon as administratively feasible. There is the one year presumption in Rev-Rul 89-87 but I would think that the presumption would be "rebuttable" in this case.

The old document had obviously not been updated for TEFRA,DEFRA,REA,TRA'86 not to mention GUST and EGTRRA.

[mbozek]

The determination letter is based upon the terms of the plan when it is submitted to the IRS. Now that the plan has further assets the plan must be qualified under the curent laws. The real question is whether anyone will issue an opinion to the plan sponsor/admin stating that the distributions are eligible for a rollover from a qualified plan if the plan does not contain the necesssary changes to qualfied plans enacted since the plan was terminated.

[KJohnson]

Although I know that I am getting off the original topic I am not sure that I agree.

Take as an example a Plan that terminates in October 2001 but does not make its final distribution until February 2002. Must that Plan be updated for EGTRRA? Similarly, a Plan that terminates today must be updated for EGTRRA and GUST. However, if that Plan does not make a final distribution until February 2003 must that plan be updated for the final 401(a)(9) regulations?

My understanding has always been that as long as you are "up to date" at termination and as long as you distribute assets as quickly as administratively feasible no further amendments are required.

[mbozek]

I thought the rule was that a plan is not deemed terminated until all assets are distributed from the plan and that a plan had to be in compliance with all IRS requirement as as of the date of termination. In order to avoid plans having to make serial amendments after a determinaton upon termination is issued by the IRS where the final distribution would not occur until a subsequent taxable year the IRS gives plans sponsors 12 months from the date of the determination letter to distribute assets. While the presumption may be rebuttable, the question is whether making a distribution 30 or more years or so since the plan was terminated is administratively feasible so as to consider the distribution of the demutualization proceeds to be eligible for a rollover. My question is will the plan admin issue 1099s to the IRS and participants certifying that the proceeds are distributions from a qualfied plan.

[KJohnson]

< the question is whether making a distribution 30 or more years or so since the plan was terminated is administratively feasible so as to consider the distribution of the demutualization proceeds to be eligible for a rollover. My question is will the plan admin issue 1099s to the IRS and participants certifying that the proceeds are distributions from a qualfied plan.>

I agree that those are the two questions. Thirty years is a long time, but then again the distribution could not have been accomplished at an earlier date.

Back in 2001 I had a conversation with the IRS with regard to a Plan that terminated but had one small asset that would not become liquid until 2003 (and for which an in-kind distribuiton was impossible). I told them that 95% of the assets would be distributed within 12 months, but 5% of the assets would not be distribyted for 1 1/2 to 2 years. I asked whether the Plan would haave to be amended for EGTRRA. Their response was no-- as long as all assets were distributed as soon as administratively feasible.

Of course I recognize that this sort of informal advice and $2.00 will buy you 1/2 of cup of coffee at Starbucks.

[Guest ladycpa]

I have a client with a terminated 401k that had a GIC with Principal before they terminated in 1997. They just received the demutualization proceeds in 8/02. We are preparing the allocation to participants based on their account balances at termination. This all seems fine to the client and reasonable to us. The problem I'm having is coming from the Information Letter the DOL put out on 2/15/01 to the Groom Law Firm. That letter dealt specifically with the Prudential demutualization and whether or not welfare benefit plans that received the proceeds had to establish a trust specifically for those proceeds even though they were exempt from the trust requirement generally. In my client's situation they would be subject to the ERISA trust and reporting requirements generally as a pension benefit plan. Does this really mean that terminated pension plans have to establish a new plan with trust and file Form 5500s until all proceeds have been distributed? If so, I think that's ridiculous. Any thoughts?

[KJohnson]

There is one PLR regarding demutalization proceeds distributed to a terminated DB plan---200214031. Sal Tripodi has an interesting discussion of this in his 2002 ASPA outline (at page 152) that can be found here:

http://www.aspa.org/archivepages/conferenc...odi-closing.pdf

He goes into such "practical" things as 1099R implications "reactivating" a 5500 obligation etc.

[Guest ladycpa]

thanks for your reply. I will check out those cites.

[mbozek]

Who is the check payable to? In welfare plans the contract was usually issued to the er so the proceeds are paid to the er. In a 401(k) plan the trustee of the plan is the payee on behalf of the participants. If there is no trustee of the plan who can legally cash the check? If the er does the cashing then it is doing so under a constructive trust for the benefit of the participants and may be required to file a 5500 to show the disposition of the assets as the plan admin. My understanding is that the DOL has been performing audits of de mut. proceeds by subpoening the list of plans that have received checks from the carriers to determine if the provisions of ERISA have been complied with.