Pre-Termination Restrictions

[Guest pensionpete]

A Restricted Participant (top 25) who terminates employment elects a lump sum distribution of his benefits. Due to the Top 25 restrictions under 1.401(a)(4)-5(b), the participant's benefit is divided into a restricted portion and a non-restricted portion.

Under Rev. Rul. 92-76 a participant can receive both portions of the lump sum benefit provided certain restrictions are established in order to protect the Plan (i.e., letter of credit, surety bond, escrow account, etc). In fact, the participant can rollover his entire benefit to an IRA provided these restrictions are satisfied.

However, in my case, the Plan Sponsor does not wish to pay out the restricted amount - only the non-restricted amount. So the participant will receive a lump sum distribution each year of only the non-restricted amount.

Question - can the annual single sum payments the participant receive be rolled over to an IRA or does this type of payout fail to meet the "lump sum" definition (i.e., the participant fails to receive the balance to the credit within a taxable year).

It would seem logical (?) that if a participant could go thru all the hoops provided in Rev. Rul. 92-76 and have the full benefit paid in a lump sum and roll it over to an IRA or other qualified plan that a participant/plan sponsor who keeps the restricted portion in the Plan (which is the safest way to go from the Plan's perspective) should not result in a worse position for the participant.

Any thoughts would be welcome.

[AndyH]

There have been many discussions of this subject here. My understanding, which to my knowledge nobody has disagreed with here, is that such payments would not qualify for rollover treatment because they are part of a series of payment extending over more than 10 years. This is because the unrestricted amounts should be similar to life annuity amounts, i.e. being paid over the participant's lifetime.

Just one opinion, but it has yet to be disproven as far as I know.

[rcline46]

I would consider this two ways.

1. since the participant cannot take all of the money, he selects lump sum and the plan pays the coverted annuity until such time as the full (reduced) lump sum can be paid. Annuity payments cannot be rolled, but the final lump sum can.

2. Participant elects lump sum and takes each year what is available to be released that year. I think the lump sum can be rolled. I also think that the amounts released each year can be rolled because they can fluctuate form -0- to full remaining balance and are arguably the balance to the credit.

(wasn't balance to credit removed several years ago as a restriction??)

I do NOT think it is a stream of payments because the participant never elected a stream, they do not fit definition of installment payments or any other definition which precludes rollover.

IMHO, and only the IRS can tell for sure.

[AndyH]

Well, the saying used to be "that's what makes horse racing"; now I guess it's "that's what makes craps tables".

This is the IRS model Benefit Payment Information Pamphlet language:

"The following types of payments cannot be rolled over:

Payments Spread over Long Periods. You cannot roll over a payment if it is part of a series of equal (or almost equal) payments that are made at least once a year and that will last for:

_ your lifetime (or a period measured by your life expectancy), or

_ your lifetime and your beneficiary's lifetime (or a period measured by your joint life expectancies), or

_ a period of ten years or more. "

I think the restricted payment fits this category.

[MGB]

Well, how about if we ask Jim Holland, et. al., at the IRS?

This is their response (2003 EA Gray Book Q&A):

QUESTION 24

Restricted Employees: Payments Under Lump Sump Option and Rollover of Payments for High-25

a) If a “high-25” HCE elects a lump sum currently that cannot be distributed immediately, would this election lock in the interest and mortality assumptions as of the date the benefits would have commenced had they not been restricted under 1.401(a)(4)-5(b)?

b) If the HCE elects the lump sum now but cannot be received due to the restrictions under 1.401(a)(4)-5(b), are the monthly “single life annuity” payments equivalent to the accrued benefit that may be distributed eligible for rollover as the lump sum would be?

RESPONSE

a) The “high 25” limits do not restrict the participant’s choice of option, just the dollar amount that can be paid in any year until the restrictions are lifted. Restricting the payments should lead to a net result for the participant that is similar to actually paying the selected benefit and obtaining a bond or security interest. Thus the plan can provide that the remaining lump sum, including interest at the rate used to determine the lump sum, is payable at the time the restrictions no longer apply. Note that the high-25 limits no longer expire on death. The restrictions continue to apply to the beneficiary until the financial targets are met or the participant is no longer one of the highest 25 paid employees.

b) No.

[MGB]

PensionPete:

I am confused by your statement "nonrestricted amount". There is only one nonrestricted amount for payment -- that is the single life annuity amount. No more than that can be paid, period (unless they pay the entire lump sum and then enter into an escrow agreement).

The rules about "restricted amounts" and "nonrestricted amounts" have to do with escrow (or letter of credit, etc.) arrangements. They have nothing to do with how much may be paid out of a plan at any particular time.

[AndyH]

Thanks, MGB. I had not noticed that Q&A. That is extremely helpful.

p.s. I had gone thru the 2003 Gray Book. I must have fallen asleep before I got to #24. It was pretty dry stuff as I recall.

[AndyH]

And Q&A 25 reminds us that if the restricted amount had qualified for rollover treatment, 20% mandatory withholding would have applied.

[Guest pensionpete]

Thanks everyone for the replies.

MGB - I think we're talking the same thing - just semantics.

Waiting to see if client wishes to go for a ruling...or go path of the escrow account.

It is my belief that the 2 pieces of law have created an unintended and illogical consequence. If you can accomplish a rollover via the methods in 92-76 why not achieve the same result by keeping the restricted amount right where the law intended it to be - in the Plan.

[AndyH]

The gray book Q&A raises a lot of questions in my mind. How is interest on the seggregated balance determined, at the initial rate used to calculate the lump sum, or based upon actual experience? If the initial rate is locked in, and assets tank, then you've got a real mess. And you could have other complications if the restricted amount is near the 415 limit.

Under the Q&A approach, is the seggregated amount subtracted from assets and liabilities for funding and current liability calcs?

I have candidates for this Q&A approach right now, but how are these issues properly handled?

[Blinky the 3-eyed Fish]

Andy, what do you mean by segregated amount? I presume this is the same as the restricted amount and not a 414(k) question.

[AndyH]

Blinky, please excuse my terminology, but what I thought the Q&A said is that you can do within the plan what you could do outside the plan if you had the appropriate escrow or bonding, that is take the lump sum amount and put it in an "account", withdrawing the unrestricted life annuity amount when available. Then I thought it implied that the balance would be credited with interest at the initial rate used to compute the lump sum.

Is this not right? If it is right, you've guaranteed a certain positive rate of return at a time when a positive rate of return is otherwise not certain.

If it is not right, then at what rate do you credit the restricted balance?

And in either case, is this restricted amount subtracted from assets for valuation purposes? If not, how is it handled?

[Guest pensionpete]

In our case, the interest rate being used to calculate the initial lump sum amount is also the interest rate to be used for the restricted balance on a go forward basis.

[AndyH]

Imagine if you did that a few years ago, the restricted amount represented 50% of plan assets, and the assets declined by 51%.

[MGB]

Why would that be any different than the person electing an annuity a few years ago?

In fact, you would be in a worse situation is they elected the annuity. The current PV of the annuity would be more than the restricted amount rolled forward with interest (they would be the same if you rolled forward with both interest and benefit of survivorship, i.e., an actuarial increase).

On your other question, the remaining restricted amount is part of the liabilities and assets of the plan, in my opinion.

[AndyH]

If the restricted amount is not subtracted from assets for purposes of funding other benefits, I would agree that there is no difference.

But in such case, I would think that the restricted balance would need to be converted back into annuity form for funding calculations. And at what rate? Surely not the initial lump sum (presumably using 417(e)) rate.

And if the conversion rate for funding, current liability, etc. differs from the interest crediting rate, wouldn't that create weird results?

[MGB]

My approach would be to consider the restricted amount the liability with no conversions. There is no way for the actual payments to be converted back into an annuity, so there should be no reason to value it that way.

I could see an argument for projecting out an expected stream of payments. For example, given the funded status, expected benefit payments and minimum required contributions, let's say that the amount is expected to become unrestricted in three years. Saying that the liability is the present value of the cash flows over three years would be reasonable. I don't think it would be reasonable to assume any contribution in excess of the minimum.

If the projection shows that it would never become unrestricted by only making the minimum contributions, then that still is not a life annuity. It is a fixed annuity until the restricted amount runs out, based on the interest crediting rate.

[AndyH]

Would you also consider the restricted amount to be the same liability for all calculations, i.e. OBRA CL, RPA CL, PBGC CL and the funding liability, even though each interest rate or mortality assumption might be different?

[MGB]

Yes, if you are viewing it as a single amount.

If you are doing the projected cash flows as described above, you would get different liabilities. Only the interest rate differences would matter, there would be no mortality as part of the calculations (the same stream of payments are made whether or not the person dies - a point made in the earlier referenced Q&A).

[Blinky the 3-eyed Fish]

I have a client in this situation and it's driving me insane. Say he chooses the lump sum option now, which the Q&A says will be credited with future interest at the current rate. Would he be required to take the unrestricted annuity amounts each year, which can't be rolled over, again according to the Q&A, or can he just wait until the plan is unrestricted to take the whole enchilada.

I am not sure on what basis he could refuse the annuity amounts if electing a lump sum now, but am hoping there is an argument for it.

[AndyH]

It seems to me that he is electing to receive it (subject to whatever limits) or he is not electing to receive it now. I don't see any argument for a middle ground.

Why would he make an election if he doesn't want some of it now, to lock in the low rates?

[Blinky the 3-eyed Fish]

Yes, to lock in the low rates and because he is past NRA and his benefit is decreasing.