Forfeited Involuntary DistributionsTo Revalue or Not To Revalue?

[Guest ircreader]

We have a debate going over forfeited involuntary distributions and would like to know how others handle it. If we make an involuntary distribution and the check is not cashed within 6 months and we have made reasonable efforts to find a valid address, our plan requires that the benefit be forfeited. Of course, in many instances we cross a tax year before we forfeit the benefit. Say we made a distribution of $2,500 in 2002 and generated a 2002 Form 1099R; now we find out in 2003 that the check was never cashed. We know that the IRS considers the $2,500 as constructively received in 2002 and would expect to see that amount on the taxpayer's return.

Here's the debate:

One side says we should revalue the forfeited benefit when we eventually find the participant because of IRC 417(e). IF the GATT AIR goes up, the value could actually be lower at a later date. But, there's a 2002 Form 1099R out there that shows they constructively received a higher amount. And, what if the revalued benefit exceeds $5,000?

The other side says we reinstate the forfeited amount and pay a reasonable interest rate until we find the participant. That way the 2002 Form 1099R is still accurate since they had a claim of right to the $2,500 in 2002 but for failing to keep the plan informed of their change in address. We would only issue a Form 1099R in the subsequent tax year if the interest earned exceeded $600.

We can't be the only ones that deal with this issue. Anybody care to enter the debate?

[mwyatt]

A couple of observations (from the hypothetical perspective of the recipient):

How did you guess that I didn't want to roll this amount over to an IRA, rather than have it paid to me directly? I know that I still have the 60-day window available to me, but I now have to float my funds in order to make up for the mandatory withholding amounts that you took out of my distribution, causing me "pain and suffering" in order to make my retirement distribution whole...

And two, I guess you didn't ask me, since I was obviously not able to make this decision, since you never contacted me in the first place. And are you so sure that it wasn't a mistake on your HR department's side that caused this check never to reach me?

My point: hope that none of these folks who now face IRS inquiries put their heads together and find some hungry lawyer. Otherwise, I'm not sure that this type of practice really is defensible in the court of law...

[Guest ircreader]

I apologize if I did not make this clear. These are involuntary distributions (under $5,000).

[AndyH]

I'd be curious to know exactly what the plan says. Aren't we either forfeiting it or not forfeiting it? How do we forfeit something and later pay it?

[mwyatt]

Hey IRC:

I know that these are involuntary distributions. I guess I'm a little uncomfortable with the idea of sending out checks to people without their knowledge and without verification of receipt/current address, and potentially triggering serious tax consequences for these folks due to their nonreceipt of funds. I do know I'd be a little ticked off if this occurred to me.

As to your point of recalculating under current year minimum lump sum assumptions, I would guess that this could be argued a couple of ways. You could take the point, if you contend that they were paid back in 2002, that their inaction to cash a check (that of course they never received) warrants no payment of subsequent interest, or at best additional interest credited on the check at the rate in effect for the year in which original distribution occurred.

The argument that you should recalculate using the current year assumptions to me would have to begin with the acknowledgement that distribution in point of fact never was made to these people (in which case a 1099-R should never have been issued in the first place). I still think that you are in a rock and a hard place here, without proof of sincere actions to ascertain the most recent mailing address before you originally sent out the checks.

Just my two cents...

Upon further review, I really don't see the rational behind forfeiting these unpaid vested benefits in the first place (assume this is a PBGC covered plan). Worst case if you could never find these people is upon termination of the Plan, their benefits would be paid to the PBGC via the Missing Participant Program. Unless you assume that this plan would never end, why would you assume in your actuarial valuation that it would be ok to not carry an actuarial liability for these missing participants?

[Effen]

I agree with MWyatt. I don't see how you can justify "forfeiting" any benefit. There are lots of ways to find missing participants if the PA gives it some real effort. I suggest that you carry the liability for valuation purposes until the plan terminates, then turn that piece over to the PBGC. I have done this several times and found it to be a very simple process.

[Guest ircreader]

The plan language is ambiguous. Practice is to send a letter telling the participant that the check is coming. If the letter is returned, no check is sent. Problem is that some letters are never returned so the address is assumed to be valid. For instance, we've had instances where the parent of the participant is the address we were given by the participant and it gets buried in the parents' stack of mail. Believe me, we try everything (conduct lots of searches, etc.) but Murphy's law abounds. The plan talks about reinstating the forfeited amount (in the plan of course) if the check is not cashed in six months and if the participant later establishes a valid claim for the forfeited amount, they are entitled to the forfeited Accrued Benefit. No, hard to believe but our plan probably won't terminate anytime in the foreseeable future. It's not just ERISA we're taking into consideration. The IRS is firm that the participant constructively receives the distribution when the distribution is made (when the check is cut). So, you have withholding sitting out there for the tax year the check is cut and that can't be changed in a subsequent tax year. So if you revalue the benefit and the AIR has gone up, the amount of the benefit will go down. Now what do you do about the withholding and 1099-R for the year they constructively (not acutal receipt) received the distribution? Seems like the only solution is to not revalue it; cut 2 checks when the participant shows up - one to replace the check never cashed and one for the interest earned and, finally; issue a 1099-R for the current tax year showing the interest earned only. I haven't found anything yet to convince me otherwise.