In-Service Distribution

[Dougsbpc]

Have a 20 participant frozen DB that is covered by PBGC.

A 50% owner participant has reached NRA and the document allows for an in-service distribution after reaching NRA. This participants benefit represents 60% of all plan benefits. Is there a problem distributing his entire benefit now?

PVAB's based on 417(e) rate is approx $1,800,000 and assets are approx $1,500,000.

The problem is that his PVAB will decrease with each future year.

[mwyatt]

Early termination restrictions under reg 1.401(a)(4) will preclude (or at least hinder) the full payment of his lump sum.

[JAY21]

The early termination restrictions require you to present value the benefits using the current liability rates under IRC 412(l)(7), which are higher than 417(e) and produce lower present values. Also presumably there's an arguement in 2005 that the temporary current bond index rate used for 412(l)(7) for 2005 can also be used for this purpose, so it might not be as restricted as it looks at first blush, although perhaps still not enough given you have to be 110% funded (using current liability rates) after the distribution.

On a separate note, I think there are at least some practitioners that feel that establishing a 414(k) account within the DB plan "might" both (a) apply the 415 limit (high-3) application at the date of election and perhaps avoid a decreasing value of benefit (trust earnings are earned thereafter on account), and (b) plan still has recourse against the 414(k) account upon pre-mature termination if language of 414k election and plan doc support using this approach. I've seen that done. I don't think there is a uniform agreement as to whether 415 is applied at time of 414k segregation, or upon ultimate distribution from the 414k plan account, although if anyone thinks it's crystal clear I would appreciate knowing.

[Blinky the 3-eyed Fish]

There are prior discussions on this, but it's the basic distribution restriction to the 25 highest paid HCE's. The guy could purchase a bond or jump through the other hoops, but none is an inexpensive option. See specifically 1.401(a)(4)-5(b) and Rev. Rul. 92-76.

Now another thing, you mentioned that the value of his distribution is going down. I assume he is at a compensation limit or a suspension of benefits was provided? Anyway, based on the funding status of the plan currently, he isn't going to get his full benefit anyway, so at least for now, he isn't losing anything yet.

(I got a visitor mid-post, so I didn't see the last one when posting.)

[Dougsbpc]

Thanks for the replies mwyatt, jay and blinky.

The 110% of CL of 1.401(a)(4)-6(b)(3) will indeed prevent him from the distribution now.

This plan is now frozen and would have no problem paying all benefits if it were not for the low 417(e) rates. As it is, we changed to unit credit (as required for a frozen plan) which results in annual contributions of approx. $75,000. So the idea is that they will chip away at the shortfall over the next four years or so. We actually wish they could fund more than $75,000 per year but are held to this amount by the 10 year amortization on the change in methods.

Suppose for example he was not currently at the comp limit or dollar limit. How would that prevent his lump sum benefit from decreasing in the future? Assume he established his high three several years ago and can no longer afford to be paid higher salary than his average for the next three years.

[JAY21]

Doug, other than someone limited by the present value of the 415 limit (comp limit) I don't believe a person's present value could decrease (absent a supension of benefits notice/election which doesn't sound like is being given here) as they would get at least an actuarial equivalent increase for deferred benefits (even with a frozen plan). That's why I was thinking he was at the 415 limit high-3 average.

[Guest dsyrett]

Have you considered paying him the life annuity amount permitted under the early termination restructions? This might sidestep the problem of an otherwise decreasing PV.

Some think that this could be done on a non-life contingent basis to avoid any forfeiture at death.

Then at plan term, amend the plan to allow a commuted lump sum as a distrn option.

[Blinky the 3-eyed Fish]

We actually wish they could fund more than $75,000 per year but are held to this amount by the 10 year amortization on the change in methods.

Is not the unfunded current liability going to provide a much higher contribution amount?

[mwyatt]

Hey Jay:

I know the Early Termination restrictions are based on Current Liability, not 417 rates. However, it appeared given the numbers that there would likely be problems since the 110% measurement would be after payment. The exact amount of the owner's PVAB wasn't explicitly given, but with the 60% statement, would peg the 417 PVAB of the owner at $1,080,000. So after payment, remaining PVAB on termination basis would be $720,000, while assets would be $420,000. Don't think interest differential between 417 and CL (even given the corporate rate) would overcome the 110% restriction.

[JAY21]

mwyatt, I certainly don't disagree with you. I'm sure the C.L. interest rate impact is not enough to release the restriction.

[david rigby]

I agree with Blinky. Why does not the UCL provide a higher deductible amount?

[mwyatt]

UCL would if the CL exceeded $1.75m given above (90% of 1.75m less 1.5m in assets = $75k, ignoring interest adjustments). However if 417 liability was only 1.8m, CL on corporate rates probably is less than $1.75m.

[Blinky the 3-eyed Fish]

Why are you taking 90%? The rule being discussed is under 404(a)(1)(D). Also, you can use the old rules for UCL, i.e. not the corporate bond rates. For example, a calendar year plan can use 4.72% for 2004 which is lower than the 417(e) rate of 12/2003 of 5.07%.

[JAY21]

Dsyrett mentioned that there might be a non-life contingent benefit option that some practitioners feel "might" be justified which can be commuted to a lump sum upon later amendment to the plan. As luck would have it, I have a restricted benefit calc I did today and client is looking for some options to soften the blow to the departing HCE.

For doing the first part of this approach (the non-life contingent benefit) do plans typically just rely upon the existing annuity certain (installment) option under the plan (not to exceed the participants life expectancy), or do you think special language must be added to the plan to allow for this non-life contingent benefit in conjunction with a restricted HCE ? I understand that later the amendment to offer a commuted lump sum upon plan term, but for now I'm more intereted in any modifications with the plan doc language to allow a restricted HCE a non-life contingent benefit option.

[Guest dsyrett]

I am not an attorney but I think it could be possible that existing installment payout language in a plan might cover this type of payout.

[Kirk Maldonado]

JAY21:

I seem to recall that there was some language in the preamble to the section 415 regulations issued in the early 1980s that said that setting up a 414(k) arrangement without a formal termination of the defined benefit plan doesn't work.

Is that the answer that you were looking for? If not, please clarify.

[JAY21]

Kirk, I don't think it would be a 414k account but rather just electing an installment payment option with either (a) new language added to the plan that allows installments to be converted to lump sum benefits if installments are being elected soley due to distribution restrictions and plan later becomes sufficiently funded, or (b) language added in conjunction with a plan term to allow a commuted lump sum at that time when assets are distributed.