What happens if the IRS does not issue a favorable determination letter?

[katieinny]

An employer has been operating a cash balance plan for the past 4 or 5 years. The employer is waiting for an IRS Determination letter relating to the plan's initial qualification. It is my understanding that the Service goes to great lengths to issue a favorable letter, having the employer make whatever changes to the plan that might be necessary in order for the IRS to give their blessing.

But what if, for whatever reason, the plan does NOT get IRS approval. Or perhaps the employer terminates the plan before IRS approval is granted?

In either case, I'm thinking the employees would be entitled to whatever assets had accumulated over these last few years. Obviously, if the IRS determines that the plan has not achieved qualified status, the participants would receive taxable distributions with no option to roll.

Could there be a circumstance where the assets would revert to the employer?

[Guest mjb]

What does the plan provide if it fails initial qualification? Usually the funds revert to the employer and the tax return is amended to removed the deductions. No benefits are paid to the employees since the plan is deemed never to have existed.

[GBurns]

Is there any vesting within this 4 or 5 years?

Even if the Plan is deemed to never have existed, this might only be for IRS purpose. There might still be conditions of employment, contractual or other obligations. Some might be addressed in the PD, some might not.

[katieinny]

Yes, there is a vesting schedule, and some of the employees are about to become 100% vested. They've been getting statements telling them about "their" plan assets.

One of the issues is that the company also as a 401(k)/PS plan and ER contributions have been going into that plan. However, when they started the cash balance plan, the contributions to the PS plan were reduced. Naturally, the employees would have a valid complaint if the cash balance plan was deemed to be not qualified and the assets reverted to the employer.

[Locust]

As a practical matter it seems unlikely that the company would forfeit employees' benefits under the Plan, and just as unlikely that the IRS would retroactively disqualify the plan.

I don't think the IRS is working on the determination letter at all - I beleive the IRS still has a suspension on the issuance of any determination letters for cash balance plans.

As I see it, the IRS decision to suspend the issuance of determination letters for cash balance plans isn't as a result of concerns about their qualification; it's more political - a way to discourage employers from implementing them until the various issues are worked out. You do have the rate of accrual issue, but since the IRS didn't initially think there was anything wrong and hasn't formally taken a position, I would think it will be give some sort of transitional relief if it decides that the rate of accrual issue is a concern.

I think the greater danger for a company that has a cash balance plan is the age discrimination issue, because it is a claim that resides with older employees (not the IRS) and would be expensive to correct.

IMHO, the practical issue the company has is whether to suspend further accruals.

[mwyatt]

Was your Cash Balance plan a new plan or a conversion? We had a client with an '03 effective date new cash balance plan that received a letter fairly promptly. Issues on the letter seem to more focus on conversions of traditional db plans.

[katieinny]

Locust, I agree with your "as a practical matter" response. I'm trying to determine what the worst case scenario would be. Based on mjb's response, the worst case is that the assets revert to the employer and the employees get nothing.

I was hoping that if the IRS deemed the plan to be disqualified, the employer would be obligated to make taxable distributions to the employees.

The employer is continuing to operate the plan under the assumption that a favorable determination letter will be issued, although I bet you're right, the IRS is probably not even looking at it.

[GBurns]

If it were me or my client, the "worst case" would not be that it reverts to the employer and the employees get nothing, it would more be that it reverts to the employer and the employees get nothing so they sue.

Are there any FLSA issues in this situation if there is revert to the employer? This was "reasonably expected" and "promised" money beyond the "their" money issue. Could it possibly end up being regarded in the same light as "bonus" money and used in the calculation of OT etc?

[Guest mjb]

My initial comment that assets would revert to the employer was based on the assumption that no vested benefits would accrue. Frankly I have never head of a 4-5 year delay in issuing an initial favorable determination letter. It usuallly takes less than 1 yr. I also recall prior posts which reported that the IRS was issuing det. ltrs for initial adoption of CB plans. It was the conversion plans that have been held in suspense because of wear away and other issues. At one time the IRS had a contact no. to call if the sponsor had not receive a response to a initial CB plan submission to move the process along. Which leads to the Q of what is the IRS answer as to why no letter has been issued. Someone should have been reviewing this delay with the IRS several yrs ago.

As a alternative you should review the board resolution for adopting the CB plan to see if the adoption was conditioned on receipt of a FDL which would allow termination w/out paying benefits if no FLD is issued under the theory that no plan was ever adopted. However, the SPD needs to be reviewed if the plan is not going to pay any benefits to see if there is reference to a failure to obtain a FDL.

[katieinny]

I can't do any follow up with the IRS since we haven't been retained by the employer. The issue was brought up to us by an employee who knows the letter hasn't come in yet, and realized that his account balance might be in jeopardy. The employee probably doesn't have access to the board resolutions, only the plan document and SPD.

[GBurns]

Quite often the Board Resolutions and any Adoption Agreement etc are kept with and incorporated as part of the Plan Document. So if you are really curious, maybe the employee can get what you need fairly easily.

Long ago, I had a fairly similar case, when HR figured out why the employee was asking, I got called by the HR Director and a VP who both wanted me to pursue it for them, as individuals, because they would do almost anything to ensure that they too did not lose. It turned out that the CEO thought that everyone else was looking after it, while everyone else thought he or someone else was. With staff and legal counsel turnover, there was no one who even remebered that there was an issue.

It might be that this company does not know that the issue fell by the wayside nor that there could be consequences. Maybe you can turn this to your advantage, render some service and get a new client.