Excess Earnings in DB

[Guest MMorgan]

We have a doctor age 70 who is still working. The market value of his DB plan is about 4.8 million. The actuary has calculated he is @ the 415 limit. The maximum distribution, according to our actuary, he will be permitted to take is roughly 2.7 million. The dr. has not contributed in years. The excess "balance" is totally due to wonderful investment return.

There are 3 employees who are low paid and work for him a few years.

We are a TPA firm. The plan has been with our firm for many years. I don't believe the dr. is aware that there is a maximum amount he can withdraw from the db. It appears (by reviewing the file) he plans to roll the entire balance over to an IRA.

Help! Any TPAs out there that have faced this situation? I'm a DC person. Any suggested remedies anyone can think of??

[david rigby]

Perhaps you could tell him.

Perhaps you could enlist the aid of accountant and/or counsel.

[John Feldt ERPA CPC QPA]

If the plan just recently became this overfunded, that's great. If it happened many years ago, then discussions with your firm and with your client should have started back then, explaining how DB plans really work.

I remember a DB client that became overfunded in the early 1980's and could not contribute ever again. We took over the work in the mid-late 1990's.

One option we provided was to terminate the DB plan and establish a QRP (Qualified Replacement Plan), transfer 25% of the excess assets (the amount over the 415 limit) to the QRP and revert the rest to the employer. The reversion amount has a 20% excise tax instead of 50% because 25% of the excess assets were transferred to a QRP. The reversion amount was also subject to corporate income tax. The QRP suggested was a profit sharing plan.

The amount transferred to the QRP then had to be allocated over a period not to exceed 7 years, so he needed to have compensation to support the allocations.

This approach would get $1.575 million back to your client's corporation, but then they would be paying $315,000 in excise tax plus income taxes on the $1.575M.

The other problem would be to allocate the transferred amount of $525,000 - it might not all be allocated within seven years. Look at 4980(d)(2)(C )(ii).

If, by reason of any limitation under section 415, any amount credited to a suspense account may not be allocated to a participant before the close of the 7-year period, such amount shall be allocated to the accounts of other participants, and if any portion of such amount may not be allocated to other participants by reason of any such limitation, shall be allocated to the participant as provided in section 415. Any income on any amount credited to a suspense account shall be allocated to accounts of participants no less rapidly than ratably over the remainder of the period. If any amount credited to a suspense account is not allocated as of the termination date of the replacement plan, such amount shall be allocated to the accounts of participants as of such date, except that any amount which may not be allocated by reason of any limitation under section 415 shall be allocated to the accounts of other participants, and if any portion of such amount may not be allocated to other participants by reason of such limitation, such portion shall be treated as an employer reversion to which this section applies.

I hope you'll hear some ideas from some other folks out there. Such as finding a buyer who would love to buy his company and merge his underfunded plan with your client's overfunded plan.

[jpod]

The last poster's last sentence about finding a buyer may be a potentially lucrative solution for the Dr. He may be able to sell his practice (including the overfunded DB plan) to a large practice or even a hospital with an underfunded DB plan. I am not saying it will pan out, but for the size of the surplus that you're talking about it is worth investigating.

[david rigby]

In addition, please ask the Doc to consider adopting me, and covering me in his plan, preferably with a 415 benefit.

[wsp]

In addition, please ask the Doc to consider adopting me, and covering me in his plan, preferably with a 415 benefit.

pax, the fact that you would so quickly toss aside the family history that you and your parents shared lo these many years is truly awful and shocking. What's more disturbing is that you beat me to the punch with the adoption scheme. I'll have to try harder next time. Perhaps I can find one of flamaster's overfunded 412(i) clients....wait, best not to give away my plans.

[masteff]

The last poster's last sentence about finding a buyer may be a potentially lucrative solution for the Dr. He may be able to sell his practice (including the overfunded DB plan) to a large practice or even a hospital with an underfunded DB plan. I am not saying it will pan out, but for the size of the surplus that you're talking about it is worth investigating.

On that note, if you calculate the dollars lost due to excise taxes on various methods of reversion, that would give you a price range for selling the plan. If the doc could only realize, for example, 70 cents on the dollar, then he'd be willing to sell it to someone else for 80-90 cents on the dollar. Thus, both parties realize a gain (and potentially offset all of a buyer's cost of acquiring the plan).

[Guest mjb]

M: its not just the 50% excise taxes but 35% fed income taxes and state taxes that reduce the reversion to 10%-15% of the surplus. I have heard of cases where the taxes exceed 100% of the reversion. Selling the surplus to a financial intermediary typically results in a haircut of 25%- 30% (depending on the quality of the plan assets). Dr might get a better deal if he sells his practice to hospital w/underfunded DB plan which would buy annuity for him but he would have to incorporate.

[zimbo]

I seem to recall an IRS ruling that allowed this 25% limit on transferring excess DB assets to a Qualified Replacement Plan to be as high as 100%. This could allow you to siphon off more of the excess.

The other rules pertaining to allocating over no more than 7 years are still in effect.

[John Feldt ERPA CPC QPA]

True, more than 25% can be transferred, but with $2.1 million of excess and only 3 low paid employees plus the 1 doc, transferring more than 25% to the QRP (more than $525,000) will simply delay the inevitable problem to a later date, and then (I think) you'll have fewer options - the 50% excise tax would (I think) apply on the unallocated amount.

Look at 4980(d)(2)(C )(ii):

"If, by reason of any limitation under section 415, any amount credited to a suspense account may not be allocated to a participant before the close of the 7-year period, such amount shall be allocated to the accounts of other participants, and if any portion of such amount may not be allocated to other participants by reason of any such limitation, shall be allocated to the participant as provided in section 415. Any income on any amount credited to a suspense account shall be allocated to accounts of participants no less rapidly than ratably over the remainder of the period. If any amount credited to a suspense account is not allocated as of the termination date of the replacement plan, such amount shall be allocated to the accounts of participants as of such date, except that any amount which may not be allocated by reason of any limitation under section 415 shall be allocated to the accounts of other participants, and if any portion of such amount may not be allocated to other participants by reason of such limitation, such portion shall be treated as an employer reversion to which this section applies."