IRA Rollover of Payouts to Restricted HCEs

[zimbo]

I have a plan where the HCEs cannot receive a lump sum because the plan does not meet the 110% "Solvency" Test. An HCE has terminated and has elected to receive a lump sum but due to the restrictions he is receiving an annual installment equal to his actuarially equivalent life annuity. At such time as the plan meets the 110% rule (for purposes of this question, ignore the PPA lump sum restriction soon to go into effect), he will take a lump sum of the "actuarial" balance of his lump sum.

I believe that the annual installment can be rolled over into an IRA. Admittedly this is a gray area. My logic is that he has not elected an annuity or a 10+ year installment payout. He has elected a lump sum and is settling for the greatest allowable annual installment until he can take the balance of his lump sum. Therefore, this is a periodic payment that qualifies for rollover.

Does anyone agree with this position or, if not, why? Has anyone heard of this issue being addressed by IRS in meetings or other forums?

[Slider]

According to the IRS Gray Book, 2003-24, the IRS unofficially says that it is not eligible for rollover. See (b) below:

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.

[zimbo]

According to the IRS Gray Book, 2003-24, the IRS unofficially says that it is not eligible for rollover. See (b) below:

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.

Thanks for that. Of course, I'd love to know the logic behind their blanket "NO". I think that they are not grasping that the form of benefit is NOT an annuity or an installment but a lump sum being taken in pieces over the shortest possible period allowable by law. But, it tells me that this position may be aggressive in IRS eyes.

[Slider]

Maybe the "logic" is that since the actual payment, the maximum amount under a single life annuity, is based on life expectancy, then it is not an eligible rollover distribution. It looks like IRS may be looking at the form of payment, rather than the actual election.

[AndyH]

It is part of a series of payments calculated to be paid over more than 10 years which makes it ineligible for rollover. I don't see any gray area here.

[zimbo]

It is part of a series of payments calculated to be paid over more than 10 years which makes it ineligible for rollover. I don't see any gray area here.

Except that it is not the benefit that was elected. The benefit elected is a lump sum and the maximum annual amount payable for a temporary period of time is that amount not in excess of a life annuity. As soon as the funding situation resolves, a lump sum is payable.

Would your opinion change if the benefit elected was defined as 8 such installments followed by the actuarial balance payable in a lump sum in the 9th year (all of course subject to IRS limitations and restrictions)? Now the form of benefit is a series of installments payable over less than 10 years. If not, then why not?

[Blinky the 3-eyed Fish]

I am of the opinion that the Gary Book answer is incorrect because the annuity is not the elected form of benefit. But what do I know? Perhaps the controversy over this issue will persuade the HCE to take no distribution at all until the benefits become unrestricted.

[Andy the Actuary]

Is the situation such that you can remove the provision from the plan, or at least modify the provision to apply only to shareholders, and go for a determination letter? For example, is the Plan sponsor a not-for-profit? You may be able to argue that the provision is not discriminatory since you may not be talking about owner employees.

[AndyH]

As you know, Blinky, Gary, or WDIK (perhaps a collaborative effort? ), if it qualifes for rollover treatment, the plan better be withholding 20% if it is not being rolled over.