401(k)(10) regulations

[Guest PGH.ERISA]

Under Code Section 401(k)(10), a distribution cannot be made in connection with a 401(k) termination if the employer maintains another DC plan. However, IRS regulations provide that this limitation will not apply if at all times during the 24-month period begining 12 months before the date of termination, fewer than 2% of the employees who were eligible under the terminating plan as of the date of termination are eligible under the other DC plan of the employer. I have a client with an acquired 401(k) plan that is now frozen and has only current one employee who still has an account. This person is an active participant in the client's ongoing 401(k) plan, and the client wants to terminate the acquired plan (merger is tenatively out due to the recordkeeper's high fees, even for one account). Since there is no one who is now eligible under the acquired plan, it would seem that the client is okay. However, it concerns me that the regs would appear to allow any employer to satisfy the 2% rule merely by freezing a 401(k) plan before termination. Can anyone give any insight on this issue?

[J Simmons]

I think your concern is well placed for why using a freeze as an end-run around the obvious purpose of the regulation--only allow distributions incident to a plan termination where the employees won't have the option to make elective deferrals for 12 months after the final termination payout is made. Faced with an employer that attempts the freeze end run, perhaps it could claim that plan termination for that purpose of the 2% exception is when the freeze occurred and employees lost the ability to make elective deferrals.