Reopening Defined Benefit Plan

[Andy the Actuary]

A defined benefit plan was terminated 5 years ago. The Plan sponsor received approval from the PBGC and an IRS D-Letter. All participants elected to receive their benefits in lump sums. And so, the Plan and Trust are long closed.

The Plan Sponsor has determined that a former vested-terminated employee had been inadvertently excluded from the process. Had the employee been included, the lump sum would have been $50,000. The current lump sum value would be about $70,000.

The (good shepherd) employer wants to do the right thing. That would be (a) gross up the lump sum for income taxes and FICA taxes (as well as pay the employer's share) or (b) reopen the plan so that gross up amounts are avoided and employee can roll benefits to an IRA.

Question: Has anyone reopened a plan under similar circumstances? If so, what steps are involved to open and then close? Are we looking at more costs and head aches than grossing up, which may cost about $50,000 in addition to the $70,000?

I'm sure this is not new ground and any thoughts would be appreciated.

a.t.a.

[Mike Preston]

I think you might want to peruse the Grey Books. I seem to recall that somebody said (Jim?) that it was ok to pay the person out as if it were a qualified plan and roll the money. No need to reopen the plan (and all those 5500's are soooooo pesky). But I'd want ERISA counsel's blessing before doing something like this unilaterally.

[david rigby]

I could find nothing on point in the Gray Book (searched all years).

[tymesup]

HCE?

Is there a DC plan?

Could the correction be done through the DC plan?

[Andy the Actuary]

I found nothing in Grey books as well. Thanks for searching. Question about DC plan: What justification would you have for making contribution to DC plan when former participant has no compensation, and even so, couldn't provide a $70,000 contribution?

There are bunches of bad solutions for accommodating this. So, as long as there is no accepted way of handling this and you've repudiated law in each case, Mike's thought would get high consideration. Unfortunately, Mike, I wouldn't anticipate an attorney to bless such action so all the attorney can do is articulate the many risks.

At this juncture, truly the biggest concern is that there are not other participants to be found.

This entire exercise may lead to evincing that "no good deed goes unpunished!"

[Everett Moreland]

In PLR 200745022, at http://www.irs.gov/pub/irs-wd/0745022.pdf, which involves a somewhat similar situation (settlement of a lawsuit over benefit underpayments from a terminated defined benefit plan), the taxpayer made the following representation about terminated Plan X:

"It has been represented that, in order to make the distributions from the above-referenced escrow account, Plan X will be updated to comply with current Code section 401 (a) qualification requirements."

[Andy the Actuary]

Everett, thank you. That PLT may pave the way for a graceful exit. Appreciate your emphasizing to bring the plan into compliance.

Question: Does this suggest the necessity of setting up an escrow trust account (e.g., Plan Name Escrow Account) and getting an EIN, making payents to this account, and then paying benefits from this account as opposed to the Employer simply paying benefits from the corporate account? Please bear with me as I am a propeller-head and not an attorney.

a.t.a

[Everett Moreland]

Andy:

My post is misleading if it gives the impression I know the answer to your question. I don't know whether the reason for the escrow account relates to the court proceeding or to requirements for treating the settlement payments as from a qualified plan.

[Andy the Actuary]

Andy:

My post is misleading if it gives the impression I know the answer to your question. I don't know whether the reason for the escrow account relates to the court proceeding or to requirements for treating the settlement payments as from a qualified plan.

Your post was not misleading at all. I was simply throwing the question out there for the peanut gallery to digest.

Thanks again,

a.t.a

[Everett Moreland]

Revenue Ruling 71-91, which holds that a pay-as-you-go plan (under which the employer pays benefits directly) is not a qualified plan, states:

"Thus, a qualified plan must be a funded plan. It may not provide for direct payments by an employer to his employees, as in the case of the pay-as-you-go pension plan described in this case."

The above, plus the following from PLR 200745022, can be read to indicate that benefits eligible for rollover must be paid from plan assets:

"In this case, the above-referenced escrow account will eventually hold amounts due Plan X participants and payable to them because of Settlement Agreement X and earnings thereon. Under the particular facts of this case, it is appropriate to treat the escrow account as an entity set up solely to hold Plan X assets for the purpose of distributing said assets to Plan X participants as soon as administratively feasible."

I doubt that payment directly by the employer would be treated as a payment from plan assets.

I don't see the purpose of an escrow account in this situation. An escrow account established as a plan asset seems to me to be substantially the same as a bank account in the name of the plan trustee.

[Andy the Actuary]

Thank you. Agreed, we're talking about form rather than substance. But, all fingers tend to point towards setting up an escrow account, if nothing else so that this isn't blatantly a pay-as-you-go plan.

Again, thanks.

a.t.a.

[Mike Preston]

I'm wondering if there isn't something in EPCRS that would help you. I don't have time to read it from cover to cover with this particular fact pattern in mind, but maybe you do, Andy. Maybe floating the question by Joyce Kahn would make sense. Certainly not paying the benefits when due could be construed as an operational failure.

[Andy the Actuary]

You could ruminate for months on this. Past due 5500s, PBGC premiums, etc. One violation after the other.

[david rigby]

Past due 5500s, PBGC premiums, etc. One violation after the other.

Possibly, but it may be hasty to assume "violation". For example, we don't know the circumstances that led to:

...former vested-terminated employee had been inadvertently excluded from the process.

Nevertheless, Mike's suggestion to review EPCRS, and Joyce Kahn, seems appropriate. Seems likely that the IRS has dealt with this question before.

[Guest Sieve]

For what it's worth, long ago (before the DOL's missing participant process was in place and before internet searches were so easy), the IRS ruled that a plan terminated by a client of mine had been partially terminated a few years before the formal termination, and agreed to let the appropriate prior forfeited amounts (of those who were impacted by the partial terminantion) be replaced and held in an escrow account for the unlocatable former participants to be paid as and when they were found. (The Service even agreed that the owner could take the funds out of the escrow account if not claimed within 4 years--which they'd NEVER permit now, although apparently the IRS still allows forfeiture of amounts owed to terminated partcipants who cannot be found.) So, I'd wholeheartedly agree that an escrow would comply with the spirit of the law without forcing the parade of adminsitrative horribles referred to in earlier posts.