Forfeitures returned to employer-Prohibited transaction or Mistake of Fact

[Guest skos]

Our client had a 403(b) plan with an insurance company which was amended and restated during January 2007 as a 401(k) plan. The plan was not terminated. It’s character simply changed. In connection with the change, the assets were transferred from the insurance company to a local bank to administer the 401(k) plan.

During January 2007, prior to the switch to the bank, the insurance company processed several distributions which had related forfeitures Those FF’s were never transferred to the bank, but instead, were refunded directly to the ER on 1-22-07. The refund check characterized it as a “Refund of contributions-premium refund”. An accompanying cover letter says “This check represents a refund of premiums received by (the insurance company) on 1/18/2007. This money has been returned to you in view of the fact that at the time of your remittance, sufficient credit was available to offset a portion, if not your entire bill.”

In a 1-31-07 fax from the insurance company to the ER, the insurance company wrote, “This was additional forfeiture credit that was available and not taken on the final contribution bill for December.” I suspect the reason was that the insurance company had already pulled the plan off of their online system and the insurance company had to manually enter the final payroll and just overlooked applying the FF suspense account against it. The ER had no knowledge of the FF’s and just paid what the insurance company told them to pay into the plan. The ER did not request a refund of the FF’s. It was initiated solely by the insurance company.

The insurance company’s product was a group annuity insurance contract. My concern is that the FF suspense account should have remained in the trust and been wired along with the other trust funds to the bank. The old plan document called for FF’s to reduce ER contributions, which is fine, but I think paying the FF’s to the plan sponsor may be a prohibited transaction. ERISA section 406(a)(1)(d).

I’ve done a little research and couldn’t find anything exactly on point, but did see Rev. Ruling 71-149 that dealt with terminating plans (which I know we don’t have here) and IRS said there, that the FF’s could not revert to the ER. An argument could be made that this is a mistake of fact due to a mathematical error in the calculation of the final contribution payment. Therefore, they can refund the premium/contribution as they should have given them the credit for the forfeitures.

Your opinions are welcome. Is this a prohibited transaction or a mistake of fact?

[masteff]

It would be different if the final premium payment had gone into the plan and then weeks/months afterwards the ins company processed a refund. Sounds to me like the extra money never got into the plan because the ins company caught it before the premium was applied. Yes, the amount of the refund is exactly equal to the amout of the forfs. That doesn't mean the forfs were disbursed to the company. The forfeitures were applied as a credit prior to the application of the premium so the forfs were used to offset a contribution in accordance with plan terms.

It's a simple refund of an excess payment that resulted because the ins company applied the forfeitures to the outstanding premium due which thereby caused less be to due than was remitted by the plan sponsor.

Jan 18, 07 was a Thursday. Jan 22, 07 was a Monday. This is an extremely prompt return of an excess premium payment and is not at all indicative of an after the fact attempt to disguise a return of forfeiture as something different.

[Laura Harrington]

I don't mean to create any additional issues for you, but I don't think you can "convert" a 403(b) plan to a 401(k) plan. There are no provisions in the Code for this.

[Bird]

Yes, the amount of the refund is exactly equal to the amout of the forfs. That doesn't mean the forfs were disbursed to the company. The forfeitures were applied as a credit prior to the application of the premium so the forfs were used to offset a contribution in accordance with plan terms.

I'm not sure. The insurance company letter said “This check represents a refund of premiums received by (the insurance company) on 1/18/2007. This money has been returned to you in view of the fact that at the time of your remittance, sufficient credit was available to offset a portion, if not your entire bill.” But something tells me that's boilerplate language that shouldn't be taken literally. I mean, the sponsor got a check from the insurance company; how can you say they weren't disbursed? If the funds were applied to reduce a contribution, and the insurance company also issued a refund, then the insurance company overpaid. Insurance companies are great messer-uppers in many ways but they don't often overpay.

It sounds like the funds were improperly deposited by the company and should be returned to the plan, and yes, I think it's a PT.

I don't mean to create any additional issues for you, but I don't think you can "convert" a 403(b) plan to a 401(k) plan. There are no provisions in the Code for this.

Right; that would be a bigger concern for me!

[Guest skos]

Let me clarify that the final ER contribution for December 2006 payroll was paid into the insurance company on 1-18-07 and it was reduced by ~$2400 of FF's that were in existence through 12-31-06. It was not further reduced by the January 2007 FF's of approximately $4500. It was these $4500 of FF's that were refunded to the ER. Does that affect your opinions?

Also, to ease concerns about the 403(b), that is another plan the ER maintains and I was in error. It was actually their money purchase plan that was converted to a 401(k).

[masteff]

Let me clarify that the final ER contribution for December 2006 payroll was paid into the insurance company on 1-18-07 and it was reduced by ~$2400 of FF's that were in existence through 12-31-06. It was not further reduced by the January 2007 FF's of approximately $4500. It was these $4500 of FF's that were refunded to the ER. Does that affect your opinions?

Did these FF's occur on or before January 18th (the date that the insurance company received the premium payment)? If so, then I stand by my answer that it was excess premium which was refunded after the current month's forfeitures were credited against the Plan's balance due to the insurance company.

I mean, the sponsor got a check from the insurance company; how can you say they weren't disbursed?

How else would you propose that the insurance company would refund excess premiums? Or do you propose they would hold the excess and not refund it at all?

This is simple and ordinary accounting. I see it as a straight forward question of what order are things applied to the Plan's account. If the forfeitures arose prior to the receipt of the premium payment, then the forfeitures can be known and applied to the outstanding balance of the Plan before the premium payment is applied. So, when the premium check arrives on Jan 18, it is in excess of the current outstanding balance. Two business days later on Jan 22, the insurance company processed a refund of the excess premium payment.

[Guest skos]

The $4500 in FF's were related to January 2007 distributions. They were computed by and known to the insurance company. The way contributions are processed is that the ER uses a computerized system provided by the insurance company to provide the insurance company with monthly payroll information. In return, the insurance company computes the mandatory ER 5% contribution and provides the ER with a bill in the following month, which is net of any FF's to be applied from the FF suspense account.

The ER does not know what the FF suspense account activity is and simply pays the amount of the bill to the insurance company. In this case, it appears as though the insurance company improperly billed the ER, because it did not reduce the bill by the FF's which occurred in 2007 and which were known to the insurance company on the date it billed the ER. The insurance company knew that the accounts were going into blackout on 1-17-07 and were going to be liquidated 1-19-07. Knowing that the insurance company was going to be bowing out of the picture, why would they not reduce their final bill to the ER by known amounts in the FF suspense account or transfer the FF suspense account to the bank and let the bank deal with the application of FF's going forward? Either of these actions would have avoided the issue, but instead they chose to refund the money to the ER.

Again, the refund check to the ER was dated 1-22-07 and the wire was received by the bank on January 23, 2007 so the insurance company refunded the ER prior to wiring the remaining funds to the bank.

[masteff]

I don't mean to create any additional issues for you, but I don't think you can "convert" a 403(b) plan to a 401(k) plan. There are no provisions in the Code for this.

And just so it's not lost, still have the issue of how can a 403(b) be converted to a 401(k).

[Guest skos]

See my 2:18 PM post above.

[Bird]

QUOTE (Bird @ Aug 21 2008, 11:59 AM) *

I mean, the sponsor got a check from the insurance company; how can you say they weren't disbursed?

How else would you propose that the insurance company would refund excess premiums? Or do you propose they would hold the excess and not refund it at all?

I suggest we forget the misnomer "premiums." They could indeed be premiums in an insurance company contractual sense but they are contributions from the plan's standpoint, and that's all that matters. The plan made a contribution that should have been reduced for forfeitures. It wasn't, and then the insurance company improperly refunded the excess to the employer. It's a mistake, but not a mistake of fact, IMO. I think a lot of accountant-types would figure this is a wash and let it slide (and probably not get "caught," and to be honest I don't know for sure that the IRS would challenge it on audit) but it's not right. To be precise, if the plan has any kind of an optional (PS or match) contribution allowed, even if it's not currently used, the "extra" contribution should have stayed in the plan and been allocated.

[Guest mjb]

QUOTE (Bird @ Aug 21 2008, 11:59 AM) *

I mean, the sponsor got a check from the insurance company; how can you say they weren't disbursed?

How else would you propose that the insurance company would refund excess premiums? Or do you propose they would hold the excess and not refund it at all?

I suggest we forget the misnomer "premiums." They could indeed be premiums in an insurance company contractual sense but they are contributions from the plan's standpoint, and that's all that matters. The plan made a contribution that should have been reduced for forfeitures. It wasn't, and then the insurance company improperly refunded the excess to the employer. It's a mistake, but not a mistake of fact, IMO. I think a lot of accountant-types would figure this is a wash and let it slide (and probably not get "caught," and to be honest I don't know for sure that the IRS would challenge it on audit) but it's not right. To be precise, if the plan has any kind of an optional (PS or match) contribution allowed, even if it's not currently used, the "extra" contribution should have stayed in the plan and been allocated.

when are premiums contributions to a 403b plan?

Why does the IRS care since only non forfeitable amounts are counted as contributions to a 403b plan (403(b)(1)©)?

Why arent the forfeitable contributions made to a Section 83 plan?

[GBurns]

See Post#5. The OP has corrected, it is an MP Plan not a 403(b).

[Guest skos]

I am attempting to find out if the insurance company deposited the contribution into the trust and then refunded a portion of it to the ER or whether the insurance company deposited the contribution into its own general account, then realized there were unused forfeitures so it refunded the excess to the ER and then deposited the net amount into the trust. If it's the latter, I don't believe we'd have a prohibited transaction. It's the former that bothers me.

And, for the record, I'm one of those "accountant-types" who is actually auditing this plan. It's our firm's "administrator-types" that feel differently. They look at the net effect of the refund and say that the Plan got everything it would have if the insurance company had left the money in the FF suspense account and transferred it to the bank. The ER would have used the FF suspense account to reduce a future contribution so the net is the same to the Plan, participants and ER, so what's the harm?

[Kimberly S]

The potential harm is that the IRS says once the employer puts money in the plan, it can't revert to the employer.

[masteff]

I am attempting to find out if the insurance company deposited the contribution into the trust and then refunded a portion of it to the ER or whether the insurance company deposited the contribution into its own general account, then realized there were unused forfeitures so it refunded the excess to the ER and then deposited the net amount into the trust. If it's the latter, I don't believe we'd have a prohibited transaction. It's the former that bothers me.

Not sure how it works w/ it being an insurance company but if it were any other trustee holding securities, there should be a trust level transaction detail report. One of those from 1/1 to account closure would be good for the audit papers in general.

[Bird]

QUOTE (skos @ Aug 25 2008, 10:36 AM) *

I am attempting to find out if the insurance company deposited the contribution into the trust and then refunded a portion of it to the ER or whether the insurance company deposited the contribution into its own general account, then realized there were unused forfeitures so it refunded the excess to the ER and then deposited the net amount into the trust. If it's the latter, I don't believe we'd have a prohibited transaction. It's the former that bothers me.

Not sure how it works w/ it being an insurance company but if it were any other trustee holding securities, there should be a trust level transaction detail report. One of those from 1/1 to account closure would be good for the audit papers in general.

skos, I agree with your assessment...if it never got into the plan and the insurance company just refunded from their general account then I would be very comfortable arguing that it was not a contribution. Masteff makes a good point about digging for the transaction detail.

[Patricia Neal Jensen]

Again, ignoring the BIG problem here:  No 401(a) plan can be merged into or converted into a 403(b).  This transaction is defective.

[John Feldt ERPA CPC QPA]

Other than the Church exception