Correction of Disqualifying Distribution

[Scott]

A company which is a member of a controlled group terminates its 401(k) plan and distributes the accounts to participants. However, another member of the controlled group also maintains a 401(k) plan which constitutes a "successor plan" with respect to the terminated plan. Thus, the distribution from the terminated plan violates Code Section 401(k)(2)(B)(i). What, if anything, can be done to correct this?

[Guest GG]

Are you sure you have a successor plan situation? Are 50% or more of the participants from the terminated plan covered by the plan of the other member of the controlled group?

If this is the situation, then I would suggest speaking with an ERISA attorney.

[M R Bernardin]

GG: 50% or 98%? In other words, if the plan of the other controlled group member does not cover the persons who participated in the plan being terminated, and that remains true for a certain time period, you might not have a successor plan.

[Scott]

As I stated in the question, it is a successor plan--all of the participants in the terminated plan are covered by the other controlled group member's plan. That is the first issue I looked at, since it would have eliminated the problem.

[M R Bernardin]

Well, it was worth clarifying, I think. I'm not sure there is anything, short of a Walk-In CAP, to correct this. I presume if the employer went that route, it could be fairly expensive and the fix would be to have that money redirected into the successor plan, but as this involves employee cooperation, I imagine the IRS would be somewhat flexible on that point, but who knows? The good news is that it should not affect the qualified status of the successor plan. The original regs would have had both the terminating plan and the successor plan disqualified, but the final regs backed down from that, and the preambles to the final regs, as I recall, contain some discussion of that point. However, the IRS may not concede on this issue, as I've encountered one who would not.

[Scott]

Thanks for the response, M R. Can you please clarify your last statement? Are you saying that you have encountered a situation where the IRS disqualified the successor plan as well?

[M R Bernardin]

Scott, no, the Service did not disqualify either plan. Frankly, I can't remember the particular facts of the situation, only that the conversation took place in the context of a large Walk-In CAP. What the Service did do was argue that the successor plan was theoretically disqualified, with the potential result that its assets could be included in determining the sanction. However, I do not think in that situation that the Service's position actually resulted in any significantly increased sanction, but that is a possibility that needs to be guarded against.

[M R Bernardin]

Sorry, but I happened across some notes of the case I worked on involving impermissible distributions due to a successor plan. Based on a John Doe oral submission, we were told the fix would be that (1) employees who had rolled their money into an IRA had to transfer it to the successor plan if they were still employed or, if no longer employed, had the option of transferring it to the new plan or leaving it in the IRA, (2) employees who had taken a cash distribution and paid income tax did not have to do anything, (3) excise taxes for rolling over non-qualified money into the IRA's would be waived, and (4) employer had to pay a monetary sanction ranging from 5-40% of the Maximum Payment Amount (which, according to this individual, could include the money in the successor plan). Because this was an anonymous discussion, it obviously has only limited usefulness, but I thought you might be interested.