Plan withdrawals

[Gary]

Say we have a one participant plan; i.e. owner/employee.

Say he is age 50 (i.e. < NRA) and he withdraws from his DB plan $75,000 and does not make any payments back to plan.

Up to 50k (assuming that is the loan limit in t his case) can be deemed distribution subject to income tax and 10% penalty.

From a practical perspective it would be easy administratively to treat the additional $25k the same way and report 75k in form 1099r.

How are small plan pratcitioners handling this type of situation?

I suppose the technical approach is to treat the 25k as a PT. Then how does this work from a tax perspective (provide specific numerical explanation) if employer never pays it back to plan?

Thanks.

[AndyH]

Where do you find these people? People in practice fun from these clients.

Did he sign proper loan documents, or did he use the plan as a savings account? It was either a loan or it was not a loan. It is what it is. If it was not a loan it is a PT. And if you know about this and do nothing except look the other way I would bet you will regret it.

[david rigby]

Failure to follow plan document? disqualification?

[Gary]

For purposes of this question:

It is all a plan loan in the amount of 75k.

The individual fails to make any payments.

My underestanding of the above is that 50k would be a deemed distribution and 25k would be a PT.

Assuming my above comment is correct.

My understanding is that it would follow that all 75k would be taxable and subject to a 10% penalty if individual is under 59 1/2.

Now re: the 25k PT it would seem that in the tax year it occurs the excise tax would be $3,750 or 15%. In the second year it would be $7,500 since it would be a PT of 25k for the prior year that is uncorrected and a 25k PT in the current year that is not corrected. This would continue until the plan is terminated and the IRS can asses a 1`00% penalty if PT not corrected. Any comments to this analysis of excise taxes on PT?

Thanks.

[SoCalActuary]

For purposes of this question:

It is all a plan loan in the amount of 75k.

The individual fails to make any payments.

My underestanding of the above is that 50k would be a deemed distribution and 25k would be a PT.

Assuming my above comment is correct.

My understanding is that it would follow that all 75k would be taxable and subject to a 10% penalty if individual is under 59 1/2.

Now re: the 25k PT it would seem that in the tax year it occurs the excise tax would be $3,750 or 15%. In the second year it would be $7,500 since it would be a PT of 25k for the prior year that is uncorrected and a 25k PT in the current year that is not corrected. This would continue until the plan is terminated and the IRS can asses a 1`00% penalty if PT not corrected. Any comments to this analysis of excise taxes on PT?

Thanks.

You should look through the precedents on PTs. The excise tax is on the interest, not the balance.

[eeyore]

I'm confused. How does anyone take a "loan" from a DB plan? Was that a typo?

[Gary]

Ok I need to get a handle on the excise tax.

That creates the question as to how much interest is reasonable to assess on the balance? Perhaps an interest rate consistent with the rate of interest that can be used for a plan loan?

Now let me back up a bit.

I want to focus on a basic practical view of the concept between DD and PT.

1. Say a plan loan of 50k is properly drafted and if participant fails to make any payment:

- than my understanding is that it is a DD only?

2. Say the same situation as 1 above occurs but the loan is instead 75k.

- my understanding is that all 75k is a DD and 25k (amount above 50k limit) is balance subject to PT (or maybe none of balance is subject to PT since there was a loan agreement in place)?

3. Say an owner just withdraws 75k with no plan loan in place.

- my understanding is that all 75k is DD and all 75k is balance subject to PT?

Thank you.

[Belgarath]

You could take a look at Revenue Procedure 2008-50, Section 6 (.07) - it's possible that you could correct this under VCP. Then they can file with the DOL under VFC if the plan is subject to Title I.

Also possible that the Service would reject the VCP filing.

These situations are tricky at best, because even if the loan papers were signed, the IRS/DOL could determine that it isn't a "bona fide" loan and deem the entire thing a prohibited transaction anyway. We always refer them to ERISA counsel in such a situation, and have the client instruct US, in writing, as to how they wish to proceed.

[AndyH]

3. Say an owner just withdraws 75k with no plan loan in place.

- my understanding is that all 75k is DD and all 75k is balance subject to PT?

Thank you.

I don't think so. I think it needs to be paid back and the plan needs to be made whole and you've got a PT and a possible disqualification for the reason that David Rigby references.

[Gary]

Regarding Andy's comment pertaining to 75k that it is a PT and a disqualifying plan defect.

However, if the reality is that the owner/participant cannot pay back plan then it would seem that the partiicpant must be taxed.

So then what?

I understand that it is a violation of plan terms, i.e. distribution before NRA; so perhaps the sponsor files VCP and tries to obtain some sort of resolution that way to avoid plan disqualification. This question is in connection with a one participant plan.

Thanks