Overfunded DB Plan

[JBones]

Our client sponsored a DB plan for several years and then acquired another entity. They froze their plan timely in order to avoid covering any of the employees of the new entity. Now after several years, the plan has become somewhat overfunded. The current benefit formula is pretty low (i.e. the 2 owner/participants are well below the 415 limit), so the overfunding can be eliminated by amending the benefit formula, but they have a rather large staff now and do not want to have to provide benefits to staff in order to increase their benefits.

They aren't looking to close the plan right now, so the overfunding is not a problem just yet, but they want to know if there are any other options other than providing benefits to staff or paying the excise tax should they need to close the plan in the future and it is still overfunded. Do they have any other options?

[David MacLennan]

You have a 401a26 participation issue you need to address first. I recall that for changes in controlled groups, you have a grace period until the end of the next plan year, but you said that this change happened several years ago so that grace period is over. Participation and coverage issues cannot be self-corrected and must be submitted under VCP.

Regarding your question, a good actuary well versed in 401a4 regs can most likely design a benefit formula that the plan sponsor would find acceptable.

[JAY21]

You might consider a Qualified Replacement Plan under IRC 4980(d). You could either transfer 25% of the excess funding and qualify for the lower 20% excise tax rate on the reversion of 75% of excess assets -OR- take advantage of Rev. Ruling 2003-85 which enhanced the Qualfied Replacement Plan option to allow that up to 100% of the excess assets can be transferred to a new/existing DC plan and placed in a suspense account and then allocated annually in lieu of new PS contributions. You have 7 years to allocate the excess assets in the suspense accounts. There are some other qualifers on this approach but I "think" you could use cross-testing to test the allocations released from the suspense account and still skew it in favor of the owners to a certain extent.

[David MacLennan]

You might consider a Qualified Replacement Plan under IRC 4980(d).

JAY, according to the post they are well under the 415 limit, so the QRP would not be applicable.

[JAY21]

Well the 4980(d) isn't limited to just those plans that are at the 415 limit. I assume if they unfreeze the plan they will have accruals for new employees via the merger, so the QRP "might" be a better approach depending on how much excesss assets there are and whether the numbers work out better allocating it to staff under a PS plan vs. a DB plan.

[ScottR]

I agree that a qualified replacement plan would be the way to go, provided that the DB document doesn't require that surplus go to participants. If it DOES say that, amend it immediately... there's a 5-year waiting period, after which the surplus assets may go back to employer or to QRP.

.. Scott

[David MacLennan]

I still don't see where the QRP would make sense, when the 415 limits are not an issue. You can do anything in the DB in terms of benefits that you can in the profit sharing plan (general tested DB). You are on the hook for DB top heavy benefits already. And you only have to benefit 40% of participants in the DB vs. 95% in the QRP as I recall. Maybe I'm missing something, but the successor plan's setup fees and resulting years of admin fees are the only advantage I see . . . ;-)

[david rigby]

"Surplus assets" usually has meaning only at plan termination.

If the plan is ongoing, then the overfunding can be (at least partially) used up thru skilled plan design and additional years of service. If the plan formula is not fully integrated, that is a good place to start.

If the owners "do not want to have to provide benefits to staff in order to increase their benefits", compare that to paying excise taxes when the plan is terminated.

[JAY21]

I don't "know" that the QRP is the better route to go. Seems to me you're almost looking at this as if it's a new proposal with X dollars (estimated over funding) that you want to allocate as much as possible to the owners at lowest cost for staff over the next 7 or less years (to meet the QRP timeframe) and if you can get it done cheaper through the existing DB plan then you go that route or if the 8.5% interest rates in using a cross-testing PS approach for discrimination testing (including the extra fees for plan set-up) produce better results then maybe you go that approach. The 95% rule applies only to participants that were in the DB plan (not new potential participants via the merger). Depending on the freeze type (hard freeze that froze out any new participants) the QRP might not have to cover that many people though the testing will include the post-merger non-excludable employees for testing purposes.