Terminating Underfunded DB Plan

[JBones]

Our client sponsors a non-PBGC client DB plan that is very underfunded. There are two owner and two non-owner participants in the plan. Their business is doing very poorly and they cannot come up with any money to make this year's contribution of $80,000. They would like to terminate the plan as soon as possible and have the owners waive a portion of their benefits to the extent funded, but since we're already in 2010, they will have another contribution for this year as well of about $80,000 again.

I told them that they are required to make the contribution even though they don't have the money, and they're wondering what happens if they just close it, make their payouts and file 5500's showing the unfunded contributions.

I realize that they can't take the waiver into account for funding, so:

1) What options (if any) do they have?

2) What happens if they don't make the contribution and just close everything out?

[My 2 cents]

Is there still a 100% excise tax for funding deficiencies? This is the sort of thing for which the IRS used to impose it.

Not to mention the fact that "owners" is not a sufficiently exclusive class for benefit waivers. The PBGC would countenance that for a person who is a majority owner and the IRS would grudgingly accept that, but without the PBGC on the scene, I don't think that waivers would be acceptable to the IRS. What about applying priority categories?

Please bear in mind that we seldom are involved with ERISA defined benefit plans not covered by the PBGC.

[carrots]

As a start, a) get the paperwork in place asap to freeze benefits and terminate the plan, b) consider assuming a higher retirement age in the calculation of the FT and TNC, c) look at PRA 2010 to use interest only on shortfall amortization for 2009 and 2010.

[JBones]

Carrots - Thanks, but unfortunately, the plan is currently frozen and the termination amendment is being finalized now, I am already using age 65 & 5 for the normal retirement age (none of the participants have even reached age 60, so it seems hard to justify using a higher age), and the $80,000 contributions already take into account the interest only SF payments.

I'm pretty sure there is not really much if anything that can be done, but I'm just hoping that someone has an idea that I'm just overlooking. It seems like this is a situation that would be occuring often lately. Has anyone else had a similar experience and if so, how did it play out?

[rcline46]

Use full yield curve calculation - helps some, pick a good month! Even for 2009 you can still do it.

[Andy the Actuary]

Haven't thought this through but what about terminating plan, make distributions with waiver to principals. Assuming you can avoid 10% early distribution penalty, make part of distribution in cash. Then, (if a corporation, they make a loan to the corporation and) make contribution and take another distribution. The waiver agreement would have to provide for additional distributions in the event of additional assets. Only issue then is part of distribution will have been taxable to participants which may be more pleasant than coming up with 80k. This may make sense only if they have taxable income in the entity to offset the contribution.

[JBones]

I was told today that if they don't make their contributions and they terminate the plan they will be subject to the 10% excise tax which the IRS cannot waive, but that the IRS may waive the additional 100% tax for not correcting the deficiency. Has anyone had experience with this?

[david rigby]

Yes, correct. The IRS has stated often that the 10% excise tax under IRC 4971 is not waivable, but that there is some leeway with respect to the 100% (second) excise tax. (A few prior discussion threads on this topic.)