Plan Freeze/Termination Lump Sum Question

[tuni88]

We sponsor a DB plan that has a lump sum included as one of the payout options, along with a list of annuity choices, at retirement. We are contemplating terminating the DB plan and starting up a 401k plan as a replacement.

An advisor has approached us and said that so long as we are fully funded (and let's say we are, cuz I think we are), we can terminate and then distribute lump sums to all the employees, who will then have the choice of rolling over their lump sum to the new 401k.

I mentioned this to our actuary. He said that's not how it works, that employees can only get a lump sum upon termination of employment, and then only if they are of retirement age. So a 42-year-old, for example, would have to wait until he was both age 55 and left our employ before getting a lump sum. He said steps would be to freeze then terminate then pay (from plan assets) an insurance company to take over operation of the plan.

Can both the advisor and the actuary be right?

[Effen]

They can both be right, however all you need to do is amend the plan to allow for a lump sum option (along with an immediate annuity) upon plan termination.

[My 2 cents]

The other actuary is right only so long as the plan remains in existence. There is no bar to accelerating lump sum eligibility when the plan is terminating and distributing assets. The actuary is not right with respect to retirement age - a plan may permit the election of lump sum payments at any time upon termination of employment (with the option for an immediate annuity, which need not match the benefits payable under the early retirement provision, especially if that is subsidized).

I believe that many of the plans we service are flexible enough to permit lump sums on plan termination without having to adopt a special amendment. For example, one plan, in a section entitled "distribution or transfer on plan termination", says "...shall be distributed to Participants and Beneficiaries by the purchase of immediate or deferred annuities, or payment of allocations in a lump sum, or transfer of such assets to another plan which is qualified under Section 401(a) of the code, or in such other manner as provided by law, in accordance with options established by the Employer at the time of Plan termination, and elections by the Participants and Beneficiaries." Even if the explicit reference to lump sums was not present, the phrase "or in such other manner as provided by law" would suffice to authorize the payment of lump sums, without having to amend the plan. The purchase of immediate annuities is already explicitly permitted, and there is nothing to prevent that from applying to people otherwise ineligible for immediate benefits under normal operation of the plan (again, in part because of the "or in such other manner" provision, which by itself is enough to modify the normal payment arrangements of the plan).