Successor Plan Issue

[SMB]

Employer terminated a solo-401(k) and did a direct rollover distribution in 2010. Also established a new PS Plan effective for the 2010 plan year. Looks to me like a "successor plan" issue. If so, which event - the distribution from the 401(k) plan or establishing the new PS plan - is actually the 401(k)(10) "violation", what are the ramifications of same - and any way to "fix"? What if no contributions are made to the new PS plan for 2010?

Almost hesitate to ask, as I am fully aware that logic and IRS regs are often mutually exclusive, but does anyone have any idea as to the original "thinking" behind the successor plan rules?

Thanks for any and all input!

[12AX7]

My understanding of the rule is to prevent plan sponsors from having frequent access to potentially large amounts of funds that normally would stay in the plan until age 59 1/2. Therefore, the "penalty" is to prohibit a new plan startup no earlier than 1 year from the date of final distribution from the plan.

I would think that your 401 (k)(10) violation occurred when the new plan was adopted, unless you consider this a chicken or egg question. I'll guess that the path to correcting this situation is to get rid of the new plan. You may want to have the client discuss this further with an ERISA attorney and review facts and circumstances and decide on a path to correction.

[Kevin C]

If the establishment of an alternative defined contribution plan made the participant ineligible for the distribution under 1.401(k)-1(d)(4), I think the amount paid to the participant would be considered an "overpayment" under Rev. Proc. 2008-50. The correction for overpayments is in

Rev. Proc 2008-50, Section 6.06 (3) Correction of Overpayment failures. An Overpayment from a defined benefit plan is corrected in accordance with the rules in section 2.04(1) of Appendix B. An Overpayment from a defined contribution plan is corrected in accordance with the Return of Overpayment method set forth in this paragraph. Under this method, the employer takes reasonable steps to have the Overpayment, plus appropriate interest from the date of the distribution to the date of the repayment, returned by the participant or beneficiary to the plan. To the extent the amount returned to a defined contribution plan is less than the Overpayment adjusted for earnings at the plan's earnings rate, then the employer or another person must contribute the difference to the plan. The Overpayment, adjusted for earnings at the plan's earnings rate to the date of the repayment, is to be placed in an unallocated account, as described in section 6.06(2), to be used to reduce employer contributions (other than elective deferrals) in the current year and succeeding year(s) (or if the amount would have been allocated to other eligible employees who were in the plan for the year of the failure if the failure had not occurred, then that amount is reallocated to the other eligible employees in accordance with the plan's allocation formula). In addition, the employer must notify the employee that the Overpayment was not eligible for favorable tax treatment accorded to distributions from Qualified Plans (and, specifically, was not eligible for tax-free rollover).

If the entire distribution was rolled over into an IRA and no funds have been withdrawn from or added to the IRA, I think you could argue that transferring the IRA back to the PS plan is an appropriate correction.