Forfeiture in the year of plan termination

[Guest Dave Peckham]

Virtually every IRS rep reviewing Forms 5310 that I have submitted has taken the position that there can be no forfeitures in the year of plan termination.

However, I cannot find firm support for this position in either my plan document or in the code and regs.

Case at hand: The plan document allows immediate forfeiture upon cash-out distribution. Plan sponsor wants to pay out all terminees and THEN sign the plan termination corporate resolution and amendment, prior to the end of the current plan year.

Of course, we would look hard at whether a partial termination had occurred. But if we determine that no partial plan termination has occurred, could we take the position that cash-outs prior to the date of plan termination trigger forfeitures, that those forfeitures could then be used to pay plan administrative expenses (which the plan document allows), and ONLY those participants not cashed out after the date of plan termination become 100% vested?

Has any practitioner argued this during a Form 5310 review and won?

[david rigby]

Without commenting on specifics of your case, I suggest the IRS reasoning is that, on the DOPT, no BIS has occurred for anyone who terminated employment in the same plan year.

[ESOP Guy]

David:

Why would a BIS be important in this case?

It has been years since I have seen this done but…

Years ago I had more than one client that amended their plan from forfeit after 5 BIS to upon payment. Then the plan made a push to make payments just to do what the original question is asking about. That is to say they made the push to pay everyone out and then they signed a resolution to terminate the plan.

[Tom Poje]

somewhere in the deep recesses of my mind I recall reading (or dreaming) the following:

Upon termination, everyone becomes 100% vested.

the one exception would be if the company itself terminated, the argument being that it would be impossible for someone who was partially vested to ever return to work and earn possible service.

but again, those are only vague memories.

but that would seem to make sense. You are going to make everyone else 100% vested, which is basically making an assumption, absent the plan terminating they would continue to accrue years of service vesting - thus avoiding the possibility of a terminee returning and having to have his forfeited balance restored.

[Guest Sieve]

IRS will not allow employer to get around the full vesting rule at plan termination by paying out out all terminated employees in the year of the plan termination, or even in the prior year (in some instances).

If they did, then what would happen to the forfeitures resulting from employee terminations/distributions followed by plan termination? Would forfeitures be allocated to the owner/HCEs who conveniently retained assets in the plan until plan termination? Or revert to the employer? Either is a bad result in the IRS's eyes (since it often is merely form over substance).

I suspect there's something about that in the IRS manual.

[Bird]

On a 5310, IRS asks about all partially vested payouts in the last 5 years, and in my experience will follow up and challenge the forfeitures unless the payout arose from a voluntary termination or termination for cause. In their minds, any other termination of employment is linked to the ultimate termination of the plan. (I'm probably oversimplifying but that seems to be their thinking - at least in the case of a termination due to adverse business conditions.) They don't really have any authority for it but you have to know that you're in for a challenge (if you submit or are audited - and I for one would not want to have that hanging over my head if I didn't submit).

Honestly, I think they're right to not allow forfeitures in the year of termination, if that is in fact official policy (I suspect it's more of a "manual" guideline). I don't see how you can separate the two actions (paying terminees to get rid of them and terminating the plan). I think it's fair (whether it is code-ified or reg-ified or not) to look at the entire year of the plan termination and require full vesting for any payouts.

And, as raised above, what are you going to do with the forfeitures anyway? They could, I suppose, be used for expenses, but re-allocating them based on comp for a partial year is questionable at best IMO.

[ESOP Guy]

IRS will not allow employer to get around the full vesting rule at plan termination by paying out out all terminated employees in the year of the plan termination, or even in the prior year (in some instances).

If they did, then what would happen to the forfeitures resulting from employee terminations/distributions followed by plan termination? Would forfeitures be allocated to the owner/HCEs who conveniently retained assets in the plan until plan termination? Or revert to the employer? Either is a bad result in the IRS's eyes (since it often is merely form over substance).

I suspect there's something about that in the IRS manual.

In the examples I saw with my clients the forfeitures were allocated to the active employess at a special allocation right before the plan termination. What the business owner wanted to avoid was what he saw as a windfall for ex-employees who just so happen to still have money in the plan. The windfall being the increase in vesting even if they hadn't worked for years. The owner didn't have a problem of giving the full account balances to the current people. But in his mind the people who left had made their choice already.

Might not be the law, but it was the way the clients saw it the two times I had the situation

[Tom Poje]

Despite the owner's opinion, the regs are still the regs. A partially vested individual who returns to work must be given the option of paying back his vested portion and having the unvested balance restored. If you forfeit that money and the plan no longer exists, then you have a problem if the person returns. how can you make an additional contribution?

yes, in 99.9% of the cases the person will not return or pay back the vested portion. but it's not out right to predict the futre, one has to assume the worst case

[austin3515]

But, Tom, what aobut the distributions from the prior yeaR? The year before that? Doth not the same situation exist??

[ESOP Guy]

Austin you beat me to the question you asked.

I would be curious also which regs people think the IRS is upholding? Like I said when I did this years ago, maybe around 10 years ago, both client’s ERISA attorney blessed the plan.

If I understand this conversation the IRS is not enforcing the regs, but a contingent hypothetical. Well, IF the plan were to stick around, and IF the person where to come back to work…..

[Tom Poje]

I looked up the reference I was referring to, in the case of a dissolution of the sponsor itself the person could not ever return and therefore no longer vest so 411(d)(3) should not apply. ERISA Outline Book cahpet 4 section XII Part A1.e. (2006 edition)

but then see 1(a)(2) which points to FSA 1992-1023-1 0% vested people do not necessarily become 100% vested, if the deemed cash-out occurs prior to actual plan termination. I'm assuming FSA means field service announcement??? so find a copy of that and have that handy.

as for paying out former terminees before the plan term date, under the regs that would seem viable because the same rules apply as someone who was 0% vested - once paid out they've received their distribution, they then forfeit, because supposedly those people aren't 'affected participants'.

all that bneing said, if some of those folks were hces and they weren't paid out but the nhces were paid out and an IRS agent actually noticed I think you might have some problems.

[Kevin C]

There are several older discussions of this issue. Here is one.

http://benefitslink.com/boards/index.php?s...10&hl=39310

You can find others by searching for "GCM 39310".

I’m not clear on whether the situation changes when the plan fiduciary tries to avoid the 100% vesting requirement by paying these individuals after the decision to terminate the plan has already been made, but before the termination resolution/amendment has been signed. Anyone see fiduciary issues with misleading the terminated participants? I would think that most, if not all of them would delay their distribution until the plan termination if they were informed of the situation.

[Tom Poje]

you raise an interesting point. under the SSA guidelines you have to provide a statement.

so if your statements provides the vested percentage, but doesn't include a blurb "Oh by the way, if we terminate the plan before you are paid out you will be 100% vested" has it satisfied all the requirements?

[Kevin C]

I was thinking more along the lines of:

Is it a fiduciary breach for the Plan Administrator, who knows the plan termination has been approved and is imminent, to withhold that information from terminated participants in an attempt to avoid the requirement to 100% vest them due to the plan termination?

[ESOP Guy]

I was thinking more along the lines of:

Is it a fiduciary breach for the Plan Administrator, who knows the plan termination has been approved and is imminent, to withhold that information from terminated participants in an attempt to avoid the requirement to 100% vest them due to the plan termination?

This is an interesting question. There was a recent court case where an ESOP administrator knew the company was in negotiations to sell the company for 6x last appraisal and he started pushing the terminated people to take their distribution. The administrator knew the sale was more likely to happen then not happen.

The court took a dim view of this behavior to say the least.

[K2retire]

Nearly every plan sponsor who has asked how to terminate their plan has said they wanted to pay out terminated people before adopting a plan termination resolution when they heard they would have to fully vest everyone. I'm sure that is exactly what the IRS reps are trying to prevent.

The fiduciary breach question is a good one!