Substantial and Recurring Contributions

[austin3515]

Employer is setting up a new plan. Without question, she hopes the day will come when she can make "substantial and recurring contributions." The motivation for now is to allow herself and her employees to have a place to park rollovers from their old jobs.

Practically speaking, how is the substantial and recurring contributions rule enforced? If a plan is opened and no contributions aside from rollovers are ever made, is that a problem? If they add a 401k feature in year 3 or 4 is that a problem?

Are people doing the 0% money purchase plans in these situations?

Finally, Corbel's 401(k) plan has a "frozen plan" option with NO qualifications (i.e., no mention of the substantial and recurring issue). What is the purpose of that, as it seems to contradict this rule?

Edit:

Another Finally - is it a disqualification issue, or a partial termination issue? I see the substantial and recurring terminology crop up in the partial term rules.

[jpod]

I never ran across anyone who would go to the trouble and expense (even if minimal) of setting up a plan with no current intention of making contributions or even allowing employee contributions. Why do they need a rollover vehicle? Aren't IRAs good enough? Years ago there was a bankruptcy protection advantage, but hasn't that disappeared since the 2005 bankruptcy law overhaul?

[Lou S.]

The only time I've seen it is when it is a small owner only plan that wants to invest in non-traditional assets, usually mortgages to unrealted thrid parties or real-estate and the cost of administering a plan is much smaller than the asset fees to an IRA trustee holding non-traditional assest but otherwise, I agree with jpod.

[austin3515]

Participant loan...

[Lou S.]

Participant loan...

Oh, yeah forgot about that. Saw that once too.

As for your original question, not sure if the plan is really considered qualified by the IRS or not but I have seen it done on occasion. I suppose you do run some risk on audit or if applying for DL.

[austin3515]

So 1.401-1(b)(2) indicates that the Plan is in trouble unless there are "substantial and recurring contributions out of profits" (emphasis added). So a small start-up probably is not turning a profit. Does that get them a free pass for a while? They couldn't be expected to make a contribution if they are losing money, and how should they know when they will begin making money? It would be one thing if they could wait until they file their taxes to establish a plan, but the plan has to be in place before the end of the particular year.

[Bird]

I think the issue is more about partial termination and vesting. You're not going to get a definitive answer...I would do it. Why not include a 401(k) feature from the get-go?

[Belgarath]

Austin - I wouldn't get excited about the "out of profits" clause - this is a very old reg, and IRC 401(a)(27)(A) trumps this portion of the reg.

COULD the plan be disqualified if no contribution ever made? Possibly - who can tell with the IRS. Generally, it is just a vesting issue. The fact that the IRS will allow a 0% money purchase plan, would make it completely ridiculous IMHO for them to disqualify a PS plan - but my understanding is that the 0% concept MP plan was approved in PLR's - I'm not aware of any official guidance that endorses this concept. The IRS has issued FDL's for 0% MP plans.

I like Bird's suggestion better. Add a (k) feature, and hope someone defers.

[austin3515]

I recognize the 401k feature helps, but unless the ps only doesn't work, they just don't want the trouble of administering a 401k plan; not only the trouble of the deposits, but also the fact that they have to find a home for the money. People starting up businesses are not looking for extra projects. They're looking for cash to start/finance their business.

[austin3515]

PS, I submitted to Corbel and they didn't have a problem with the PS only / no contributions scenario. They have never heard of this being issue. They did not say that it was a slam dunk, only that they have never heard of the IRS taking the position.

And I actually do put a lot of faith in the "out of profits language" because it appears to me nonsensical to make a profit sharing contribution when profits do not exist. I go back to the original intentions - the business owner would love to have profits from which to make contributions. Can it be held against him that profits never materialized? I figure they will either go bankrupt or add a 401k feature eventually.

[david rigby]

You could take a direct approach and ask a question: RetirementPlanQuestions@irs.gov

[austin3515]

Forgive me for being skeptical

[Belgarath]

Never heard of the IRS taking which position? I'm not clear. do you mean disqualification? 100% vesting? I've never heard of disqualification, but I most definitely have seen 100% vesting required, on more than one occasion.

[KJohnson]

The issue came up in the discussion of ROBS in a discussion of "permanency" They seem to concur with others that if you have a CODA, even if someone does not use it there is no substantial and recurring problem. But note footnote 9 where they say the CODA has to be communicated to employees.

I had previoulsy sumitted frozen profit sharing plans for determ letters because of this concern and always received letters. That said, I think the advice has always been if you want to do this the "fix" is to set up a money purchase pension plan witha $0 contribution. Then you can convert it to a profit sharing plan and add a CODA down the road.

Here is a link to the ROBS guidance.

http://www.irs.gov/pub/irs-tege/robs_guidelines.pdf

Here is what they said...

Consider that business reasons - tax motivated or otherwise - are generally the only reasons why a retirement arrangement is installed. Similarly, they are likely to be the only reason why they are terminated as well. For this reason, permanency is not an area where the Service has aggressively challenged plan terminations or design considerations. Additionally, Regulations address permanency within the context of an entire plan arrangement, not necessarily to a feature within a plan.

Therefore, a plan containing a ROBS arrangement would have to be shown to be nonpermanent in its entirety. Many of the ROBS arrangements we have examined also contain a CODA feature. Plans which suffer from permanency failures are generally deficient in that they do not receive substantial and recurring contributions. Because CODA features receive contributions only if participants make contributions, the issue of permanence is resolvable in favor of the employer.

[austin3515]

OK, but since the IRS is "hating" on the ROBS plans, isn't it more of an issue for ROBS plans, than say a PS plan invested in mutual funds (and maybe a participant loan)?

[KJohnson]

I think the fact that it is ROBS doesn't makes a difference to the analysis but it might make a difference in whether they are interested in pushing the issue. FWIW Sal raises it as an issue and cites "many practitioners" on the money purchase pension solution.

[david rigby]

Sal raises it as an issue and cites "many practitioners" on the money purchase pension solution.

I believe all of us, including the IRS, would be better off if the IRS started by using Sal's solutions and advice.