Participation in DC plan by participant in frozen, overfunded DB plan.

[Guest Jae]

Doctor is sole participant in a frozen DB plan. The plan is substantially overfunded. Doctor now wishes to participate in a different plan, maintained by a member of the same affiliated service group. Can he do so? It appears to me that there should be no problem especially given the repeal of 415(e). Can anyone confirm this or correct me if need be?

Thanks.

[AndyH]

I think some more info is needed. How can the Doctor be the only participant in a plan sponsored by "the same affiliated service group"? Something doesn't make sense on the surface.

[Guest Jae]

Sorry about the confusion. The doctor has recently joined the affiliated service group. When the DB plan was created, he was alone.

[AndyH]

I don't see a problem with participation in the new plan, provided it isn't a DB (in which case there might be 415 issues), but the old plan could have some big problems with minimum coverage and participation requirements.

[Guest Matt Tuttle]

There may be a simpler solution. The plan may be converted to a Section 412i defined benefit plan. The interest rates are much lower and it may get rid of the overfunding and allow the doctor to resume contributions.

[Guest CT_EA]

Hi,

I don't have a lot of experience with affiliated service groups but I was wondering how Sec 401(a)(26) will effect the qualified status of this frozen overfunded DB plan.

Thanks

[AndyH]

I think the minimum participation requirements of 401(a)(26) are a problem because the exception to 401(a)(26) applies to a frozen plan only if the lesser of 50 or 40% of employees have "meaningful benefit accruals" under the plan to satisfy the prior benefit structure requirement.

In year 2 or 3, presumably there would be 3 or more (affiliated) people who wouldn't meet the minimum age and service requirements.

My understanding is that it would therefore fail 401(a)(26).

I'm curious about the comment of Matt Tuttle regarding 412(i). I don't know much about them, but aren't the 415 maximum payout rules the same? If so, why would the doctor want to put more in if he can't get it out? Maybe I'm missing something, but I don't see how that would be a good idea.

[david rigby]

Well, the answer to Andy's question can be obtained by viewing the "profile" for Matt Tuttle.

[AndyH]

Ditto, pax. I was trying to say the same thing less directly.

[Guest Matt Tuttle]

I don't know that means but it probably wasn't a complement. A 412i plan is subject to the same limits but the interest rates used are much lower in the early years requiring much higher early contributions and lower later contributions,it might make sense given the situation. If the lower interest rates are assumed he may be able to resume contributions if he wants to without having to worry about overfunding. If the plan is severly overfunded this may not immediately solve the problem although it might help.

[Guest Matt Tuttle]

Obviously if this guy is 60 and has 3 million built up in the plan this won't do anything.

[Guest Alex B]

If Doctor had his own practice with an overfunded DB plan and has now joined an affiliated service group, could he sell the sponsor of the DB plan to a strategic buyer that pays 75% or more for the overfunding, and roll his benefit over to an IRA? I have worked with Pension and Tax Advisors (888) 801-5269 on these types of transactions.

[Guest merlin]

jae-Are you sure the plan is overfunded? With asset values declining, repeal of 415(e),low GATT rates,and the coming of 94GAR mortality,excess assets have pretty much disappeared from the landscape.

AndyH-Nice catch on the exception to the exception to 401(a)(26) for a frozen plan.

Matt Tuttle-How does a 412(i) plan help? My experience with 412i usually goes the other way: set up the 412i plan,run it 4-5 years , then convert it to a traditional (and probably overfunded) db plan.Unless you're referring to the fact that the insurance/annuity contracts are so heavily front-loaded for expenses,mortality charges,etc. that those items eat up the overfunding.

Alex B-I've seen this approach used several times. The transaction involves the sale of the business which sponsors the plan,and the purchase price is pegged as a percentage of the overfunding The new plan sponsor then merges the overfunded plan with an underfunded plan. But there may be a pitfall. The IRS has offered the opinion that since the amount received by the seller is based on an excess asset, such an amount constitutes an indirect reversion under 4980(2)(A), so the excise tax still applies.Nothing official,though. I think it was in the Q&As at the ASPA conference a few years ago.

[Guest Alex B]

merlin, just for the record, here are some of the reasons why for the last 10 years the IRS has offered their indirect reversion theory as an opinion (to try and deter those transactions) and why nothing is official:

1. The overfunding is a property interest of the plan sponsor, and as such, the sellers are entitled to receive value for it (whether it is 10% value of reversion or 75% value of merger).

2. After the sale, the sponosr still has an overfunded plan, no money leaves the plan. If the IRS were allowed to successfully assert the sale was an indirect reversion, can they then collect a second excise tax if the plan is later terminated? i.e. two bites at the apple.

3. The reversion excise tax is a sponsor tax. The IRS must try and collect it from the sponsor corporation and cannot collect it from the selling shareholders without some kind of transferee liability (receipt of money from the corporation or the plan). If the seller gets paid with cash up front, they are protected.

[Guest merlin]

Alex B,very interesting and educational. Thank you very much.Does the "indirect reversion" position have any merit at all? Or is it just a bluff?

[rcline46]

ASSUMING the plan were properly frozen prior to the Dr. joining the group (accruals and participation) then I disagree with AndyH's thought that 401(a)(26) can come back.

When the plan was frozen, 100% of eligible employees had meaning accruals under the plan. After the freeze, no eligible employee can have a meaningful accrual - the plan is frozen!!!

Therefore the exception does not apply. The exception is that the 401(a)(26) meaningful accrual must be true BEFORE the plan is frozen for the plan to continue to satisfy 401a26 after the freeze.

Is the plan overfunded on a J & 100S benefit value, paid currently? If not, change normal form and retirement age if necessary, start distributions, and in a few months terminate the plan. Since the plan has a liability, IMNSHO, it can then pay the J & S. The rule requiring lump sums at life annuity only is when the participant elects an option. Here the participant is not electing the option, the plan trustee is discharging an obligation at plan termination.

My ERISA attornies have said no to this, but can find no explicit reason why not. They say no because the cannot find anything that says the CAN do it. Too conservative!

[Guest Alex B]

merlin, my sources tell me that the the IRS's hands are tied on the strategic overfunding buyer transaction and that it is on the list of things to look at so they can recommend changes to the Code. Currently, it is very far down on the list. The IRS refused to provide a PLR on this issue (positive or negative) about 4 years ago, and as far as I know, no challenges have been made to date using the "indirect reversion" theory.

[AndyH]

rcline46, I disagree (or isn't that already apparent) regarding 401(a)(26) question but I've been away from the boards and don't have the time (or the reference materials) at the moment to argue the point. Maybe somebody can help out. I'm certain of my comments, however, so I don't want that interpretation to go unquestioned in the interim.

Would you please clarify your comments about 415 and a life annuity/joint & 100% nonelection? I don't understand what you are suggesting. The life annuity 415 benefit is always payable in the same amount as a qjsa 100% j&s if the plan states that to be the normal form, so what is relevant about payments having started and the trustee doing something?

[rcline46]

Regardless of the normal form in the plan, any other benefit must be an actuarial equivalent of the benefit. Usually the normal form is a life annuity or a 10 year certain, so the equivalent j & S is a smaller benefit.

The lone exception is a lump sum payout. That amount cannot exceed the value of a life annuity at the 415 limit. Therefore, if the normal form happened to be a 100% j & S at 415 limit, ALL other forms will produce the exact same monthly benefit since no benefit can exceed 415! Therefore, if a participant were to pick a lump sum benefit, it would only be at the life annuity value, not the J & 100 s value! Example - value of j & 100S might be 1.6 mil while value of life annuity might be 1.1 mil. If the participant elected lump sum, they would get 1.1 mil, the $500,000 would be left in the plan.

The question is what happens if the participant elected the normal form of j & 100s? The plan is obligated to keep the 1.6 mil in reserves and pay the benefit.

After 6 months, the sponsor terminates the plan. The trustee is then obligated to provide the j& 100s benefit. Suppose the trustee decides not to buy an annuity, but instead satisfies the obligation by distributing the annuity to the participant. The participant then gets the 1.6 mil, not the 1.1 mil! (adjusted for benefits paid of course)

on the 401a26 I am home. will have to check at work. I know I could use benefitslink, but...

[mwyatt]

Actually, what would happen in termination would be an annuity contract would have to be purchased from an insurance company covering the 100%J&S benefit provided in the plan (hope that cruise ship comes back to port... good windfall to the insurance company). I would be very skeptical of providing that the "annuity purchase" amount could be distributed on the 100%J&S form of payment to the participant. I would dare to say that 415 would still override on the lump sum distribution. Of course, given current market conditions, an annuity purchase is looking better and better every day (boy, I really wish these financial websites could start using green instead of red on the charts).

[mbozek]

Could some one please give me the citation to the definition of an indirect reversion? Last time I looked at the IRC the sale of an equity interest in a company was regarded as a the sale of a capital asset and taxed as capital gain or loss or a non taxable exchange of stock. If the owner of a company which has a DB plan with surplus assets sells the company to a willing buyer then the owner has sold the company not an interest in the plan. The plan assets continue to be held by the buyer of the company. Under IRC 4980©(2) a reversion occurs when the employer receives cash or property from a qualified plan, not when the employer receives cash or property from the buyer. I dont think there is any doubt about the meaning of that language. If the indirect reverson theory was viable then the IRS should make a claim under 4980 every time a corporation with an over funded DB plan is sold because part of the sales price would be an indirect reversion of plan assets to the seller.

[rcline46]

Of course you are skeptical! But as I said, I have had more than one ERISA atty research the matter, and they cannot provide a cite as to why it cannot be done. Remember, and this is the critical issue - THE PARTICIPANT DID NOT ELECT A LUMP SUM.

[mwyatt]

One thought: if this distribution of 1.6 million is not a lump sum (which I think it is), what is your tax treatment? Since it isn't a lump sum (so you can argue that 415 wouldn't apply to the amount of payment) then I guess this is ineligible for rollover and hence is all ordinary income.

[AndyH]

The point is moot anyway if this is some type of single payment scheme. Clearly the Trustee cannot discharge a Joint & Survivor Annuity obligation as a single payment to a participant. That would violate multiple provisions of law so if that's the idea then forget it.

Just a couple of little problems like 411(d)(6), 417, et al even before getting to 415.

[rcline46]

Hi AndyH. First, the way I read 1.401(a)(26)-2b, a frozen plan satisfies -3 (the prior benefit structure rules), not that it must satisfy -3.

Second, I do not see any violation of 411 nor of 417. Remember, a J & 100S payment stream was selected and started. Sometime later the plan itself was terminated. The situation is then in the hands of the trustee as how to best settle the liabilities of the plan. I have not seen any requirement that the trustee MUST purchase an annuity unless the participant demands it.