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Paying surrender penalties with forfeitures?


Lori H

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A small 403(b) plan is considering paying (using forfeitures) surrender fees for those participants who roll the balances into a new 401(k) plan. However, this would not apply to terminated participants who take their money in cash. I believe this would be discriminatory. Am I correct? Would surrender fees be considered a valid plan expense? I believe they would.

Thanks

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Surrender fees might be a valid expense, but it would likely be unreasonable to allocate the surrender fees with respect to an account to be allocated in any way except to the account. If not an expense, the surrender fee is a factor in investment return, likewise allocated to the account that holds the investment that is subject to the fee.

Using forfetures is improper, but I don't think "discriminatory" would be the correct term for the impropriety, although the term does get across the idea of improper allocation of the forfeiture amounts.

If the employer wishes to cover the cost of the surrender fee, you might explore the idea of a restorative payment. See Rev. Rul. 2002-45 and PLR 200317048 among others. Beware the narrow circumstances. The IRS is not giving a "get out of surrender charges free" card.

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Revenue Ruling 2002-45 [http://www.irs.gov/pub/irs-drop/rr02-45.pdf] describes a restorative payment (the ruling’s antidote against counting an amount as a contribution) as a payment “made to restore losses to the plan resulting from actions by a fiduciary for which there is a reasonable risk of liability for breach of a fiduciary duty under Title I of the Employee Retirement Income Security of 1974 (ERISA)[.]”

The Treasury department’s interpretation requires also that “plan participants who are similarly situated are treated similarly with respect to the [restorative] payment.”

Does the plan’s document provide for using forfeitures as a set-off against future contributions?

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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Thanks for the responses. Forfeitures are allocated to pay for plan expenses first then used to offset future contributions.

I used discriminatory since they were considering making whole those accounts that got rolled over instead of those accounts that were paid in cash and took the surrender hit.

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You are right to be concerned about the possibility of an inappropriate discrimination (not necessarily limited to IRC 401 and IRC 403(b)(12)).

One assumes that the Rev. Rul. 2002-45 condition about treating similarly those who are "similarly situated" relates to the participant's exposure to the exit charge.

For those and other reasons, it would be unwise for the employer to proceed until it can say that it acted in good faith and prudently following the written advice of its expert employee-benefits counsel.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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