DB Plan Termination - NonPBGC - Assets Insufficient

[Guest LDorsa]

I am in the process of terminating a non-PBGC defined benefit plan in which the assets are less the present value of the accrued benefits.

Since the plan is not PBGC covered, I want to pay out benefits "to the extent funded"; that is, to have all participants share in the asset shortfall rather than having the owners waive/forego receipt of benefits.

Mike Preston has been telling us for years that this is acceptable in a non-PBGC plan but I have questions about the logistics:

Does the plan sponsor have to make some election/statement re this methodology?

What do I put on the participant benefit statements since participants are 100% vested in the full AB by formula but will only receive some % of that benefit (for sake of argument we can call it 90%)?

Anything else I need to consider?

FYI - client is not going to file for an IRS determination letter.

[Andy the Actuary]

You may want to check eith Mike Preston because it would be surprising if what you're proposing to do is what he "said." In this regard, you may not want to ascribe a position to a practitioner without citing a published reference.

[Guest LDorsa]

I'm not relying on the rules, not Mike (although he is reliable). What I'm asking for are practical considerations on how to do this.

[Lou S.]

I believe Revenue Ruling 80-229 provides the authority for what you are describing and has several examples that should be reviewed before doing so.

I'm not sure what the practical consideration are but I would strongly recommend a DL to client and hold harmless release if they decided they don't want a DL.

After that I think a cover letter or notice with the withdrawal packages stating something to the effect of - "Because the assets in the Plan's trust are not sufficient to cover all benefit liabilities your distribution will only be made to extent funded but the Plan's trust. You will be receiving X% of your benefit accrued under the plan "

We have not done one of these where the owner did not waive a portion of their benefit to make it whole but it does appear permissible under IRS guidance and I don't believe the IRS considers it a prohibited 411 cut back.

[david rigby]

Here is a current link to 80-229
http://www.charitableplanning.com/document/669148

Prior discussion:
http://benefitslink.com/boards/index.php?/topic/12131-distributions-from-terminated-small-db-plan/#.VGErOk10yUk

IRS Manual for plan terminations
http://www.irs.gov/irm/part7/irm_07-012-001.html
See especially section 7.12.1.20.2

To original poster: does the plan address this question?

[My 2 cents]

Would the old priority categories apply or are you thinking of cutting everyone equally? What does the plan say should be done?

[Guest LDorsa]

Plan document says the following (standard ftW language). I am planning on a prorata reduction (everyone gets X% of their benefit with X = assets/pvab).

...In the event of the termination or partial termination of this Plan, the rights of all affected Employees to benefits accrued to date of such termination or partial termination (to the extent funded as of such date) shall be nonforfeitable.

[Effen]

We have done this without any problems. As long as you follow the plan provisions, there should be no problems. I think if you dig into the language in the plan the allocation of assets due to a plan term will follow the priority categories, which is not necessarily the same as a straight pro-rata reduction, especially if you have any retirees or anyone would would be currently eligible.

[My 2 cents]

Plan document says the following (standard ftW language). I am planning on a prorata reduction (everyone gets X% of their benefit with X = assets/pvab).

...In the event of the termination or partial termination of this Plan, the rights of all affected Employees to benefits accrued to date of such termination or partial termination (to the extent funded as of such date) shall be nonforfeitable.

I was asking what the plan said about how to allocate the assets. I don't think that anyone is questioning whether the participants are supposed to be treated as fully vested. Some of the plans I have seen say to pay for the retirees in full, then (if anything remains) the active participants over normal retirement age, then (again, if anything remains) everyone else. If there is not enough money to cover a category, the benefits in that category are covered prorata and everyone in the later category or categories gets nothing. If the plan is truly silent, then you may be at liberty to allocate prorata to all as you propose.

Also, as this is a defined benefit plan, when you refer to PVAB, do you mean on the basis of insurance company annuity rates? Remember that the default course of action is to buy annuities, and you cannot say to anyone that they have to be limited to the annuity that can be purchased by the amount otherwise payable as a lump sum. If you reduce someone's benefit to $X per month, you must give them a choice between a lump sum payment equal to the present value of $X per month or the purchase of an annuity of no less than $X per month (however much more that actually costs). To the extent that some participants exercise their absolute right (by law nobody can so much as try to make them choose otherwise, and if they are married, the spouse also has veto power over a lump sum) to demand an annuity be purchased, the amount available to every participant may have to be reduced further.

[Mike Preston]

I trust LDorsa to cite me any time she wants.

"Does the plan sponsor have to make some election/statement re this methodology?"

Since the plan is not being submitted, I would hope that the four corners of the document either reference a specific application of RR 80-229 or 4044 of ERISA. If there really is an election to be made, I suggest amending that provision of the plan *before* the plan termination date *and* submitting a 5310. I don't believe that the allocation methodology specified in the plan regarding how to divide assets in the case of an underfunded plan is subject to 411(d)(6), so making whatever changes need to be made should be doable through a pre-termination amendment.

"What do I put on the participant benefit statements since participants are 100% vested in the full AB by formula but will only receive some % of that benefit (for sake of argument we can call it 90%)?"

Anything you think is an honest reflection of the benefits they are entitled to. As has been mentioned in at least one prior response there are unknowns that may cause the assets allocated to various priority categories to shift. Chief among them is if a participant demands an annuity. This is likely to cause a loss to the plan thereby reducing the amount available to other participants. This makes the communication tricky. I know I've included a paragraph that essentially tells the participants that the plan is underfunded, that we have estimated the benefits shown on the distribution paperwork and that the actual benefit payable will be increased or decreased in accordance with the plan's provisions which depend, in part, on the actual cost to the plan of the benefits elected by participants. As long as the resulting benefit is not significantly different from the displayed benefit then the termination can chug right along. If something happens to change things dramatically, another round of elections can be sought, potentially devolving into an iterative process that is quite lengthy. Important to tell the client of this possibility, although in practice almost everybody elects a lump sum.

"Anything else I need to consider?"

I agree with the hold harmless suggestion.

It might also be helpful to educate the client on the history of how the IRS has treated underfunded non-PBGC plans. There was a period (two or three years in length, ending about two years ago --- ballpark timeframes as I don't remember the specifics) where the lower level reviewers were bullying plan sponsors into making non-owner's whole and "insisting" on owner (not just majority owners) waivers. Only those that pushed back hard were able to resolve things in favor of the plan document's provisions which invariably cite 80-229 or 4044 in some manner.

"FYI - client is not going to file for an IRS determination letter."

Since this client isn't submitting the issue framed in the last paragraph should be based on the expected behavior of an IRS auditor rather than a reviewer.

In essence, the whole process should be laid out before the plan sponsor and the communication to the participants needs to be honest and transparent. Be prepared for lots of questions from the plan sponsor, other advisors (like "Do you really need to do that?") and participants.

mike

[figure 8]

My previous firm did this once with no issue. However, they did file for a determination letter first to get approval. I don't recall what sort of language was in the plan document.

[thepensionmaven]

Same situation - client is a PC with two common law employees. Assets not sufficient to provide PVVABs at plan termunation. Client unwilling to waive, but rather wants to make participats' PVVABs whole by contributing the difference so the participants will be whole.

Wouldn't the contribution be deductible in the year of termination?

[Mike Preston]

Yes.

[thepensionmaven]

Mike, you da man!

[thepensionmaven]

Client has contributed to make the DB sufficient for termination and all rolled over by July 2016.

Does 401(a)(7) apply if the client wants to make the full $53,000 contribution to his PSP for 2016, made prior to March 15th of 2017?

[Mike Preston]

I see no reason why 404a7 wouldn't apply.

[thepensionmaven]

Assume you are saying that client can not make the full $53K to new PSP?

[Mike Preston]

Depends on how much the contribution was to the DB plan to make it sufficient.  I'm saying 404a7 applies with all of its worts.  You started this with saying the DB contribution had been made by July 31, 2016.  Some portion, if not all, of the contributions made between 1/1/2016 and 7/31/2016 might have been deductible and deducted in 2015.  To the extent not deducted in 2015 it would be deductible in 2016.  To the extent it is deductible in 2016 404a7 applies if there is a PS plan involved.