Overfunded DB - Intentional Disqualification

[dan.jock]

Client started a H & W DB plan in 2016.  They bought a stock that increased 4000% so now they are way overfunded and benefits will never catch up.  I am going to suggest they take out the money into a regular brokerage account and thus intentionally disqualify the plan.  Pay regular capital gains.  Taxes and penalty on the disallowed deduction are better than a reversion tax on an overfunded DB.  Or are they?  Please help!!

[jpod]

Doesn't the reversion tax apply if the plan was EVER qualified under 401(a)?

[dan.jock]

Not according to this

https://www.irs.gov/retirement-plans/tax-consequences-of-plan-disqualification

 

[dan.jock]

reversion taxes are described in the context of plan termination

 

[Mike Preston]

2 hours ago, jpod said:

Doesn't the reversion tax apply if the plan was EVER qualified under 401(a)?

I think it is even more inclusive.  The reversion tax applies if the plan was EVER INTENDED to be qualified.  Anybody who takes a different position is asking for the IRS to punish their client.

[dan.jock]

Thanks MIke.  So my client made an ill-advised (more like non-advised) investment decision and he is about $8M overfunded.  What should I suggest?

[jpod]

Why ill-advised?  Maybe I am naïve, but let's say the overfunding upon a reversion is projected to be $1,000,000.  Isn't 10% of $1,000,000 better than 100% of $0?

Let's look at it another way.  I intended to fund an eventual benefit of $2,000,000, through tax-deductible contributions of $200,000 over a period of years - let's say 8 so $1,600,000 of deductions and a tax deferral of let's say $640,000.  As it turns out I have my benefit of $2,000,000, plus the 10% of the $1,000,000 of reversion, so that's $2,100,000, and it only cost me one year's contribution of $200,000!  Yes, I lost $560,000 of future tax deductions, but I still got my $2,000,000 benefit anyway.

Sure, it would be a neat trick to find a way around the reversion taxes, but how can you complain about an investment return of such magnitude?   

 

[Luke Bailey]

There may have been guidance on this, or not, but I remember years ago that there used to be an M&A market between companies with overfunded/underfunded DB plans. Seemed like the threat from IRS was that if economically part of the acquisition price was payment for the overfunded DB that would be a PT and/or constructive reversion, but I don't recall if any definitive guidance ever came out on this. Seemed like there might have been a reported case, forgot how it went.

[ERISAAPPLE]

What is an H&W DB plan?  Is that a DB plan with a 401(h) account?

If so, there are lots of good ways to handle this.  I don't think plan disqualification is one of them.  

[NJ Mike]

3 minutes ago, ERISAAPPLE said:

What is an H&W DB plan?  Is that a DB plan with a 401(h) account?

If so, there are lots of good ways to handle this.  I don't think plan disqualification is one of them.  

I thought it was Husband & Wife.

 

Mike

[ESOP Guy]

40 minutes ago, ERISAAPPLE said:

What is an H&W DB plan?  Is that a DB plan with a 401(h) account?

If so, there are lots of good ways to handle this.  I don't think plan disqualification is one of them.  

I read it your way also. 

[WhoLetTheDogsOut]

WTH didn't they buy this stock in a DC plan??????  I know it's an unrelated (and somewhat rhetorical) question but that would have been a sweet result if that had been done.

[ERISAAPPLE]

Even with Husband and Wife plan, there are lots of ways to handle this.  It really depends on the goals of the client and the surrounding facts and circumstances.  I still don't think disqualification is the answer.