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I have client with a solo-DB (husband and wife) that is overfunded by about $500k.  They contributed the maximum deductible against recommendations and investments were aggressive (again, against advice) and returned about 15% a year.  They also have a solo-401(k) plan - the plan I administer.  Both are in their mid-40's so nowhere near retirement but they are at a point where they finally understand they can no longer make contributions to the DB.

Can they:

1) Rollover their DB benefits to their 401(k) and transfer the excess in the DB plan to an escrow account in the 401(k) (without excise tax) to fund employer contributions until they are exhausted?

2) Then, in a couple of years, can they start-up a new DB plan?

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1) Yes, but the entire suspense account has to be used up within 7 years if they want to avoid the excise tax on the reversion. The amounts allocated are still subject to the annual additions limit, so if it's just the two of them, and they are allocating (let's say) $35k each per year that ends up as only $490k allocated after 7 years. Make sure you will be able to fully allocate the amount before you transfer it.

2) No. Assuming that they take a distribution equal to the max lump sum, that is by definition the present value of their 415 limit. The 415 limit is a lifetime limit so any distribution they take now permanently reduces the future benefit they can receive from any DB plan sponsored by the same company (or controlled group etc). If they take the max lump sum there would be zero 415 limit left so no additional benefits could accrue under a new plan.

Free advice is worth what you paid for it. Do not rely on the information provided in this post for any purpose, including (but not limited to): tax planning, compliance with ERISA or the IRC, investing or other forms of fortune-telling, bird identification, relationship advice, or spiritual guidance.

Corey B. Zeller, MSEA, CPC, QPA, QKA
Preferred Pension Planning Corp.
corey@pppc.co

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1) Maybe.  Review the rules for Qualified Replacement Plan.  They can reduce the excise tax on whatever they can allocate within 7 years.  They might be able to use up the entire $500K of excess.  Make sure they understand it counts as an annual addition.  IOW, if they allocate $58K of the excess assets each year, there is no room for any employer contributions.  Also, be aware of earnings on the excess assets they transferred also need to be allocated, so most people invest conservatively.  

2) Sure, they can start a new one tomorrow.  They won't be able to put any money into it, but they can have one.  You only get one 415 limit per employer.  If they hit the 415 limit in the DB, they are likely done.  If COLAs increase the 415 limit in the future, it might make sense in a few years, but not as likely to happen with the current Congress.  If they worked for a new employer (less than 50% ownership) they might be able to fund a different 415 limit.

 

The material provided and the opinions expressed in this post are for general informational purposes only and should not be used or relied upon as the basis for any action or inaction. You should obtain appropriate tax, legal, or other professional advice.

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May be I am not seeing but are the DB plan benefits are fully accrued i.e. 10 years of participation?

There is no more room for further benefit accruals? No room for salary increase possibilities?

Remember that the 415 lump sum limits go up every year. It is possible to eat up some overfunding in the next couple of years. They need to cool off on the investments.

If they transfer to a QRP, with minimal salaries and no deductions, 500k can easily be spent in 7 years, assuming no crazy returns. You only need to worry about 415(c) limits.

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My DB was overfunded at 67 by a much smaller amount ( 12 years of not max contributions but great investment results ). Only comment here is my actuary kept me posted before being overfunded- this is a fairly large amount at a relatively young age. I could be wrong ( it would be the first time this hour) but where was the communication on this to the client ? 👀

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I'm assuming that was thinly veiled sarcasm by Bob.  Heck, I just got yelled at by an advisor because I told the client that their 32% investment return for 2020 was too high and can have significant consequences in the future.  The communication was probably there and ignored.

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I have never worked with an over-funded DB.

I have almost the same situation as Hojo. My client is a sole prop and sponsors a DB with one active and one term vested participant.

I designed the DB ( a CB) plan and heavily mentioned (at least a dozen times) the rate of investment can't be more than 5-6%.  Needless to say, the investments yielded on average 6-9%

First year contribute was $250k and the investment individual told the client he could contribute $250K each year, which he did, and all during the year. Against my advice.  Similar to Hojo above

Needless to say the plan is overfunded, by about $350K.  I was thinking he could start a new PSP, rollover a good portion of the over-funded, in addition to a contribution to the plan and just let the DB sit for awhile, then terminate.

But how long is "a while"?

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40 minutes ago, thepensionmaven said:

Needless to say the plan is overfunded, by about $350K.  I was thinking he could start a new PSP, rollover a good portion of the over-funded, in addition to a contribution to the plan and just let the DB sit for awhile, then terminate.

A distribution will not help over-funding. What they need to do is stop contributing until the benefit accruals catch up with the plan assets. Is the participant already at their 415 limit? How old are they?

If the plan is relatively new, and they still have several more years to retirement, the current over funding might not even be an issue. It's not an uncommon strategy to juice the contributions in the early years when you have more income, and let the benefit accruals catch up in the later years if income drops off.

I have found that reminding sponsors (and advisors) that reversions of excess assets are subject to a 50% excise tax helps them take the issue of over-funding a little more seriously.

Free advice is worth what you paid for it. Do not rely on the information provided in this post for any purpose, including (but not limited to): tax planning, compliance with ERISA or the IRC, investing or other forms of fortune-telling, bird identification, relationship advice, or spiritual guidance.

Corey B. Zeller, MSEA, CPC, QPA, QKA
Preferred Pension Planning Corp.
corey@pppc.co

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Benefits are fully accrued, this is a cash balance plan, so no average salary.

Are you saying just freeze the plan?

The principal is going to retire shortly.

I have mentioned the 50% excise tax many times, both to client as well as accountant.  Seems like all they are thinking of is deduction, deduction, deduction; and the broker?  Well, you know - commission, commission, commission.

Someone had suggested starting a profit sharing and/or 401(k).

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If it is assumed that the total distribution is at 415 dollar limit (not compensation limit unless over age 68 or 69 - depending on the actuarial equivalence assumptions) and the participant has full 10 years of participation, there is no room for growth. If this is not the case , then C.B. Zeller's approach in the second paragraph is the way to go.

However, if the owner is retiring soon i.e. no more business, how is setting up a qualified replacement plan will help with the overfunding?

350k over funding, with very little return on investments and with a salary at least equal 415(c) limit, will allow the overfunded portion to be eliminated within 7 years e.g. 58k salary for 7 years = 406k. There will be no deductions except for possible catch up only, as they would want full 415(c) limit for the profit sharing portion.

If the owner is going to retire in the next couple of years or so, the overfunding issue will not go away. In this case, transfer a minimum of 25% of the overfunding into a profit sharing plan and reduce the 50% excise to 20%. Of course you also have to deal with using up the amount that you will transferring into the new profit sharing plan, possibly in the 90k range which can easily be used up in 2 years with minimal salaries.

I am curious if someone has a very creative solution out there.

Have a great weekend.

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