Distribution from Underfunded Cash Balance Plan

[RamblinWreck24]

My wife is a participant in a cash balance plan as a partner in a medical practice. Some internal discussions have made it seem like the plan is underfunded even though the 5500 for 2022 shows over 120% funded status. She will be separating from employment next year and our plan was to rollover her vested benefits to an IRA. 
 

When others have left, there have been discussions about who should be responsible for the “make-whole” payment if the plan is truly underfunded at the time of separation. Some thoughts have been that the employee should just true up their own balance through an additional deduction from their P&L. That struck me as odd, so I was curious if there were any actual federal guidelines or regulations that would govern a situation like this where vested employees are seeking their benefits from an underfunded plan. 
 

The plan is covered by PBGC. Not sure what other details might be relevant, but thanks in advance for any assistance!

[justanotheradmin]

Is she an HCE? is she eligible for a distribution right away up separation or does the High 25 rule apply that would delay her payout until a future year? when an HCE takes a distribution from a small Cash Balance plan the plan needs to be pretty well funded / over funded so that the benefits for the NHCE aren't jeopardized by the distribution. 

 

[Peter Gulia]

What does the partnership agreement provide about how the partnership’s funding of the cash-balance pension plan is allocated among the partners?

Even when public law governs the partnership’s funding obligation to the pension plan, the private law of the partnership agreement might govern the allocations of those and other expenses among a partnership’s partners.

A partner might want her lawyer or her certified public accountant (or, perhaps better, their collaborative work) to check the partnership’s accountings and allocations of expenses against the partner’s and her professionals’ independent reading of the partnership agreement.

And if those professionals are not pension experts, they might bring in an actuary’s or a lawyer’s work to discern how much of the partnership’s funding obligation is incremental because of a particular partner’s or other individual’s benefit, which might, in turn, help discern how much is allocable to the partner under her partnership agreement.

[RamblinWreck24]

13 hours ago, justanotheradmin said:

Is she an HCE? is she eligible for a distribution right away up separation or does the High 25 rule apply that would delay her payout until a future year? when an HCE takes a distribution from a small Cash Balance plan the plan needs to be pretty well funded / over funded so that the benefits for the NHCE aren't jeopardized by the distribution. 

 

Yes, she would likely be an HCE in the context of the entire clinic and after reviewing the High 25 rule she would probably be covered by that as well.  At the end of 2022, her balance amounted to only 2% of the total funding target for the plan and about 1.6% of the market/actuarial value of the plan assets.  Using those same values from the end of 2022, it would appear that the plan would exceed the 110% funding requirement for paying out an HCE.  That should allow her to take an immediate payout despite her HCE/High 25 designation, correct?

I still can't really reconcile why some of the administrative staff are treating the plan as underfunded when the last form 5500 shows it was overfunded.

[RamblinWreck24]

3 hours ago, Peter Gulia said:

What does the partnership agreement provide about how the partnership’s funding of the cash-balance pension plan is allocated among the partners?

Even when public law governs the partnership’s funding obligation to the pension plan, the private law of the partnership agreement might govern the allocations of those and other expenses among a partnership’s partners.

A partner might want her lawyer or her certified public accountant (or, perhaps better, their collaborative work) to check the partnership’s accountings and allocations of expenses against the partner’s and her professionals’ independent reading of the partnership agreement.

And if those professionals are not pension experts, they might bring in an actuary’s or a lawyer’s work to discern how much of the partnership’s funding obligation is incremental because of a particular partner’s or other individual’s benefit, which might, in turn, help discern how much is allocable to the partner under her partnership agreement.

I'm not even sure if they have a formal parthership agreement and even if they do I suspect that it is silent on cash balance funding.  Some of the decision-making on expense allocation seems very ad hoc - some expenses are shared equally by each partner while others (especialy administrative overhead types of costs) are paid according to a formula (half fixed and half variable according to certain productivity measures).

Just by way of example for how arbitrary some of the decision-making seems, a rank-and-file employee (not a partner) left with a remaining balance < $5,000 in the plan.  As they were looking to distribute to her, one of the HR admins noted that her account had a shortfall of about $500 and they were deciding on whether to invoice her for the shortfall.  This didn't make any sense to me since I don't believe the rank-and-file employees contributed any of their own funds.  That situation is what prompted me to start researching rules about taking distributions and funded status of the plan.

We are in the process of getting a lawyer to vet everything as part of her upcoming separation next year, since neither of us really trust that the officers and administration of the practice have a good grasp on things in general, not to mention the specifics of the cash balance plan.

Would it be worth reaching out directly to the actuary that performs the calculations on behalf of her plan to get a better understanding of where things stand?

[truphao]

There are several issues at play here.   

1) While the plan might not be underfunded on Funding Target basis it still can be underfunded on Plan Termination basis (Total of Accumulated Cash Balances is more than the current assets in the trust).  This is for an actuary (plan actuary or an independent actuary you might hire) to review and explain.

2) 110% limitation applies to top-25 highest paid ever.  It might or might not have an impact on your spouse. This is for the plan actuary to determine.  Please be aware there is quite a bit of latitude how to calculate 110% test (funding basis, plan termination basis, etc.).   The test needs to be satisfied AFTER the payout.  Most likely your spouse  (as individual participant) is not able to "manipulate" the process in your favor since this would be a plan sponsor/plan administratior function.

3) Allocation of pension expense to individual partners is definitely governed by the partnership agreements, review that carefully, ideally with legal assistantce.

4) It sounds like you are going to challenge the existing processes/administrative processes.   If so, the plan's actuary might find herself in an akward position facing a potential conflict of interest.  The plan's actuary job is to assure the proper administration of the plan in accordance with the legal plan document and the current laws.  I personally would probably turn that type of inquiry from an individual partner down. You might want to consider hiring your own actuary for evaluation of the best options form your perspective.

5) Keep in mind that your spouse does not need to take the money upon termination.  She has a right to simply leave it in and wait until the funding improves and keep earning interest while waiting.  If she is responsible for underfunding of the plan or not mostly likely it would be on the partnesrship agreement level.

[Lou S.]

On 11/23/2023 at 6:12 AM, RamblinWreck24 said:

I still can't really reconcile why some of the administrative staff are treating the plan as underfunded when the last form 5500 shows it was overfunded.

Because the way you value liabilities and assets for the 5500, might not be the same as if you terminated the Plan and had to pay out all participants. The IRS mandated interest rates for valuing the Funding Target might produce a number that is higher or lower than the sum of all hypothetical balances in plan which might be different still form the actual assets in the Plan. Also if the Plan is using Actuarial Value of Assets instead of Market Value of Assets to smooth out losses, the Assets reported on the 5500 for calculating that "overfunding" might be more that what is currently in the Plan.

That is a long winded way of saying, it's complicated.

[Luke Bailey]

On 11/23/2023 at 5:10 AM, Peter Gulia said:

What does the partnership agreement provide about how the partnership’s funding of the cash-balance pension plan is allocated among the partners?

Even when public law governs the partnership’s funding obligation to the pension plan, the private law of the partnership agreement might govern the allocations of those and other expenses among a partnership’s partners.

A partner might want her lawyer or her certified public accountant (or, perhaps better, their collaborative work) to check the partnership’s accountings and allocations of expenses against the partner’s and her professionals’ independent reading of the partnership agreement.

And if those professionals are not pension experts, they might bring in an actuary’s or a lawyer’s work to discern how much of the partnership’s funding obligation is incremental because of a particular partner’s or other individual’s benefit, which might, in turn, help discern how much is allocable to the partner under her partnership agreement.

RamblinWreck24, I completely agree with Peter's legal analysis and with the other posts as well, but I will add the following from the standpoints of business and fairness, based on my experience in similar situations:

 -- Suppose 10 people form a partnership at the same time and are all of the same age and get paid the same (I know, stupid assumptions, but bear with me). They form a cash balance pension plan under which everyone has the same benefit and there is perfect consensus among the 10 partners regarding how it will be designed and invested. If the plan also covers non-owners, assume there is equal staff cost/utilization by each partner in the practice. Each year, the same reduction occurs to the partners' taxable/distributable profits to fund their benefits (and possibly the benefits of any staff participants). Then one of the partners pulls out early and an additional amount must be contributed to fund that person's distribution. The other nine will forge ahead and make contributions to fund their benefit on a going forward basis, just as before.

-- In the above situation, it might make sense that the partner retiring early would need to make a contribution to fund his/her benefit fully (although as pointed out by justanotheradmin and truphao above, if there are non-owner participants, it generally would not be possible to fund a full distribution for the early retiree even if an amount is contributed equal to the allocated underfunding for the one departing partner). On the other hand, in virtually any real-life situation, where there may not have been equal buy-in by all participants regarding plan design, crediting rate, annual contributions, and investment policy, where different partners will have had larger or smaller demands on staff (assuming staff participation in the plan) and different shares of firm profit, and where partners of different ages will have come and gone at various points in the market cycle), reaching a consensus about handling the departing partner's share of the underfunding may be difficult to achieve.

But again, the above is just an intro to the business/fairness aspect. As Peter points out, the legal documents govern, most critically the partnership agreement.

[Effen]

This won't help RamblinWreck, but it might help future readers.  Traditional Cash balance plans are great, but when you have multiple owners you run into these types of distribution problems that are generally not fully explained at the front end of the engagement.  If the cash balance plan is overfunded, the exiting owner wants a piece of the excess, and if the plan is underfunded, the remaining owners don't want to give them full value - or in this case, the exiting owner can't be paid at all until the funding level meets the 110% rule.    

There are other types of plan designs that handle these situations more efficiently.  "Market based" cash balance plans can be a better solution, but you still end up with overfunding/underfunding at different points in time.  They are a better solution, but still not perfect.  There are also "Direct Recognition VIP Retirement Plans", or VIP plans which are not based on the cash balance regulations but look very similar.  In a VIP plan, the value of the assets is always equal to the sum of the account balances because the benefit is based on the number of "units" and not a stated dollar amount.  Each of these options comes with a little higher price tag, but the extra administrative cost can save a lot of expense and frustration if one of the partners wants to leave before the others.