small Cash Balance Plan - just wasn't right

[TPApril]

I have a feeling this happens more often than it should.

Financial Advisor convinces one-person business owner to start up Cash Balance Plan. It is explained clearly that the plan is meant to be long term, at least 5 years. Nice contribution made in first year. Nothing in second year and Plan Sponsor decides it's not for them. No 5500-ez filed as of yet.

Contemplating how to react.

[Lou S.]

Plan is "supposed to be permanent" but maybe facts and circumstances have changed. Advise of potential Plan disqualification, tell them they may want to consult with their ERISA counsel.

When you say "nothing in the second year" was that the required minimum contribution or did they just say, nope don't want to? Because those might be two different situations.

And by no EZ filed I'm presuming because assets are under $250K at least hoping that's the case.

[TPApril]

Lou:

Yes assets remain under $250K and there was no required minimum for second year of plan.

Thank you for your thoughts.

[truphao]

That makes it somewhat easier.  You can suggest to proceed with the plan termination with a proper communication advising the sponsor of the potential disqualification risk upon audit.  Make sure you create a well organised paper trail having your advices well documented.  The burden is on the plan sponsor.  Billing hourly (vs a previously agreed fixed) might be a good idea as well.  And here is a reminder (I have almost tripped over that several times myself so I am paranoid now) - although no F-5500-EZ is not required, the SB still has to be prepared.  Do not forget to review if the combined assets are over 250K if there is a 401(k) plan.

[TPApril]

Come to think of it, even though assets remain under $250K, if I recall correctly, a final 5500-EZ would indeed have to be filed. Since it would be for the 3rd year of the plan, we'd attach 3 Schedule SB's if I'm correct.

Either way, we're still going to encourage him to keep the plan open.

[Lou S.]

We'll if it's an EZ you don't actually attach the SB at all. But you do have to send a signed SB annually to the client for their records.

Maybe propose a smaller formula for a few years then terminate?

[CuseFan]

Confirming - SB gets prepared/signed and provided to plan sponsor but is not filed, and a first and final EZ filing would be required. On the form there are check boxes for first and final as well as a line to disclose the effective date of the plan, so it could very easily be flagged for IRS scrutiny. And if the situation is as described, plan sponsor changed their mind after an initial tax deferral, that is precisely what IRS does not like, as we all know.

[Jakyasar]

I have dealt with this numerous times when the client said "I do not like it". My response was, "you knew this and were told minimum 3 years (some push to 5 years), committed to it in writing."

"If you want to shut down because you do not want it and not stick around for 3 years, then either go away or provide me a letter stating that you are voluntarily terminating the plan against TPA's advice and take full responsibility for any action that may be brought against you by the IRS".

As an alternative, I tell them to freeze the plan, stick around for another year or so and then terminate but no guarantees that IRS, upon an audit, will be happy about it.

Of course, a financial instability that can be backed up is no issue, easily defendable, life happens.

This biz became the ultimate CYA.

[CuseFan]

Note the IRS presumption is that a plan in existence at least 10 years will not be questioned concerning its permanency. I think 3-5 years is a good interval for design changes, like reducing or freezing benefits, but there is no guarantee IRS won't come looking for justification if you terminate after 5 years. An owner starting a plan at 57 who retires at 62 and winds down the business, sure, no concerns for me, but a 45-year-old who decides 5 years later (s)he doesn't want the plan anymore where nothing materially changed with the business is a riskier proposition. I would recommend freezing and running it out to 10 years if possible unless some significant business event happens in the interim such as a transaction, material ongoing decline in revenue, significant increase in workforce/payroll, etc.