Overfunded DB Plan

[sobrienTPS]

I have a client who is set to terminate their Defined Benefit Plan in conjunction with the sale of their business. It's a stock sale and the buyer intends to continue maintaining the seller's 401(k) Plan. The DB Plan is significantly overfunded. According to the current Plan document, reversions are not an option when handling the distribution of residual assets. Instead, the Plan says any excess should be allocated among participants. We intend to reasonably increase benefits in a non-discriminatory manner and transfer the rest to the 401(k) Plan, which will serve as a Qualified Replacement Plan. The buyer's attorney insists that because the Plan does not allow for a reversion, use of a Qualified Replacement Plan is not an option. He's pushing for a determination letter. It is my understanding that IRS 7.12.1.17.1.2 (11-10-2022) explicitly says we can use a Qualified Replacement Plan in the event that a reversion is not allowed or has not been in place for 5 calendar years. The attorney is still arguing that because such language is lumped in with reversion language, the reversion provision is required. The attorney is also arguing that we would need to amend the document to say we're using a QRP for residual assets. When making use of a QRP, do you usually amend the document to say residual assets will transfer to a QRP? Also, if you could share any references that clearly specify a QRP can be used independent of a reversion, I would greatly appreciate it.

[david rigby]

Lots to unpack.  It's not clear what your client relationship is; TPA?, Actuary? Auditor? Something else?  My sense of your phrasing is you are NOT the attorney; is that correct?

If you are not the attorney, this seller should get its own legal advice, rather than use the advice of the buyer's attorney.

[sobrienTPS]

Apologies, I am the TPA. The seller does have their own attorney.

[Effen]

You said, "reversions are not an option when handling the distribution of residual assets. Instead, the Plan says any excess should be allocated among participants".  Assuming that is true, then I agree with the attorney and you can't use a QRP.  A QRP is essentially a reversion to the employer, which your client's document does not permit.  You can change this wording, but it can't be effective for 5 years.  The excess assets need to be reallocated to the participants, and cannot be reverted to the employer.  A QRP is an employer reversion since it essentially reduces the cash the employer would have contributed on future DC allocations.   

[truphao]

agree with Effen, QRP is a reversion.  The final decision is with the client and their attorney.

[sobrienTPS]

I agree that the decision ultimately lies with the buyer, seller, and attorneys. Obviously though, as the TPA, those parties look to us for input when making that decision.

I disagree that a QRP is a reversion. It's a tool that can help avoid or reduce the tax implications of a reversion and, in a QRP, the assets remain tax-sheltered as qualified plan money. 

For what it's worth, IRS 7.12.1.17.1.2 (11-10-2022) says:

"Generally, plan participants aren’t entitled to excess assets unless the plan specifically allows it. Therefore, a plan could provide a direct transfer to a qualified plan or choose to allocate the excess assets to participants (as IRC 415 allows) in the event the reversion language is absent or not in existence long enough to allow a reversion."

Also for the sake of this discussion, what if we reallocated the excess up to every participant's 415 Limits and there was still $200,000 leftover in excess assets? Would you say the remaining excess could then be transferred to a QRP?

 

[CuseFan]

1 hour ago, sobrienTPS said:

"Generally, plan participants aren’t entitled to excess assets unless the plan specifically allows it. Therefore, a plan could provide a direct transfer to a qualified plan or choose to allocate the excess assets to participants (as IRC 415 allows) in the event the reversion language is absent or not in existence long enough to allow a reversion."

Agree with Effen and truphao. I think says more that participants don't have to get excess unless plan says so, or its reversion provision wasn't old enough.

7.12.1.17.1(2)c says: "Establish a qualified replacement plan per IRC 4980(d). Follow the processing procedures in IRM 7.12.1.17.1.2 (5), Reversion of Excess Assets." I think that also seems to indicate that IRS views transfer to a QRP like a reversion from the perspective of plan provisions. If you look at pre-approved plan language, the options are allocate to participants or revert to employer, so transfer to a QRP needs to fit under one or the other, and it has to be reversion. 

[Artie M]

I agree with buyer's counsel.  Also, I agree on requiring a determination letter filing on the terminating plan.  As buyer in a stock sale, it assumes all the obligations of the seller corporation.  Presumably the plan is being terminated pre closing and the buyer is going to handle post-termination administration.  Even if the DB plan was spun off and terminated, if there is an issue under that DB plan, there is a potential that liability could still fall back on the buyer if the IRS/PBGC thought that the spin off was a sone type of subterfuge to escape liability.  Normally, in the case of a terminating DB plan, you would seek a letter and no distributions would occur until after the letter is received. 

I also agree that a QRP cannot be used if the plan terms simply state "any excess should be allocated among participants" without anything else.  You conveniently left out language in IRS 7.12.1.17.1.2 (11-10-2022) @sobrienTPS states that provision from the manual correctly "a plan could provide a direct transfer to a qualified plan or choose to allocate the excess assets to participants (as IRC 415 allows) in the event the reversion language is absent or not in existence long enough to allow a reversion."  The conditions of if the reversion is not allowed or not in place for 5 years modifies the allocation of excess asset to participants... the conditions do not modify the use of a QRP.  I have always read this language to mean you either can (1) use a QRP or (2) allocate if you can't use a QRP. 

But youhave the perfect scenario to let the IRS decide.  Amend the plan to permit the QRP, with the amendment laying out exactly how much of the excess assets will be transferred to the QRP, and how those amounts will be allocated in the QRP, CLEARLY indicating the effective date of the termination of the DB plan and the effective date of the change to the reversionary language.  If the IRS blesses it, then all is well.  If not, you are back where you are at now.  If they don't permit the QRP, it should not be a problem because most plans would not permit distributions prior to the issuance of the IRS determination letter, and all that will be required is to work out is how to allocate the excess assets to the participants.  If there is more than can be allocated, the IRS will be there to let you know what to do with the rest.   Either way, as buyer's counsel, I would not be letting the seller walk off with any of the potential reversion.  At most, we could escrow the amounts until resolved.

And, yes, we always amend a plan for the QRP provisions (usually these provisions will contain language that is also going to be used in the QRP plan document) along with always requiring a letter on the termination of the plan.  You should tell the seller/buyer, you are a TPA... not a lawyer.  They can ask you your thoughts but no matter what you say, it should always be followed up with... but you should really ask your lawyer.

As always, just my thoughts with absolutely no research...

[Artie M]

One other thing...  Excess assets from the DB Plan is a reversion, but the excise tax is waived if 25% of the excess assets is "transferred" to a QRP and then not treated as a reversion.  Though amounts are "transferred" to the QRP, a Form 5310-A is not required (even though that form applies to plan to plan transfers) because the view is that the amounts are first reverted to the employer who then contributes it to the QRP (I believe there is an IRS ruling somewhere that supports this conclusion).   We never file a 5310-A in QRP situations.  The first time this occurred we were confused so for each QRP we have done since we include language in the IRS determination letter filing materials stating no 5310-A will be filed and the IRS has always agreed.

just more ramblings

[david rigby]

On 6/3/2025 at 7:53 PM, Artie M said:

One other thing...  Excess assets from the DB Plan is a reversion, but the excise tax is waived if 25% of the excess assets is "transferred" to a QRP and then not treated as a reversion. 

To be clear, "at least 25%".

Another thing: has the seller explored the idea of having the buyer deal with it, via the buyer assuming the DB plan?  Although the (apparent) reversion language might be a deterrent, there may be other reasons why the seller would encourage this option.  There may be an advantage to the buyer which could result in a higher sale price. For example, if the buyer has an underfunded DB plan. (Every Enrolled Actuary will know how to find the answer to this question online.  If so, you will kick yourself if you don't at least raise the subject with your client.)  Don't laugh, real money on the table.

[John Feldt ERPA CPC QPA]

You asked: what if we reallocated the excess up to every participant's 415 Limits and there was still $200,000 leftover in excess assets? Would you say the remaining excess could then be transferred to a QRP?

Once all participants are at the 415 limit and paid out, to fully terminate the plan, the excess must revert, and I would argue a portion of that reversion can be a transfer to a QRP. Now whether the IRS agrees, that’s a separate question. Counsel is advised.

[Artie M]

Right @david rigby  I have slow down sometimes... Thx!

 

[Tom Veal]

While I agree with Artie M., let me note that a favorable IRS determination letter would not prevent participants from bringing an action under ERISA.  The IRS has no authority over Title IV of ERISA, which includes rules governing reversions.

[TheBoxMan]

2 hours ago, Tom Veal said:

While I agree with Artie M., let me note that a favorable IRS determination letter would not prevent participants from bringing an action under ERISA.  The IRS has no authority over Title IV of ERISA, which includes rules governing reversions.

I agree with Tom. Even with a favorable IRS determination letter, if this is discovered during a PBGC audit, the plan will be on the hook to pay the excess assets as described in the plan document. 

[Lou S.]

I agree that this could be covered by getting an IRS DL and specifically asking on a ruling about the excess asses above and beyond the IRS 415 limit for participants. But if benefits are increases to the 415 limit for all employees and there still excess assets, there must be some mechanism to deal with the excess where that is reversion to Employer or transfer to QRP but if it is against the terms of the document and less than 5 years from the change, I think the DL would be required to get the IRS blessing. It seems like one of those odd set of circumstances that should have a reasonably simple explanation but is at odds with the either the Code or the Plan document.