Restricted HCE distributions-Any suggestions?

[AndyH]

I'm sure I'm not alone in facing a number of problems with small plans with lump sum provisions that cannot meet the 110% funded current liability percentage requirement for a lump sum to an HCE.

Does anyone have a solution to this? Does anyone know a financial institution that is informed enough to handle the escrow or bonding requirement at reasonable cost?

With the low GATT rates and tanking stock market, this is going to get much worse before it gets better. Most of the plans that I handle that have lump sum provisions have this problem, even the ones that have been at the Full Funding Limit recently! How do you explain this to the small (10-40 employee) client, that's there's not enough money but they can't put the necessary money in?

It's been hard enough to convince these clients not to terminate their DB plans in recent years. Now the owners get older, they've provided benefits for employees, but they can't take lump sums!

Now I can't justify this ridiculous rule. Any suggestions?

[Guest]

For whatever it's worth, I agree with you and sympathize with you. Having said that, we still have to deal with the rule. From your message I assume the situation you're dealing with is that of an older HCE who now wants to retire,but can't get his full unrestricted lump sum because of the (a)(4) rule on payment to HCE's from underfunded plans. There are other HCE's left in the plan who will want their money at some time in the future. I'm working on a similar problem now. (As an aside,when I told the three younger siblings that their older brother cuouldn't get his money they said "That's not fair!" When I told them that if he was fully paid out and they then wanted to terminate the plan they would be responsible for the shortfall they said "That's not fair to us!!". They didn't think the rule was so stupid then.)

As an alternative to posting the security, would your client agree to take annual payments? You can always pay the unrestricted amount,which is one year's single life annuity.This will also keep money in the trust ,leaving a larger asset base to work on.

If your client insists on a lump sum you can set up two IRA's,one for the unrestricted amount,and one with the appropriate restrictions. Each year as necessary he can move one year's annual payment from the restricted IRA to the unrestricted. Obviously you need an ERISA attorney for this approach.

That's all I can think of. Hope it's of some help.

[AndyH]

The dual IRA idea is a good one. Thanks for the feeback.

Regarding the annual payments, one problem is that they are taxable, since they are computed over a period exceeding 10 years, so that defeats the purposes of a lump sum rollover.

You are right about the need to get an ERISA attorney involved. I don't think that can be avoided. That's fine for the owner with a big payment, but (among several situations), I have one where the Controller (HCE and our primary contact, of course) isleaving a small company with a lump sum of about $20,000, and he can't take it, and the legal fees would be prohibitive. Plus, who would be responsible for the legal fees? The client, I suppose. Another reason why they should have terminated the plan years ago?

I've always been an advocate of DB plans. Now I'm second guessing myself.

[Guest]

I don't understand your 2nd paragraph. Please clarify it for me. As for your observation about DB plans,I think that DB plans are becoming more and more a "niche" product,exceot maybe for unions. But maybe with the market downturn the bloom is comung off the 401(k) rose.

[AndyH]

The annual amount would be somehow related to the life expectancy, which would obviously be over more than 10 years.

What I was trying to say is that distribution of substantially equal periodic payments payable over 10 or more years, or over a life expectancy do not qualify for rollover treatment. Therefore, they are taxable.

1.402©-2, q&a 5(a), 1.403(B)-2, Q&A 1

[Guest]

OK,we're on the same page. I took it as a given that such payments would be ordinary income. I didn't mean to leave you with the impression that they could be rolled over. We make our living with assumptions,so sometimes we ASSUME too much.

What about this? At such time as the restriction can be removed,commuting the remaining payments to a lump sum and rolling that amount over. Do you see any problem with that?