A Real Problem

I have a long time client that has both a 401(k) Plan and a Cash Balance Plan. These plans have been in place for quite a while and each has 1 -2 million in assets. Here's the problem, the defined benefit plan's assets consisted of all CD's. As they all became due during 2025, the proceeds from the CD's were mistakenly transferred to the 401(k) plan leaving the DB plan with zero assets. 

I don't see any good solution for this problem. If I was pressed, I would suggest transferring the assets back into the DB plan with an estimated income adjustment. Using this approach, how much risk would there be if the plan would be audited in the future? Could the risk potentially be as great as a disqualification of both plans?

Agree with your suggested solution but also strongly suggest some formal legal guidance which could also ascertain risk. I would not "cheap out" given the size of the assets. Other key thoughts: who made the mistake, when did it occur, when was it discovered, and how soon thereafter was it corrected? Was this one big errant transfer or a series of errant transfers? Were they caused by honest clerical errors or was someone asleep at the wheel not paying attention. Was this the plan sponsor's doing or a third party? Documenting all that and fixing ASAP at a minimum is what I would suggest - put the plans where they'd be had the mistake(s) not occurred. Maybe a VFCP filing would be appropriate.

My only formal advice here - get qualified legal guidance.

Consider also that only communications with one’s lawyer for the purpose of getting the lawyer’s legal advice can get that evidence-law privilege.

Any way to amend the trust so that a single trust holds both plans assets rather than moving dollars? I would have legal counsel opine because I don’t know that it can be done after the fact. But we do know it can exist. 

This really should be addressed in future EPCRS because it's more common (plans' assets getting mixed up between them) than half the stuff they worry about in the Rev Proc as it is!

And, beyond tax-law corrections, an eligible correction under Labor/EBSA’s Voluntary Fiduciary Correction Program (because the Treasury/IRS lacks authority regarding ERISA title I fiduciary breaches).

Expenses for a correction should be the personal responsibility of the breaching fiduciaries.

4 hours ago, david rigby said:

Although not recently, we used to see mistakes where Plan A contribution was mistakenly deposited into Plan B.  The solution was simple: just transfer it to the correct location/trust.  If you need an adjustment for earnings, make a reasonable estimate and do it.  But do it immediately, and document it completely.

Yeah, the times I have seen this error we didn't put this much thought into it.  We got the money moved to the correct plan.  If we thought it was material there was some earnings transferred.   

I have to admit I don't recall any of these plans ever getting an IRS or DOL audit also. 

But at times the KISS Principle works.  

In the days before computers we lawyers would have two stacks of deposit slips in the desk drawer, one for the office account (earned fees) and one for client/escrow funds.  Normally the banking would be handled by an office manager or a secretary and on occasion the wrong deposit slip would wind up putting money into the wrong account.  As soon as we realized what happened we moved the money to the correct account, not stealing a dime, and life went on. 

Then we and the bank got computers.  If we put escrow money into the office account and a check drawn on the escrow account overdrew that account, the bank was required to instantly notify the Grievance Commission and we would be investigated.   We could not correct the problem quickly enough. What procedures did we follow?  How could this have happened?  What training did the secretary have?  (One firm was forced to fire it's computer illiterate secretary.)  What policies had we adopted and how would they be amended?  What was out motivation?  Were we stealing client money?  Let's examine your records for the past three (3) years.  If it happened more than once we might be sanctioned, from a slap on the wrist to a brief suspension (unless you really were stealing), and those sanctions would result in an increase in our malpractice insurance coverage. 

So I feel your pain.  By all means call your lawyer who will tell you exactly what you colleagues have suggested in this post.  Go to Confession.  Say the Al Chet.      

While the preferred approach is to obviously transfer the assets back to the appropriate plan/trust with an interest/earnings adjustment as soon as possible (and should be done in any event), technically you may have a prohibited transaction (employer and/or fiduciaries utilizing plan A assets for plan B obligations).  The employer may need to consider filing an IRS Form 5330 (Return of Excise Taxes Related to Employee Benefit Plans) and possibly a DOL Voluntary Fiduciary Correction Filing (benefit payments based on improper valuation of plan assets, depending on the underlying facts). Many employers/plan sponsors will likely choose to make the adjustment (no harm/no foul) without a filing and take the position that the IRS/DOL will not pursue if no loss in benefits/harm to participants or the ultimate amount of plan assets; others may treat as simply an "administrative error." Other considerations may include, e.g., possible violation of any reps and warranties in sale agreements or other financial commitments (if a prohibited transaction). Also, Form 5500 (under penalties of perjury) has a line asking whether there have been any prohibited transactions during the year; also, the independent auditors for the plan(s) may flag the corrective transfer in their opinion.