Editor’s Note: This is the second of a four-part series concerning a recent ASPPA webinar by Kelsey Mayo, ASEA Director of Regulatory Policy and Partner at Poyner & Spruill LLP, in which she took a look at the basics about plan freezes and terminations in the context of current circumstances and regulations. The discussion put a special emphasis on compliance, since knowledge of the procedures for these functions can be helpful in avoiding mistakes, complications and even penalties. This first installment, on freezing a DB plan, is here.
A defined contribution plan can be terminated in by a stand-alone resolution to terminate, by plan amendment or by a combination of resolution and amendment. Mayo suggested reviewing the plan to ensure that any specifically required action is taken, and setting the termination date.
A DC plan can be terminated for a variety of reasons, Mayo said, including:
- sale or discontinuance of business;
- merger and acquisition;
- a substantial change in ownership of employer’s stock; and
- a change of objective/strategy for saving.
“The IRS expects there to be a valid reason for a plan termination,” warned Mayo. Such reasons could include:
- change in ownership;
- liquidation or dissolution of employer;
- substantial change in stock ownership;
- adverse business conditions;
- adoption of new plan;
- employee dissatisfaction with the plan; and
- bankruptcy of employer.
Mayo discussed a variety of specific matters relevant to DC plan terminations, including the following:
Permanency Rule. Mayo also pointed out that under the Permanency Rule, a plan must be established with the intent to be a “permanent,” not “temporary,” program. If a plan terminates within a few years after its initial adoption, it should have valid business reason for the termination; otherwise, the presumption is that the plan was not intended to be a permanent program from its inception. However, no business reason is required for the termination of a long-established plan.
Successor Plan Rule. Under the Successor Plan Rule, Mayo said, the termination of 401(k) plan is not a distributable event if there is a successor plan. A Successor Plan is a DC plan of the employer that exists at any time during the period beginning on the date of the 401(k) plan’s termination and ending 12 months after distribution of all the 401(k) plan’s assets. Unless less than 2% of the eligible employees in the terminating 401(k) plan (as of the termination date) are eligible under the other plan during the 24-month period beginning 12 months before the termination date, the other plan is not a successor plan. The following plans are not successor plans: SIMPLE-IRA, 403(b)s, 457s, SEPs, SIMPLE IRAs and ESOPs.
Ceasing Contributions. Generally, this is a freeze with respect to periods after the termination. There may be lagging contributions that occur after the termination date regarding periods before the termination date, such as a final profit sharing or matching contribution. A termination amendment cannot cutback contributions already earned. And when ceasing contributions, ensure that any notice requirements are satisfied.
Vesting. Participants are fully vested on the termination date.
Optional Determination Letter Application. “It is not required to file a determination letter application,” said Mayo, continuing, “But if you do, it’s important to do it on time—within one year from the date of the termination.” But if one chooses to file a Form 5310, said Mayo, it is considered to be filed in connection with the termination if filed by the later of: (1) one year from the date of the termination; or (2) one year from the date on which the action terminating the plan is adopted. Presumably, Mayo said, one may elect to wait on final distributions until after the determination letter is received. The form cannot be filed more than 12 months after distribution of substantially all plan assets.
NTIP Distribution. Distribute NTIP at least 10 days, but not more than 24 days, before filing date. Be careful that the NTIP group is different than an ordinary determination letter.
Steps to Take. When terminating a DC plan, said Mayo:
- Contact participants. Provide distribution notices, and ensure that communications clearly indicate what happens if no response is received (ordinary distribution kits generally must be modified).
- Make distributions as soon as administratively practicable. If no 5310 is filed, that generally should be 12 months from termination date; if the 5310 was filed, no earlier than 6 months after receipt of determination letter.
- Deal with any missing participants. Look for participants, ideally early on in the termination process. One can take advantage of regulatory safe-harbor for making a rollover distribution to an IRA or annuity on behalf of participant or beneficiary. One also can use the Pension Benefit Guaranty Corporation’s missing participants program, which allows the plan to transfer missing participants’ benefits to the PBGC after searching for participants and meeting certain requirements. “Don’t wait” to deal with missing participants, said Mayo.
Why terminate a DB plan? Mayo said that the reasons may include:
- employee dissatisfaction with the plan;
- financial inability to continue the plan;
- no additional benefits for the owner(s);
- changes in laws regulating retirement plans;
- discontinuance of business; and
- substitution of the DB plan with another type of plan
Mayo discussed a variety of specific matters relevant to DB plan terminations, including the following:
Permanency Rule. The analysis regarding the Permanency Rule for DC plans applies to DB plans, as well. She adds that the issue may appear more frequently with DB plans.
Successor Plan Rules. There are no successor plan rules, Mayo said. However, Section 415 limits are aggregated. It is not possible to max out, terminate and then begin again.
Steps to Take. When terminating a DB plan, said Mayo:
- There can be a stand-alone resolution to terminate, a plan amendment or a combination of resolution and amendment.
- Review the plan to ensure any specifically required action is taken.
- Set the termination date.
- Authorize other actions that may be necessary, such as adopting amendments, funding, applying for a determination letter, etc.)
- Make necessary plan amendments; for instance, update the plan for compliance with legislative and regulatory changes, even if the deadline for such amendment has not occurred. Amendments should reflect 100% vesting on termination if that is not already contained in the provisions. Also, said Mayo, most amendments should be made before the termination date, but one may make amendments after termination in order to bring the plan into compliance with laws or regulations. However, if the plan is covered by the PBGC, generally one cannot make an amendment after termination to decrease value of benefits.
Available on Demand
The ASPPA Webcast “Plan Freezes and Terminations” is available on demand. More information is available here.
Next in this four-part series: plan terminations and the PBGC.