SOLUTIONS IN A FLASH – RETIREMENT PLAN CORRECTION SOLUTION:
MY PLAN TERMINATION HERO

by: Isaac Thuesen, Esq.

Superhero duo Javelin Jen and Discus Don (collectively known as JJDD) together own a firm called JJDD Co. that provided financial services to their fellow superheroes. Business was going well for a while, and they decided to open both a 401(k) plan and a cash balance plan for themselves and their five employees. But then disaster struck. In the process of finally defeating their nemesis, Axe Chucker, JJDD accidentally destroyed Megalopolis’s premier axe-throwing facility. While no one (other than Axe Chucker) was hurt, intense lobbying from the axe-throwing industry caused Megalopolis to pass an ordinance banning all superhero activity.

Forced to change what they do – with superhero speed –  JJDD decided to terminate the 401(k) and cash balance plans. They signed termination amendments for both plans and put the matter out of their minds.

The Problem

Two years go by and JJDD have settled into their new lives as track and field coaches (still providing those financial services through JJDD Co. on the side, with the help of all their employees). But their newfound sense of peace is shattered when one day they receive a sternly worded letter from the IRS. Much to JJDD’s surprise, it appears that benefits may have continued to accrue for all plan participants in the cash balance plan, despite the termination amendment they had signed two years ago. JJDD gives their superhero TPA buddy, Mr. Icicle, a call to get some advice.

Mr. Icicle does not mince words. By doing nothing more than signing termination amendments, JJDD has created several problems. Mr. Icicle is particularly alarmed that they did not amend the cash balance plan to freeze benefits or tell participants about the termination, which means benefits have been accruing to plan participants all this time.

Mr. Icicle explains that, under section 204(h) of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), plan sponsors must give participants advance notice of any amendment that significantly reduces the rate of future benefit accrual. Plans with 100 or more participants must distribute this notice at least 45 days in advance of the effective date of the amendment, while plans with fewer than 100 participants must distribute the notice at least 15 days in advance. Here, since JJDD never distributed a 204(h) notice, benefits continued to accrue to participants, despite the signed termination amendment. Even if they wanted to argue that the termination amendment did freeze the plan, it still isn’t a solution: they still didn’t provide the required notice.

This continued benefit accrual led to even more unforeseen consequences. Since the plan was not frozen to new entrants, any new employees of JJDD Co. could have become eligible for the plan. Moreover, since benefits continued to accrue with no accompanying contributions, the plan became underfunded. Under section 4971 of the Internal Revenue Code (“IRC”), qualified plans that become underfunded are subject to a 10% excise tax on missed minimum contributions. Though plans may be able to avoid this tax by filing for a waiver, JJDD did not do so. Even worse, if the funding deficiency is not corrected by the funding deadline specified in IRC section 430 of 8½ months after the end of the plan year, the IRS can increase the penalty from 10% to 100% simply by mailing a Notice of Deficiency.

Mr. Icicle goes on to explain that, while the 401(k) plan does not suffer from the benefit accrual problem (and there was no obligation to provide participant notice), it has issues of its own. Under Revenue Ruling 89-87, the assets of terminating plans should be paid out as soon as administratively feasible, and any distributions not made within one year of plan termination are presumed to have failed this standard. The IRS treats plans to which this applies as ongoing, which creates compliance risks for JJDD. For example, if JJDD had opened a SIMPLE IRA during this period, they would have violated the rule against simultaneously maintaining a SIMPLE IRA and another qualified plan, leading to a qualification failure for the SIMPLE IRA that would necessitate filing with the IRS’s Voluntary Correction Program.

And, not incidentally, no Forms 5500 had been filed for the two plans since they were “terminated.”

The Solution

Mr. Icicle acts swiftly to tie up these loose ends. For the cash balance plan, he distributes a 204(h) notice to all participants, notifying them that their benefits will cease accruing within 15 days, and prepares a revised termination agreement for the cash balance plan that reflects this new date. He then gets actuarial valuations done for the missing plan years and has JJDD make contributions to fix the plan’s funding shortfall. He files Form 5330 with the IRS to report the underfunding and pay the associated excise tax. He prepares Form 5500 for the missing years, accompanied by the actuary’s Schedule SB, and files them under the Department of Labor’s Delinquent Filer Voluntary Compliance (“DFVC”) Program, along with JJDD’s payment of the much reduced late-filing penalty. Finally, he distributes benefit election forms to plan participants, and ensures that benefits are paid well in advance of the one-year deadline set out in Revenue Ruling 89-87.

For the 401(k) plan, Mr. Icicle prepares and files the missing Forms 5500 using the DFVC Program. He then distributes election forms to plan participants and pays out all remaining benefits owed. In the case of a participant whom he cannot find, he checks the plan documents for a mandatory force-out provision, which would allow him to pay out small participant account balances, usually through an automatic rollover to an IRA. It turns out that the plan permits mandatory force-out distributions up to the maximum extent allowable by law, i.e., for accounts with balances of up to $7,000. This allows Mr. Icicle to roll the missing participant’s balance over to an IRA, completing the distribution of all plan assets.

While the delay in the plans’ termination caused some major stress for JJDD, some swift and incredible actions by their superhero TPA helped minimize the damage.

If you find yourself mired in a plan termination mess, feel free to contact us about your options. After all, we ARE your ERISA superheroes solution!