2008 Western Benefits Conference Terminating vs. Freezing a Plan: What’s The Difference?

2008 Western Benefits ConferenceTerminating vs. Freezing a Plan:What’s The Difference?

Presenter: Cheryl L. Morgan, CPC, QKA • PensionPodcasts.INFO • Morgan Consulting Services • Consultant to Pension Professionals • Located in San Francisco, California • Phone: (415) 586-2309 • Webmail: cherylmcs@earthlink.net

Points for Discussion • Let’s start with definitions • Commonality between freezing a DB Plan and terminating a DB Plan • ERISA §204(h) Notice • Going Back to Basics: IPS • 401(k) Plan Terminations • To submit a 5310 filing, or not • Form 5310: Comments on some of the details • OK, the 5310 has been submitted, now what? • The 5310 DL has been received, then what? • Plan Termination Distributions • Employer Confusion; ambiguities of what plan termination means • Plan Termination: Are We Done Yet?

Let’s start with definitions - I • Plan Termination. Rev Rul 89-87 says that, by definition, a terminating plan must distribute all plan benefits as soon as administratively feasible after the date of plan termination.

Let’s start with definitions - II • Freezing a Plan is more of a loosely constructed concept than Terminating a Plan. • Simplified, it could be said that a Frozen Plan is one in which participants are no longer accruing benefits, even though plan termination has not occurred.

Let’s start with definitions - III • It could also be said that a Frozen Plan is any dormant plan which is not fully “active” where the employer’s intent to continue making full contributions and funding retirement benefits has ceased, yet the plan is not “terminating” with the intent to disburse all benefits and provide 100% vesting.

Let’s start with definitions - IV • For plan documentation purposes, it can be said that a plan is either “terminated” or “active” and, only when plan assets are distributed as soon as administratively feasible in accordance with IRS guidelines will the need to satisfy IRC 401(a) qualification standards cease as of the plan termination date.

Let’s start with definitions - V • In a terminating plan situation, the plan documents/amendments must be up-to-date with all laws in effect as of the plan termination date -- without regard to qualification requirement changes that take place after the plan termination date, even though the closure of the plan is not official until the date the final benefit distribution is made.

Let’s start with definitions - VI • In an ongoing plan situation (including “frozen” plans or “wasting trusts”), the plan documents/ amendments must be kept up-to-date under one of the two basic standards for “active” plan document qualification. • The 5-year rotation cycle for individually designed plan documents; or • The 6-year program for employers utilizing prototype or volume submitter type plan documents.

Commonality between freezing a DB Plan and terminating a DB Plan • The ERISA §204(h) notice could be viewed as the common thread between the process for freezing a DB Plan and terminating a DB Plan. • You could say that, for a terminating DB, the first step in the process is to freeze benefit accruals by issuing an ERISA §204(h) notice.

ERISA §204(h) Notice - I • Freezing benefit accruals in a DB Plan is a well-defined concept that can relate to either a plan termination or a frozen plan. • ERISA 204(h) requires a formal notice be given to plan participants whenever there is a plan amendment that may result in a significant reduction in the rate of future benefit accruals or …

ERISA §204(h) Notice - II • ERISA §204(h) also requires a formal notice be given to plan participants whenever there is a plan amendment that may result in a significant reduction in an early retirement benefit or retirement-type subsidy (RTS).

ERISA §204(h) Notice - III • Accrual rate reduction scenario. The 204(h) notice must include a description of the benefit formula before and after the amendment, and the effective date of the change. • Today, an example of a common “freeze” is to say that a participant’s plan benefits shall not exceed the existing level of accrued benefits -- as of the date that benefit accruals are frozen (by this notice).

ERISA §204(h) Notice - IV • General Timing. Notice must be give 45 days in advance of the effective date of the amendment. • Exception. Only 15 days advance notice is required for plans with fewer than 100 participants as of the effective date of the amendment or multiemployer plans plus corporate merger or spin-off situations.

ERISA §204(h) Notice - V • Delivery Methods. ERISA §204(h) notices can be provided by hand delivery, first-class mail, or by electronic means. • As with other ERISA notices, use of electronic means must be supported by reasonable access and participants must be alerted of the significance of the message and the option to receive a free paper copy.

ERISA §204(h) Notice - VI • Delivery to Whom? Every affected party and any labor organization representing them needs to receive a copy of the ERISA §204(h) notice • Affected party includes participants, beneficiaries, and alternate payees who may be impacted by the future reductions due to the plan amendment changes.

ERISA §204(h) Notice - VII • Distinction between notice to “freeze” vs. notice to “terminate.” • Termination invokes 100% vesting. • Termination anticipates disbursement of all assets by way of benefit distributions. • Termination distribution timing is linked to whether Form 5310 is filed, or not.

ERISA §204(h) Notice - VIII-A • PPA funding levels; AFTAP rules • IRS announced in the November, 2007 News Flash published as “employee plans news” that an ERISA §204(h) notice is NOT required with respect to situations where a DB plan may be deemed to be frozen under PPA’s AFTAP rules. • Rather, the IRS says that the PPA notice required under ERISA §101(j) for amendments restricting benefits in accordance with IRC §436 will satisfy both the timing and content requirements for an ERISA 204(h) notice.

ERISA §204(h) Notice - VIII-B • PPA Notice Requirements • The Plan Administrator must provide written notice of the applicable benefit restriction(s) to plan participants and beneficiaries within 30 days after the date the plan becomes subject to a benefit restriction. • This PPA Notice becomes applicable when the plan’s AFTA is determined or presumed to be less than 60%.

ERISA §204(h) Notice - VIII-C • Adjusted Funding Target Attainment Percentage (AFTAP) • Funding level less than 60%: • The plan must freeze all future benefit accruals as of the date the plan’s enrolled actuary certifies that the AFTAP is less than 60%; or, this status must apply when no AFTAP certification has been done by the first day of the 10th month of the plan year. • No (lump sum) benefits can be paid to anyone. • No amendments can be adopted to increase benefits.

ERISA §204(h) Notice - VIII-D • Notice of Plan Restrictions. The Pension Protection Act of 2006 (PPA) and Section 436 of the Internal Revenue Code require the calculation of a funding ratio called the AFTAP. Actuarial calculations are required in order to determine whether your plan is subject to new limits on plan amendments, lump-sum distributions, and benefit accruals.

ERISA §204(h) Notice - VIII-E • If a plan’s AFTAP is 90% or higher, there are no current benefit or amendment restrictions. • For the plan year ending 12/31/2007, the AFTAP for your plan is: 42.7%.

ERISA §204(h) Notice - VIII-F • You are hereby notified of the following restrictions: • All benefit accruals are frozen in accordance with the Pension Protection Act (PPA) law. • No lump-sum distributions can be paid to anyone in the plan. • No amendments can be made by the employer to increase benefits. • The above restrictions will possibly change via Technical Corrections to the PPA law; you will be notified of any changes as soon as administratively possible; you can expect an annual update soon after the 12/31/2008 AFTAP certification is completed by the plan’s actuary.

ERISA §204(h) Notice - IX • Which plan types are subject to ERISA §204(h) notice requirements? • Pension plans covered by IRC §412 minimum funding standards -- DB, MP, TB. • Best Practice to amend benefit/contribution formulas to = 0% when terminating the plan. • NOT applicable to PS, 401(k), ESOP, etc.

Going Back to Basics: IPS • In this post-PPA environment, with new rules to identify and disclose the funding level of DB plans, the number of frozen DB Plans is definitely on the rise. • The Investment Policy Statement (IPS) for such plans should be implemented, reviewed and carefully monitored in conjunction the freezing of a DB Plan.

401(k) Plan Terminations - I • Although an ERISA §204(h) notice is not required for profit sharing and/or 401(k) Plans, the 401(k) Plans have the unique issue of salary deferrals coming out of paychecks – and the employer does not technically have the authority to pull the plug on payroll withholding without notifying the employees in advance. • Therefore, a “courtesy notice” should be issued to employees when a 401(k) plan is terminating – to let them know what pay date the deferrals will stop. • Note: It is probably a good idea to emphasize the fact that payroll withholding for participant loan payments should continue.

401(k) Plan Terminations - II • When a decision is made to “terminate” a 401(k) plan, it is important to caution the plan sponsor that: a decision to terminate and distribute benefits from a 401(k) plan results in a required moratorium on the company sponsoring any other defined contribution plan – for at least 12 months following the date of the final distribution from the terminating 401(k) Plan.

401(k) Plan Terminations - III • This special rule for 401(k) Plan Terminations is called the “successor plan rule” meaning there are restrictions on the company (or related companies) maintaining a successor DC Plan once a 401(k) Plan Termination occurs.

401(k) Plan Terminations - IV • Think about the actual time frame: 12 months following the date that the final distribution is made from the terminating 401(k). • If a 5310 was submitted, the employer first waited 9-12 months for the IRS, then some participants take their time with distribution paperwork, and before you know it, more than 2 years has gone by before the final distribution is made. This could translate to roughly 3 years that the company cannot sponsor another DC Plan.

To submit a 5310 filing, or not - I • The fee you quote for plan termination, submit or not, needs to be uniform and the same fee dollar amount should apply to IRS Submissions as to those employers who choose NOT to submit. • In other words, pricing differentials on plan termination work, resolution only practices, and the like need to be eliminated to truly support plan terminations being submitted.

To submit a 5310 filing, or not - II • At a time when we are “between laws” as far as IRS standards for plan document qualification, it is far riskier to not submit a plan termination than if we were in a stable period for plan documents/ amendments. • Remember, the IRS has not approved the good-faith language used for EGTRRA and other interim compliance amendments and now we have PPA, §415, and DB §401(a)(9).

To submit a 5310 filing, or not - III • The biggest down-side to “submission” (once you eliminate “pricing differentials”) is the additional time the employer has to wait for the IRS to issue a determination letter before plan termination distributions should be made. • In situations where the company is shutting down, the decision-makers often feel pressured to accelerate the plan termination processing which means NO submission.

To submit a 5310 filing, or not - IV • What potential liability risks does an employer face when a decision not to submit is made? • A great percentage of terminated plans are selected by the IRS for audit. • When plan termination distributions have been made without obtaining a 5310 determination letter, any “audit issues” discovered by the IRS could result in plan disqualification which would mean that the qualified status of any IRA Rollovers would be jeopardized.

To submit a 5310 filing, or not - V • In plan compliance situations, the level of risk is tied to the level of plan assets. This means that: the greater the amount of plan assets is, the greater the potential liability.

To submit a 5310 filing, or not - VI • Does submitting a 5310 “guarantee” that the plan will not be audited later? NO • One of the biggest advantages to “submission” is that, if an audit occurs later, a “limited-scope audit” can be negotiated when a plan sponsor has obtained a 5310 determination letter. • A “limited-scope audit” after plan termination would focus on the plan termination distributions, whether 1099-R Forms were done properly, and whether the Final 5500 return matches up with the 5310 and the 1099-R Forms.

To submit a 5310 filing, or not - VII • The biggest advantage to submitting a 5310 is the “guarantees” that it offers as far as IRS being the only legitimate “judge” on the qualification of plan documents. • Once a 5310 determination letter is received, it means that the plan document/ amendments have been reviewed by the IRS and that the “qualified” status of the plan’s documentation is not at risk.

Form 5310: Plan documentation - I • Question 3c asks: Has the plan received a determination letter?Date of letter? If yes, submit a copy of the latest letter and subsequent amendments and indicate number of subsequent amendments. • Answers: Hopefully, the employer has a GUST determination letter which will help to expedite your plan document compliance review.

Form 5310: Plan documentation - II • If the plan has their GUST letter, what about “subsequent amendments”? • The EGTRRA amendment would be considered a “subsequent amendment” and so would the other interim compliance amendments be counted as being subsequent to the GUST restatement -- since the IRS has not officially ruled on these “model amendments.”

Form 5310, Question 20: Plan Balance Sheet • Certain line items on the asset/liability statement have always provoked questions a Form 5310 is submitted. These include: • Receivables (especially late salary deferrals) • Real estate, partnerships, other illiquid assets • Loans to participants (be sure to get your ducks in a row on any “late loan payments” to get current) • Other Investments or Other Loans • Liabilities (in general)

OK, the 5310 has been submitted – now what? • Since it will take a minimum of 6 - 9 months to receive a 5310 determination letter (and lately, it can easily take 12 months or even a little longer sometimes), the plan sponsor has plenty of lead time to clean up “pending issues.” • Pending issues might include making deposits to the trust to cover “receivable” plan contributions. • Pending issues might include solving participant loan or illiquid asset issues before it is time to distribute benefits. • Pending issues might also include any compliance issues that have not been fully addressed. • Pending issues might also include tracking down an accurate list of employee addresses and contact information (to avoid lost participant issues when it is time to distribute).

Once the 5310 DL has been received, then what? • With DL in hand, it is time to proceed with the plan termination distribution process. • First, plan account balances need to be updated for earnings through the current date. This process is simple if the plan is in a “daily valuation” environment with one of the alliances. • Then, distribution paperwork needs to be issued. • To minimize the number of distribution notices needed, it may be best to send the 1st set of paperwork via Certified Mail – and a bright colored Cover Page saying: Please return this paperwork within 30 days to ensure that your distribution is complete and timely. Otherwise, substantial plan expense charges may be imposed against your account.

Once the distribution paperwork has been released, common questions: • Can participants, with vested accounts less than $1,000, just be given a check for their benefits (minus the 20% withholding)? Not until they have received distribution election forms and the opportunity to make distribution elections. Therefore, the employer needs to make sure they go out of their way to have accurate address and contact information for each employee so that the distribution mailings get to everyone on the 1st attempt. • Can participants with vested accounts less than $5,000 be “cashed out,” once a plan is terminating? NO, but the plan officials can choose to implement “auto IRA rollover” rules to expedite the disbursement of benefits upon plan termination -- for any dollar amount, when participants are unresponsive to signing and returning distribution election form(s).

What happens when the last distribution is made? • Once the trust is zeroed out, the next step is to think about the Final 5500 return. • A Final 5500 return is due: The last day of the 7th month following the month in which plan termination distributions are finalized (when the trust is reduced to a $0 balance). Note: It is still possible to file a 5558 to get an extension of 2-1/2 months beyond this final return due date. • This Final 5500 deadline overrides the normal rule for 5500 due dates which typically ties to the “plan year end.”

Wrap: “Employer Confusion” that may delay plan termination processing - I • But I didn’t know I still had to pay for annual administration and 5500 filings...Note: Our plan termination informational letter tries to explain that 5500 filings will continue to apply until all plan assets are distributed and a “final return” can be filed. • But my plan assets have always been below the $100,000 benchmark in a one-person plan...Note: A Final 5500-EZ is required even if a plan sponsor always had plan assets below $100,000.

Wrap: “Employer Confusion” that may delay plan termination processing - II • But I can’t find a way to “sell/liquidate ” my limited partnerships. Can’t I just distribute segments of these partnerships to my employees? • But why will my loan obligation be taxed to me unless I repay the outstanding balance?

Plan Termination: When is everything really “done”? • Plan termination information letter • Board resolution to terminate • ERISA §204(h) notice for pension plans subject to IRC §412 • Courtesy notice to 401(k) participants to let them know when salary deferrals will STOP and to inform them that loan withholding will continue. • Form 5310 submission for those who say YES, equal pricing • Distribution processing • Final 5500 Form • Forms 1099-R (by January 31st following year of distributions) • Potential for “after-the-fact” audit within 3-year period (if 5310 submitted, can be narrowed to a “limited scope”

2008 Western Benefits Conference Terminating vs. Freezing a Plan: What’s The Difference?