It’s possible that more retirement plans could be terminated this year as a result of the economic impact of COVID-19 and business closures.
In addition, if a business is going south, a plan sponsor could decide to terminate its retirement plan, says David Klimaszewski, partner at Culhane Meadows. “As an alternative, plan sponsors may freeze their plans to see if things get better.”
While many in the retirement plan industry are familiar with frozen defined benefit (DB) plans, Klimaszewski explains that defined contribution (DC) plan sponsors can freeze their plans as well. Typically, employer contributions stop, then the plan can stop accepting employee contributions. “Normally, if employer contributions are not received for a while, participants remaining in the plan become 100% vested, but it doesn’t affect the qualification of a plan,” he says.
However, unlike DB plans, Klimaszewski says he’s never seen a DC plan completely frozen and left to hang around. “I’ve always seen deferrals accepted up to a date before termination.”
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Beth Garner, national practice leader for BDO’s employee benefit plan audits practice, says BDO has had several clients with more than 100 employees decide the administrative burden was too much and terminated their DC plans.
Before terminating a DC plan, plan sponsors should make plan amendments for all law changes as of the date of termination, says Lisa Tavares, employee benefits and compensation partner and co-chair of the Business Division at Venable LLP. “There will likely be an accelerated amendment deadline from the IRS extended amendment deadlines,” she says.
Plan sponsors may make a general amendment regarding the plan termination but many plans only require the adoption of a resolution terminating the plan, Tavares says. “Plan sponsors should adopt a resolution to terminate the plan on a specific date, discontinue contributions, vest all participants 100% and distribute all assets as soon as administratively feasible,” she says. “They should provide the recordkeeper and/or third-party administrator [TPA] with a copy of the adopted resolution terminating the plan.”
If a plan sponsor decides to amend the plan, the amendment should document when contributions stop, Garner says. If the plan is a prototype or volume submitter adopted from a recordkeeper or TPA, plan sponsors can tell the provider when the termination is effective and the provider will prepare the agreements that need to be signed, she adds.
When a plan is terminated, all active participants become 100% vested in their accounts and participants who were recently terminated will also be made 100% vested, Klimaszewski says.
Plan sponsors need to have all assets distributed within one year of the plan termination, Tavares says. “They need to start this process right away in order to get notices out and provide the opportunity for multiple mailings to nonresponsive participants in order to get all money out in one year,” she says.
Plan participants must be notified of the effective date of plan termination and notified of distribution options. Following plan termination, the recordkeeper or TPA must provide the appropriate Internal Revenue Code (IRC) 402(f) rollover notice within 30 to 180 days of the distribution date, Tavares adds.
Klimaszewski notes that IRC Section 204(h) mandates that for money purchase pension (MPP) plans, when future benefit accruals will be significantly reduced by a plan amendment, participants should receive a notice explaining how future accruals are expected to be reduced. The notice must be provided at least 45 days before benefits cease to accrue.
“It can be complicated to send notices to everyone and get their [distribution] elections,” he adds. “Frequently, a few people don’t respond, and if assets are not distributed, it can cause a plan disqualification.”
But, as long as plan sponsors show they are making a concerted effort to find people, the IRS is not likely to disqualify the plan, Klimaszewski says. This can include hiring a commercial locator service, rolling a participant’s money into an individual retirement account (IRA) or escheating a participant’s assets and filing a 1099-R.
Other than the steps for terminating a plan outlined in the Employee Retirement Income Security Act (ERISA) and IRC, Klimaszewski says plan sponsors should see what procedures might be specified in the plan document.
Garner says the plan document should specify rules about cashing out plan participants with low balances if plan sponsors have decided to do that. Typically, plan sponsors can send a check to the participant’s address on file if his account balance is $1,000 or less. If his balance is greater than $1,000 and up to $5,000, assets are rolled to an IRA.
“Loans are always another issue,” Klimaszewski says. Plan sponsors usually accept participant loan repayments for a little while—perhaps until distribution of assets begins, he notes, but how plans handle outstanding loans varies a great deal from company to company.
“Participants have to be notified and given a chance to roll over loan amounts before a loan is defaulted,” Klimaszewski says. “There are also cure period rules and loan offset rules. Under new rules, participants have until the due date for filing their federal income tax return to do a rollover.”
Klimaszewski also reminds plan sponsors that do a match true- up to budget for it and make sure it happens, because there will be problems if there are unpaid benefits.
Tavares recommends that the retirement plan committee continue to monitor benefits until all assets are paid out of the plan. She notes that for money purchase plans, there may be special distribution rules, including annuity forms of distribution that may need to be distributed, and some special rules apply for 403(b) plan terminations.
She also suggests that plan sponsors apply to the IRS for a favorable determination letter (Form 5310) on the termination of the plan. “The determination letter is not required but is recommended to ensure that there are no issues that the IRS can raise in a later audit,” she says. Form 5310 needs to be filed within one year of plan termination.
Klimaszewski says he thinks it’s a good idea to file for a determination letter when terminating a plan. He adds that when plan sponsors file for bankruptcy, often the bankruptcy trustee will decide to file for a determination letter.
Klimaszewski says plan sponsors in dire financial positions may forego getting a determination letter because of the cost. The filing fee for a Form 5300 is $2,500 for single-employer plans. According to Garner, getting a determination letter also takes so long that some plan sponsors decide not to go through with it.
Tavares says the process takes six to nine months or longer depending on the IRS’ backlog. “Plan sponsors need to consult with counsel to determine if all the information necessary to complete the application is available and in good order before filing,” she says.
Tavares adds that the Form 5310 filing requires a Notice to Interested Parties that is sent to all participants between 10 and 24 days before the IRS application, and the notice explains the plan sponsor’s request for a favorable determination letter on termination.
Plan sponsors should file a final Form 5500 and continue filing until there are zero assets in the plan, Tavares says. Garner says plan sponsors might “get tripped up” about filing the final Form 5500. It needs to be filed by 7 1/2 months after the date of termination, but plan sponsors can file for an extension.
To make sure the plan’s trust is clean, Garner says, plan sponsors should pay all outstanding plan expenses that are paid by the plan.
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