Plan Terminations

 

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A plan termination refers to the situation where an employee decides to discontinue a qualified retirement plan.

If you offered a defined contribution plan, such as a 401(k) plan, there isn't too much to worry about when the time comes to discontinue the plan. The plan administrator will see that each employee receives the proper amount in his or her account.

Defined benefit plans, on the other hand, may cause you some concern because the rules are such that some of the benefits can be unfunded (in other words, someone is entitled to benefits but the money hasn't actually been paid to the plan yet). So the following rules concern only defined benefit plans.

Your defined benefit plans are supposed to be permanent. Generally, a plan that has been in operation for at least five years will be treated by the IRS as permanent. If you need to terminate your plan, you should have valid business reasons for doing so.

In some cases, the IRS will question whether a termination was for a valid business reason. If the IRS determines that the plan was never intended to be permanent, it may retroactively disqualify the plan, resulting in dire tax consequences to your business and to the participants.

There are a few different types of terminations. If the assets you have in the plan are sufficient to pay all the benefits that are owed, the termination is referred to as a standard termination. If there are not enough assets to pay benefits, and the termination is initiated by the employer because of financial hardship, the termination is referred to as a voluntary termination. If there are not enough assets to pay benefits, and the termination is initiated by the Pension Benefit Guaranty Corporation, which insures defined benefit plans, the termination is referred to as an involuntary termination.

There are also steep excise taxes that may apply if you discontinue a plan that is overfunded and hope to pull cash out of the plan to use for other purposes. If you are considering such a step, you'll need to consult a pension specialist who can help you determine whether this is actually possible in view of the potential tax liability.