By Jenny Kiffmeyer, J.D – The Retirement Learning Center

Steps to plan termination

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in California is representative of a common inquiry related plan terminations. The advisor asked: “My client is thinking of terminating the 401(k) plan for her business. She has numerous employees. What are the steps to plan termination?”

Highlights of Discussion

Before terminating a plan, it is best to check with the plan’s record keeper or third-party administrator to determine the set procedure for executing a plan termination. Be sure to document the reason for and all actions taken to terminate the plan.

Generally, under treasury regulations the steps to terminate a defined contribution plan that covers common-law employees include the following.

1. Execute a board resolution to authorize the plan termination and set the date of termination.
2. Amend the plan to establish a plan termination date and make the language of the plan current for all outstanding law changes or qualification requirements effective as of the plan’s termination date.
3. Make all required contributions accrued as of the plan termination date.
4. Fully vest the benefits of all affected participants[1] and beneficiaries as of the set termination date.
5. Notify all plan participants and beneficiaries about the plan termination.
6. Authorize the plan to distribute all benefits in accordance with plan terms as soon as administratively feasible after the termination date.
7. Provide a rollover notice to participants and beneficiaries who may elect to receive eligible rollover distributions.
8. Distribute all plan assets as soon as administratively feasible (generally within 12 months) after the plan termination date.
9. File a final Form 5500 series of return, whichever is appropriate.
10. Although not required, the plan sponsor may file for an IRS determination letter upon plan termination, using Form 5310 PDF, Application for Determination for Terminating Plan, to ask the IRS to make a ruling about the plan’s qualified status as of the date of termination. If a filing is done, the plan sponsor must notify interested parties about the determination application.

Conclusion

Terminating a defined contribution plan involves multiple steps. The plan sponsor and committee must carefully execute and document each step to ensure plan fiduciaries fulfill their obligations to affected participants and beneficiaries. For additional guidance, please see Chapter 12. Employee Plans Guidelines, Section 1. Plan Terminations.

[1] Applies to any employees or former employees with an account balance as of the termination date

Since 2002, contributions to 457(b) plans no longer reduce the amount of deferrals to other salary deferral plans, such as 401(k) plans. A participant’s 457(b) contributions need only be combined with contributions to other 457(b) plans when applying the annual contribution limit. Therefore, contributions to a 457(b) plan are not aggregated with deferrals an individual makes to other types of deferral plans. Consequently, an individual who participates in both a 457(b) plan and one or more other deferral-type plans, such as a 403(b), 401(k), salary reduction simplified employee pension plan, or savings incentive match plan for employees has two separate annual deferral limits.

Another consideration when an individual participates in more than one plan is the annual additions limit under IRC Sec. 415(c),[1] which typically limits plan contributions (employer plus employee contributions for the person) for a limitation year [2] made on behalf of an individual to all plans maintained by the same employer. It this situation, the annual additions limit is of no concern for two reasons:  1) there are two separate, unrelated employers; and 2) contributions to 457(b) plans are not included in a person’s annual additions [see 1.415(c)-1(a)(2)].

Conclusion

IRS rules would allow a person who participates in a 457(b) plan and a 401(k) plan to contribute the maximum amount in both plans. However, it is important to work with a financial and/or tax professional to help determine the optimal amount based on the participant’s unique situation.

[1] For 2020, the limit is 100% of compensation up to $57,000 (or $63,500 for those > age 50).

[2] Generally, the calendar year, unless the plan specifies otherwise.