IRS Deems Transfer of Surplus Assets of Terminated Plan to Replacement Plan Permissible

A recent private letter ruling from the IRS discussed transferring assets from a terminated defined benefit plan to two 401(k) “qualified replacement plans” under Code Section 4980. The two replacement plans are employer-sponsored retirement plans that qualify for special tax treatment. Without this transfer approval, the IRS Code would require a 20% excise tax on funds transferred after a plan terminates.

Employer Reversion and Replacement Plan Requirements

When an employer receives cash or property from a terminated qualified plan, it is considered an employer reversion. The IRS levies a 20% excise tax on this amount. The private letter ruling confirms that transferring these surplus assets from the terminated plan to a qualified replacement plan is a permissible use of funds and avoids the excise tax.

In order to qualify as a replacement plan, the new plan must be established in connection with the terminated plan and must satisfy participation, asset transfer, and allocation requirements established by the IRS Code.

  • Participation: To meet this requirement, a replacement plan must have at least 95% of the active participants of the terminated plan, so long as they remain employees after the termination, become participants in the replacement plan.
  • Asset Transfer: Assets from the terminated plan must be directly transferred to the replacement plan before any employer reversion occurs.
  • Allocation: The third requirement is met when the transfer of any value from the terminated plan is not included in the business’s gross income and no deductions are taken regarding the transfer. It is not treated as an employer reversion but strictly as an asset transfer between old and new plans.

In the specific case discussed in the private letter ruling, a business terminated a qualified defined benefit plan which covered two groups of employees. One group was part of a bargaining unit of hourly employees and the other group was hourly but not part of a bargaining unit. The collective bargaining agreement with one group led to the termination of the old plan and the inception of the new plan, replacing the defined benefit plan with a 401(k) plan. At the same time, the business set up a 401(k) plan for the group of hourly employees not covered by the collective bargaining agreement. 100% of the participants were enrolled in one of the two new 401(k) plans.

Surplus assets remained after the old defined benefit plan satisfied its liabilities, and the business directed those assets to be divided proportionately between the two new plans and requested a ruling from the IRS to confirm that they did not owe excise tax on those surplus assets.

IRS private letter rulings help guide other companies with similar situations. The experienced, responsive benefits attorneys at Hall Benefits Law help plan administrators understand what regulations and rulings are relevant to them and how best to apply these rulings in practice. Learn more by calling 678-439-6236, or visit the Hall Benefits Law website.

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Hall Benefits Law, LLC

HBL offers employers comprehensive legal guidance on benefits in mergers and acquisitions, Employee Stock Ownership Plans (ESOPs), executive compensation, health and welfare benefits, healthcare reform, and retirement plans. We counsel a wide spectrum of clients including small, mid-sized, and large companies, 401(k) investment advisors, health insurance brokers, accountants, attorneys, and HR consultants, just to name a few. HBL is passionate about advising clients, and we are dedicated to our mission: to provide comprehensive, personalized, and practical ERISA and benefits legal solutions that exceed client expectations.

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