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Retirement Planning > Spending in Retirement > Required Minimum Distributions

Conversions and mergers involving money purchase plans

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Before retirement plan provisions of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) took effect on Dec. 31, 2001, the choice between money purchase and profit-sharing plans was fairly clear.

Money purchase plans allowed employers to deduct up to 25% of the aggregate taxable compensation of employees covered by the plan, provided employers agreed to make required annual contributions for all eligible employees. Profit-sharing plans allowed more flexibility in employer contributions. In any given year, employer contributions could drop as low as zero, but the maximum deduction was limited to 15% of aggregate taxable compensation.

This made money purchase plans preferable in many companies with steady year-to-year profits and a desire to set aside as much money as possible for owners and other highly compensated employees (HCEs). On the other hand, profit-sharing plans were favored by companies that wanted more flexibility in year-to-year funding.

EGTRRA raised the employer deduction ceiling in profit-sharing plans from 15% to 25% — the same as in money purchase plans.

For profit-sharing plans with a 401(k) elective deferral feature, EGTRRA also excluded participants’ elective deferrals from the 25% ceiling.

Finally, in all defined contribution plans (money purchase or profit-sharing), maximum annual contributions per participant were raised to the lesser of $40,000 (as indexed) or 100% of compensation.

Why more conversions and mergers?

As a result of these changes, it appears that profit-sharing plans can now achieve the same goals as money purchase plans, with more year-to-year funding flexibility. Therefore, many older money purchase plans have converted to profit-sharing.

Also, some companies that offered both money purchase and profit-sharing plans are merging the two plans into a single profit-sharing plan.

But for some companies, such a conversion or merger could prove costly. This provision involves stringent participant notification requirements under Section 204(h) of ERISA. You may want to become familiar with the process for monitoring money purchase-to-profit-sharing plan conversions or mergers in your market, so that you can make plan sponsors aware of notification requirements.

Step 1:  The first step is to monitor FreeERISA’s 5310 database for recent “open” listings in your market. The 5310 “open” listings give you the name, address and EIN of a company that has filed for an application of (tax-qualified) determination. In many cases, plans that are converting from money purchase to profit-sharing formats (or merging two plans into one) will seek such a determination and become visible in this database. However, the 5310 data does not explicitly identify a money purchase plan.

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Step 2: To determine that the plan is a money purchase plan, check FreeERISA.com’s 5500 database for the same company. On line 8a., a code of 2C indicates a money purchase plan. (A code of 2B indicates a “target benefit plan,” which is similar.)

Step 3:  In today’s market, a money purchase or target benefit plan that has filed for a determination letter is likely to be involved in converting or merging into a profit-sharing plan. To make this conversion, the money purchase plan is required under Revenue Ruling 2002-42 to provide notice to plan participants prior to adopting a plan amendment authorizing the conversion. The notice must be given at least 15 days in advance in all companies, and companies with 100 or more employees should provide at least 45 days advance notice. If the notice is not given, a federal excise tax is assessed against the plan sponsor at a rate of $100 per participant per day.

Notice is required even if the conversion does not involve a full or partial termination of the money purchase plan. In many cases, a plan that has filed a 5310 and is listed with an “open” status will still have time to provide the required notice to participants, provided the sponsor is aware of this requirement and takes timely action.

Once you have identified a money purchase or target benefit plan that has filed a 5310, you should immediately call the person listed as plan administrator or employer. Offer to inform this person about the details of the required Section 204(h) notification rules, as explained in our November article.

Step 4: Revenue Ruling 2002-42 indicated that full vesting does not automatically occur on conversion of a money purchase plan into profit-sharing, unless a full or partial termination also has occurred. It also clarified specific conditions under which a full or partial termination would notoccur, including:

1) all participants who were covered under the converted or merged money purchase plan must be covered under the continuing profit-sharing plan; and 2) plan assets must retain their characterization; and 3) the same vesting schedule must continue.

In a money purchase plan, a spouse of a participant has rights that must be considered, because without the spouse’s consent the normal method of paying out benefits is a Qualified Joint and Survivor Annuity.

Some analysts have indicated that without a plan termination, the profit-sharing plan into which a money purchase plan converts or merges must adopt this same payout method. Since these requirements may be too burdensome for some sponsors to accept, they may choose to simply terminate the money purchase plan and distribute its assets to participants (with full vesting), with the option of transferring them into the profit-sharing plan.

Accepting this choice triggers another required notice to participants, specifying the options for handling plan money. So, you may want to suggest to the employer or plan administrator that a pension specialist be retained, to weigh the advisability of an outright termination of the money purchase plan. (It’s a good idea to prospect for plan conversions or mergers with a technical expert on your team.)

In summary, there has never been a better time to help plans in your market effect conversions or mergers involving money purchase and target benefit plans.

For many sponsors, these plans now look relatively less attractive, compared to profit-sharing. The 5310 “open” database of FreeERISA.com can be an “early warning system” to help you identify conversions and mergers in your market. Follow the four steps above to generate more profits and new plan relationships.