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This Can Happen to You

Several years ago at the advice of an accountant or investment advisor a client adopts a defined benefit plan for her business. She did so because she had been advised that under this type of plan she could contribute tax deductible contributions far greater than the limits permitted under a defined contribution plan. Each year she funds the maximum that the IRS permitted based on a report from her actuary. The plan investment returns have been very good.

She is now ready to sell her business or retire and informs her advisors that she wants to close out the plan and roll the money over into her Individual Retirement Account. The advisors come back with the following news. The plan is overfunded and some of the funds cannot be rolled over to an IRA. Those funds that are ineligible for a rollover must return to the company as taxable income and the IRS will in addition, levy a non-tax deductible penalty of at least 20%.
What happened?

She has done nothing along the way that the IRS could challenge. What happened was a combination of several things.

1. Though defined benefits allow larger contributions there are limits on the benefits that can be distributed based on the law, the individuals’ salary history, age and years in the plan.
2. The IRS allows companies to pre fund on a tax deductible basis benefits that have yet to be earned.
3. Very good investment returns increases the prospects of the assets growing too large.
4. Congress imposes a penalty on a company that terminates a plan and takes back excess money whether it is voluntary or required.

Is there anything that can be done to prevent this from happening to you?
The first thing you could do is request an analysis of the maximum benefits that would be payable if the plan needed to terminate. Compare this with the level of plan assets and decide whether the future contributions need to be reduced or the investment approach needs to be modified. If you are already past the point of no return; options may exist to minimize the negative consequences of the overfunding that require a high level of expertise.

By Lance Wallach, CLU, CHFC
Abusive Tax Shelter, Listed Transaction, Reportable Transaction Expert Witness
ABOUT THE AUTHOR: Lance Wallach, Mark Shemtob
Lance Wallach, National Society of Accountants Speaker of the Year and member of the AICPA faculty of teaching professionals, is a frequent speaker on retirement plans, abusive tax shelters, financial, international tax, and estate planning. He does expert witness testimony and has never lost a case.

Copyright Lance Wallach, CLU, CHFC

Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.

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