Hello everyone. This is my first post. I hope someone can point me in the right direction

I have a client who is a highly compensated employee and participant in a small (+/- 10 employees) DB plan. Client wants to take a lump sum payout of his benefit. However, a plan actuary told him that he cannot b/c the distribution would bring the plan funding down too low. I guess bellow 80%.

Question 1:
Can the plan take into consideration the affect the client's distribution would have on the funding percentage of the plan, or should it only look at the current funding percentage?

Question 2:
Additionally, client said that a plan rep. told him that he could take a percentage of the lump sum equivalent to the percentage the plan is funded. EX- if the plan is 80% funded, client could take 80% of the lump sum value, and take the other 20% as an annuity. Has anyone heard of this?

Thank you everyone for any help you can provide

The presumption is the plan is not terminating and that the lump sum is a significant portion of the Plan assets. In such case:

(1) Plan would need to be at least 110% funded after distribution.

(2) If plan would be less than 110% funded after distribution, cannot take a percentage of the lump sum.

See IRS Reg. 1.401(a)(4)-5(b)

Welcome.

For an HCE in a small plan, the threshold is that the plan must be funded at 110% after the distribution, not 80% before.
These are two different sets of rules.

There are theoretically bonding and letter of credit exceptions to get around the 110% restrictions, but these options are not easy to satisfy, and in most cases not worth considering.

I'm not aware of any partial payment opportunity such as you reference with regards to the 110% rule. There is a 50% option that may apply with 80% rule, but that is not an option to an HCE in a plan that is funded below 110%.

See IRS Rev. Rule 92-76 for provisions a plan may contain to work somewhat around the restriction.

Thanks for asking good questions.

1. You need a more informed plan rep. You got the wrong answers. Under 80% funded - maximum lump sum is 50%.

2. Look for an explanation of IRC 436(d), describing the restrictions on lump sum payments.

3. There is another and more restrictive limitation in the regulations under 1.401(a)(4)-5 where an HCE is unable to get their benefit unless the plan is considered 110% funded after the payment is made.

If the person only takes an annuity payment, then neither restriction applies.

Don't forget that a benefit payment to the person will just make the funding ratio worse for the plan.
A little algebra here:

D is the distribution to the person.
DL is the plan liability carried on behalf of the person.
A is the asset before the distribution used for all participants.
L is the total plan liability for all participants.
F is the funding ratio used for the test, generally F(old) = A / L.

So F(old) is less than 80% in your example.

The new funding ratio will be F(new) = (A-D) / (L - DL)

Now, if the ratio of D / DL is less than F(old), then F(new) would be higher than F(old). In practice, that is never true.
Lump sum payments that underlie the calculation of D are based on very low interest assumptions, while the liabilities that are used to determine DL are based on a higher interest rate. So my experience is that D is higher than DL.

This means that D / DL is greater than 100%, so F(new) will be lower than F(old).

Thank you very much! Your answers and citation to the IRS 92-76 rule are very helpful.

Has there been any guidance that the 110% test is now based on PPA funding liabilities? In the past, we had based it on RPA current liabilities, but those generally are no longer calculated.

.. Scott

One of my clients obtained a d-letter with FT substituted for CL in the 110% test.