PLAN TERMINATIONS. Anne E. Moran, Steptoe & Johnson, LLP 1330 Connecticut Avenue, N.W. Washington, D.C Telephone: (202)

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1 PLAN TERMINATIONS Anne E. Moran, Steptoe & Johnson, LLP 1330 Connecticut Avenue, N.W. Washington, D.C Telephone: (202) I. OVERVIEW A. Definitions of Termination. Whether a plan is terminated generally is determined with regard to all the facts and circumstances of a particular case. Treas. Reg (1), superseded by Treas. Reg (d) IRS. a. Defined Contribution Plans. Revenue Ruling provides that an individual account plan terminates once all plan assets are distributed within an administratively reasonable period after the stated termination date. Discontinuance of Contributions. Suspension of Contributions. The regulations distinguish a suspension from a discontinuance by defining a suspension as merely a temporary cessation of contributions by the employer. Although the regulations suggest the three factors listed below, in practice the IRS has examined whether contributions have been suspended for a long time without any evident business reason. IRM 251(4). ( (2) & 1.411(d)-2(d); Rev. Rul ) Whether the employer labels a discontinuance a suspension to avoid the full vesting requirement, Whether contributions are recurring and substantial, Whether there is any reasonable probability that the lack of contributions will continue indefinitely. (iii) Liquidation. PBGC not involved. b. Defined Benefit Plans. Section 4041(2)(D) of ERISA clarified the definition of termination with regard to DB plans, making it clear that an essential component is the distribution of plan assets. 2. Partial Terminations. A partial termination is a complete or partial

2 cessation of accruals or contributions such that the possibility of reversion is created or increased. (See Treas. Reg (d)-2(2); 4 IRM 21,150) Although ERISA provides no guidance for determining whether a partial termination has occurred, Treasury Regulation 1.411(d)-2(1) provides that the determination is based on the facts and circumstances and includes several examples. Partial terminations generally are characterized as either vertical or horizontal. a. Vertical Partial Termination. A vertical partial termination involves the exclusion of a group of employees who had previously been covered by the plan, or a plan amendment that adversely affects the rights of employee to vest in plan benefits. Significant Reduction. Treasury Regulation (2) states that the dismissal of a significant number of employees in connection with a major corporate event qualifies as a partial termination. The Second Circuit has upheld these regulations as reasonable and consistent with the legislative intent. See Weil v. Retirement Plan Admin. Comm. of the Terson Co., Inc., 933 F.2d 106 (1991), vacating 750 F.2d 10 (2d Cir. 1984), reversing 577 F. Supp. 781 (SDNY 1984) (33.4% reduction). Note also that a 20% reduction constitutes a PBGC reportable event as defined in ERISA 4043(3). Examples of partial terminations include: (d) (e) (f) (g) Rev. Rul : Employer closed one of two divisions, terminating 95 of 165 covered employees, Rev. Rul : Employer moved to a new location and 12 of 15 covered employees elected not to relocate, Rev. Rul : Plan was amended to exclude hourly employees when they became unionized, thus precluding 120 of 170 covered employees, In re Gulf Pension Litigation, 764 F. Supp (SD Tex. 1991): Merger of Gulf Oil plan into Chevron plan reduced non-vested participants by 45.2% (as well as vested participants by 34.7%), Bruch v. Firestone Tire and Rubber Co., 828 F.2d 134 (3d Cir. 1987), Babb v. Olney Paint Co., 764 F.2d 240 (4 th Cir. 1985), See also Treas. Reg (2) (stating that partial termination occurs when a group of covered employees is excluded via a plan amendment that

3 would adversely affect employees rights to receive benefits), (h) But see Halliburton Co. v. Comm r, 100 T.C. 15 (1993): No PT for 19.8% reduction in force, absent bad faith or major corporate event. Partial terminations have not been found where terminations were voluntary and initiated by the employees: GCM (Oct. 16, 1984) (47%) Sage v. Automation, Inc. Pension Plan and Trust, 845 F.2d 885 (10 th Cir. 1988) (7 of 23) Anderson v. Emergency Med. Assoc., 860 F.2d 987 (10 th Cir. 1988) (50%) Other Considerations. The IRS considers the potential for reversion and discrimination in determining whether a partial termination has occurred. Internal Revenue Manual 252 cites the following examples: An employer amends a money purchase plan to cease or reduce future accruals, but forfeitures are not reallocated, An employer ceases future accruals in a DB plan when the fair market value of assets exceeds the present value of the accrued benefits, or An employer relocates but only highly compensated employees decide to move, causing forfeitures from the rank and file to be distributed to the highly compensated. b. Horizontal Partial Terminations. A horizontal partial termination involves the cessation or decrease of future benefit accruals where a potential reversion to the employer occurs. Although Code 411(10) prohibits plan amendments from decreasing vested rights previously accrued, employees rights to benefits could be adversely affected through the adoption of less liberal eligibility provisions or, in a DC plan, a decrease in the rate of employer contributions. 3. PBGC. A defined benefit plan maintained by a single employer may be terminated either voluntarily (by the employer) or involuntarily (by the PBGC). a. Voluntary Terminations. A voluntary termination can be either

4 "standard" (where plan assets are sufficient to cover all benefit liabilities) or distress (where plan assets are insufficient). Standard Termination. A plan may terminate under the standard termination procedures if it has sufficient assets to pay all benefit liabilities as of the termination date. A plan is considered sufficient when there is no amount of unfunded benefit liabilities under the plan. This amount is the excess, if any, of the benefit liabilities over the assets of the plan. See ERISA 4041(1)(D). Benefit liabilities defined. Benefit liabilities include all fixed and contingent liabilities to plan participants and beneficiaries, including liability for benefits in effect on the date of termination that are not protected under 411(d)(6) or 204(g) or ERISA (PBGC Not., 53 FR 1904 (1988)) This includes all early retirement subsidies and supplements for which the participant has not yet become eligible on the basis of service or age, as well as cost of living adjustments (to the extent accrued). Valuation of Benefit Liabilities. Plan liabilities are equal to the present value of the accrued benefits of all participants under the plan as of the date of termination, using the actuarial equivalence factors provided in the plan document. These factors are limited to pre- and post-retirement interest and mortality assumptions. Section 417(e), as amended by the Retirement Protection Act of 1994 (part of the General Agreement on Tariffs and Trade, or GATT ), establishes a floor on the single-sum actuarial equivalent of the accrued benefit. i) Pre-GATT, this floor was based on the PBGC rates used for valuing a participant s or beneficiary s vested benefits. Where the benefits met or exceeded $25,000, however, in no event could the present value be reduced below $25,000. ii) GATT changed 417(e) to link the applicable rates to the 30-year Treasury rate (adjusted monthly) rather than the PBGC rate, and to require use of the 1983 Group

5 Annuity Mortality Table. Plans are permitted to select a monthly, quarterly, or annual period in which the applicable interest rate remains constant, in order to increase benefit stability. [See Treas. Reg (e)-1T] This change is generally effective for plan years beginning after December 31, 1994, although a plan sponsor may apply the rules as of the beginning of the first plan year beginning after December 31, 1999 if the plan was adopted before December 9, Required Steps. See Section II.B.4, infra, for a discussion of termination procedures. Distress Termination: In a distress termination, a plan lacks sufficient assets to pay all benefit liabilities as of the termination date. See ERISA A distress termination, which is initiated by the plan sponsor acting as the plan administrator, is distinguished from an "involuntary" termination, which occurs in distress situations but which is initiated by the PBGC. Practically speaking, however, the PBGC may convert a voluntary distress termination to a (quicker) involuntary termination. Grounds for Distress Termination. In determining whether a plan qualifies for a distress termination, it is necessary to evaluate the plan s contributing sponsor as well as all members of the controlled group. ERISA 4041(2)(B). The sponsor and each controlled group member must fall into one of the categories below: i) Petition filed seeking liquidation in bankruptcy under federal law (or similar insolvency proceedings under state law), ii) Petition filed seeking reorganization and court ruling obtained stating that: entity is unable to pay all of its debts, entity is unable to continue in business outside the reorganization process, and termination is approved, or iii) Termination is necessary to enable payment of debts while staying in business or to avoid unreasonably burdensome pension costs

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