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Insurance and Employee Benefits
Chapter 13-TAXATI0N, 401(k) & OTHER PLANS


Better known as 401(k) plans, "Cash Or Deferred Arrangements" (CODAs) have become very popular as retirement vehicles, by themselves or as a supplement to other plans.  The beauty of CODAs is that the employee can elect to receive payment from the employer, either as cash (normally current compensation) or as a pre-tax contribution to a defined contribution plan.  For the employer, an advantage is the relative ease of administration, and for the employee, an advantage is the flexibility in allocating income between current compensation and retirement savings.

At first blush, this seems so simple that there should be only a minimum amount of regulation and IRS rules.  This would be so, except for the problem of discrimination—highly compensated employees are more likely than those not-so-highly compensated employees to elect to receive a plan contribution instead of current income.  Therefore IRC § 401(k) (which is, obviously, the Code section primarily governing CODAs) is mostly concerned about discrimination, and nondiscrimination standards will be pointed out in the following discussion of CODAs.


Definition:  A CODA is an arrangement in which an eligible employee may elect to have the employer make payment either as contributions to the plan (elective contributions) or in cash to the employee.  If the plan is a qualified plan, the CODA will not cause it to be disqualified, provided the CODA is a qualified cash or  deferred arrangement.387

To be qualified CODA, the plan must satisfy three main requirements:

  1. The CODA must not allow distribution of amounts attributed to elective contributions earlier than age 59 ½ except in case of termination of employment, death or disability, some plan terminations, or, in special situations, employee hardship, and the distribution of elective contributions just because of the completion of a stated period of participation or the lapse of time.388
  2. The employee's interest in amounts attributed to elective contributions must vest immediately.
  3. The plan may require no more than one year of service as a condition of participation.

Contributions to CODAs

Every CODA must provide for elective contributions, such as permitting an eligible employee to defer up to 5% of salary or wages per year.  The elective contribution may not only be salary, but it may be a bonus also.  There are qualification standards that limit the aggregate amount that an employee may defer to a specified maximum dollar amount ($12,000 in 2003).  This amount is less than the total limit on contributions to defined contribution plans.

Other types of contributions are provided by 401(k) such as after-tax contributions.  Also, it may provide for an employer to make matching or partially-matching contributions.  A plan, for instance, could provide for elective deferrals of up to 10% of compensation and contributions by the employer that match (dollar-for-dollar) the first 3% (as an example) of such deferrals.  Qualified matching contributions are those matching contributions that  meet the investing and distributing requirements applicable to elective contributions for qualified CODAs.

There are also nonelective contributions for which there is no employee option to have the contributions paid in cash instead of into a plan.  Qualified nonelective contributions other than matching contributions, satisfy the vesting and distribution requirements that apply to elective contributions in order to become a qualified CODA.389

Other Benefits

While a CODA can provide benefits to participants other than those benefits attributed to elective or nonelective contributions, a qualified CODA can not, either directly or indirectly, condition any benefit other than matching contributions, on the employee's electing to have the employer make or not make contributions in lieu of his receiving cash.

Other benefits may include benefits under a defined benefit plan, nonelective contributions under a defined contribution plan, life insurance, plan loans and subsidized retirement benefits.


For a CODA to become qualified, the employees eligible to benefit under the arrangement must satisfy the coverage standards of 401(k), such eligible employee is one who is directly or indirectly eligible to make an election for all or part of the plan year.  As an example, an employee who must perform additional service to be eligible to make the election is not an eligible employee unless the service is actually performed.390

Actual Deferral Percentage Test

Before a CODA can be qualified, the "actual deferral percentage" (ADP) must satisfy one of two tests.

One test is where the ADP for eligible heavily compensated employees does not exceed 125% of the ADP of all other eligible employees.  The other test is where the ADP for eligible highly compensated employees, and the former percentage does not exceed the latter by more than two percentage points.  There are further definitions as to how to calculate the formulae and defining the procedures for the tests. 

This can best be understood by using an example.  If the actual deferral percentage for eligible highly compensated employees is 12% and the actual deferral percentage for all other employees is 9%—then the plan fails both tests.  Failure of the second test is because while 12 is less than twice 9, the difference between the figures is more than the two percentage.  The plan can satisfy that test by decreasing the actual deferral percentage of the heavily compensated employees by decreasing the ADP of the HCEs to, as an example, 11%.In respect to the first test, the plan can satisfy that test by increasing the actual deferral percentage of the other employees to 10%.

To calculate the actual deferred percentage of a group of employees, first, for each employee,  the ratio of the amount of employer contributions paid to the plan for the year to the employee's contribution for the year, and the ADP for the group is the average of these ratios for each group member.  There are many other considerations, rules and formulae in order to arrive at the ADP of a group of employees.  One of the most important rules is that basically all CODAs included in a plan are treated as a single CODA for the purpose of these tests—if an employee participates in two or more CODAs of the employer, for the purpose of determining the deferral ratio of the employer, all such CODAs are considered as one CODA.391

One of the easiest rules in this respect, is the Safe Harbor rule that is used for plans that prefer not to use ADP testing.  Simply put, a CODA is treated as satisfying the Code requirements if it meets two conditions:  (a) eligible employees must be given written notice of their rights and obligations under the arrangement, and then (b) the employer must make matching contributions on behalf of each NCE in an amount equal to either 100% of the elective contributions of the employee, up to 3% of compensation, plus (b) 50% of the elective contributions that exceed 3% of compensation, but do not exceed 5% of compensation. 

Excess Contributions

The employer does not have total control of a CODA as far as meeting the ADP test because it all depends on the employee's decision regarding how much income to defer.  Therefore, they have the option to count qualified matching and qualified nonelective contributions as elective contributions so as to provide a way for the employer to compensate for a disproportionate  level of deferral by highly compensated employees, but this would create a cost to the employer.  The alternative method for the employer to bring a plan into compliance with the ADP test for a year is simply to return some or all of the amounts contributed to the plan to the employees. 

As one would expect, there are rules as to how the contributions can be returned to make the plan qualified.  There are similar rules that apply if there are excess aggregate contributions (aggregate matching and employee contributions exceeding the amounts permissible under the test.

Catch-Up Contributions

CODA rules allow participants who reach age 50 or more in the taxable year to make catch-up contributions.  A catch-up contribution is an additional elective deferral in an amount no greater than at statutorily specified amount ($2,000 in 2003) and the amount of this additional deferral is not allowed to be more than the excess of participant compensation over other elective deferrals.392

Catch-up contributions are not subject to ADP testing and are not subject to the 401(k) standards for nondiscrimination in amount of contributions as long as the election is available to all participants who attain age 50 during the taxable year.393  Further, they are not subject to CODA contribution limits.


Another way for a CODA to meet the requirement of Section 401(k) is for it to be created as a SIMPLE 401(k) plan.

Eligible Employers

A SIMPLE 401(k) plan must meet three statutory requirements:

First requirement pertains to contributions.  Under this plan, an employee may elect to defer a percentage of compensation up to a statutory amount adjusted for inflation ($8,000 in 2003), the employer must match these contributions up to 3% of salary, and, further, there may not be any other contributions.394  As an alternative to the 3% match requirement, the employer may make a nonelective contribution of 2% of compensation for each eligible employee who earns at least $5,000.395

The second requirement is that the SIMPLE 401(k) plan be the exclusive one for eligible employees, therefore there cannot be any benefit accruals or contributions under any other qualified plan of that employer for that year. 

The third requirement is that contributions to the plan be vested immediately.

A SIMPLE 401(k) plan is not subject to the top-heavy rules for the year.  Catch-up contributions are permitted, but in amounts less than for regular CODAs or other plans.396


Employer contributions to a plan are deductible if they are ordinary, necessary and reasonable business expenses, but there are limits to the amount of deduction allowed.397


Employer contributions to stock bonus or profit sharing plans are deductible in the year in which they are paid (as opposed to accrued), up to 25% of the total compensation paid or accrued to participants in the plans for the year.398

For tax deductible purposes, all stock bonus and profit sharing plans of the employer are treated as one.  For SIMPLE plans, there is a separate limit.  Excess amounts may be deducted in future years, as long as the total amount that is deducted in any one year for contributions (past and present) to the plans, are not more than 25% or other taxable limitations.

Compensation for these purposes include all of the compensation paid or accrued except that for which a deduction is allowable under a qualified plan.399 Compensation does include elective deferrals which are not subject to the limitation on deductions.400 Regulations allow for an upper limit which is indexed ($200,000 for 2003) to the amount of a participant's compensation that can be taken into account in the computing of contribution limits.


As a general rule, the amount that can be deducted for contributions to a defined benefit plan, which includes an annuity plan, is the amount necessary to satisfy the greater of minimum funding standard or either of two alternative amounts.  Both of the alternative plans use the amount necessary to amortize unfunded past service, and there are qualifications to the rule that are detailed and complex and beyond the scope of this text.  Money purchase plans, incidentally, are subject to the IRC Code regarding pension plans—but of recent vintage, money purchase plans are subject to the same limitations as stock bonus and profit sharing plans.401 


Some employers maintain both defined contributions and defined benefit plans, and some participate in more than one plan, so in these cases, there are additional limits—the maximum of the total compensation paid or accrued to the participants of the plans, or the amount of contributions to the defined benefit plans up to the amount that is needed to satisfy the minimum funding standard for each, with a provision for carryover of nondeductible excess contributions.402


There is a ten percent (10%) tax on the amount of nondeductible contributions for a year.  The tax will continue to be imposed each year to the extent a contribution has not yet been deducted under a carryover provision. 

If the contribution was made by a mistake, or if it was conditioned on the plan's initial qualification, or on the contribution's deductibility, then the tax can be avoided by returning the excess contribution within one year as long as the ERISA rules [(403(c)(2)] and the plan document allow its return in such cases.


Terminating an employee benefit plan is more than turning off the lights and locking the door (so to speak) as the concern for the welfare and continuation of benefits for the employee that initiated ERISA still remains to some degree.  One outstanding example is where the fund may not have sufficient assets to pay all promised benefits.  Or, a situation could arise where the annuity provider may not have the financial wherewithal to meet future obligations

There are many scenarios of businesses not being able to honor their commitments in providing employee benefits, with the principal situations discussed below.


Internal Revenue Code

There are several Code provisions dealing with terminations and its impact on plan qualification.  As discussed earlier, the Code requires any accrued benefits to vest upon termination or partial termination, plus the code requires that in some cases, a plan must be a permanent and not a temporary arrangement.  "The abandonment of the plan for any reason other than the business necessity within a few years after it taken effect, will be evidence that the plan from its inception was not a bona fide program for the exclusive benefit of employees in general."403 Accordingly, a plan can be retroactively disqualified. This can cause considerable expense to the employer so the usual practice when a plan is to be terminated, is for the employer or administrator to ask for a determination letter from the IRS confirming that the termination has not affected its qualified status.


Title I, as has been noted earlier, deals with fiduciary relationships, so it does not address plan termination in any great detail, however, the statute does provide that fiduciary standards govern the transfer of assets from a terminated plan to a replacement plan, and court cases have made it abundantly clear that misrepresentations concerning termination may constitute a breach of fiduciary duty.404


ERISA Title IV deals with termination, but basically with problems relating to the termination of underfunded defined benefit plans.  Title IV establishes a program to guarantee benefits that are due from such plans, it prescribes the conditions under which a plan can be terminated, it provides for involuntary terminations in cases of severe financial problems, regulates the employer withdrawals from multiemployer plans, and it specifies the Pension Benefit Guaranty Corporation (PBGC) as the regulatory authority for plan terminations.


The PBGC was established by ERISA as an enforcement arm, with principal objectives: (a) to encourage continuation and maintenance of pension plans, (b) provide for the uninterrupted payments to beneficiaries, and (c) to maintain premiums at the lowest possible level.  One of the primary objectives is the regulating and enforcement of termination regulations.

Title IV covers only pension plans and those that have operated as qualified plans for at least five years, and basically, it governs only single employer defined benefit or multiemployer plans.  It does not cover defined contribution plans, the part of a defined benefit plan at pertains to voluntary employee contributions, "top-hat" plans, excess benefit plans, or plans for professional service providers that have no more than 25 participants.

Title IV is called "plan termination insurance," even though is not a social insurance or a transfer payments programs, it is that of spreading the risk.  The PBGC guarantees the payment of nonforfeitable pension benefit plans in terminated, underfunded single employer plans, and insolvent multiemployer plans up to a specified limits.  This is handled by PBGC by actually paying guaranteed benefits for single-employer plans, and loans money for multiemployer plans so that the plan can pay them.  These funds come from a tax on annuity contributing employers, and if necessary, from the US government (read tax-payers).  The PBGC does have a right to reimbursement when it makes guaranteed payments.

Funds come from revolving funds for single employer plans and for multiemployer plans.  For each single-employer plan, the employer who is or has been responsible for funding the plan—known as the "sponsor," —ERISA or the administrator must pay an annual premium to PBGC and which is deposited in the single-employer plan fund.  Each member of the contributing sponsor's group is jointly and severally liable for the premiums.  Congress sets the rates, and currently the rate for single-employer plans is $19 per participant, increasing by $9 per $1,000 of unfunded vested benefits.  The rate for multiemployer plans is $3.60 per participant.

Single-Employer Plan Guaranteed Benefits

Not all single-employer benefits are guaranteed by the PBGC.  For starters, only pension benefits are guaranteed, defined as benefits that are payable in annuity form to a participant or surviving beneficiary upon the employee permanently leaving employment, and that, either by itself or when combined with Social Security, Railroad Retirement, or workers' compensation, provides a substantially level income to the person.405

Secondly, only nonforfeitable benefits are guaranteed, unless they are nonforfeitable only because of termination.  A nonforfeitable benefit for this purposes, is defined as a benefit for which all conditions to entitlement under ERISA has been performed by the termination date except for filing of a formal application, retirement, completion of a waiting period, or, in some cases, death.406

And the last requirement is that the participant or beneficiary must be entitled to a benefit for it to be guaranteed.  If, for instance, the benefit payment requires consent of the employer, the absence of such consent before termination defeats entitlement.407

There are three qualifications to this guarantee:

  1. There is an upper limit which is the actuarial value of an individual's guaranteed benefits under a plan cannot exceed the actuarial value of a single life annuity, starting at age 65, subject to stated times and amounts (Actuarial calculations).408
  2. The guarantee is effective only for plans or a minimum of 60 months duration at time of termination, and only for increases resulting from amendments made to the plan or effective at least 60 months before the termination, subject to a lesser guarantee if the beneficiary does not meet the requirements. 
  3. The guarantee is limited to a greater degree for substantial owners (sole proprietor, 10% partner or 10% stockholder) to an extent as determined by formula.409 

Multiemployer Plan Guaranteed Benefits

For multiemployer plans, the PBGC guarantee is triggered by the insolvency of the plan (as opposed to termination for single-employer plans), and as with single-employer plans, nonforfeitable pension benefits are those guaranteed.

The actual amount of the guarantee is limited to benefits or benefit increases of 60 month duration and the amount of benefit guaranteed is derived from formula using components of the accrual rate (defined as the monthly amount of normal retirement benefit, expressed as a single life annuity, divided by years of credited service).


There has been considerable publicity in recent years in respect to the concern that there may not be enough money in the PBGC to pay for retirement benefits for the thousands of employed persons who are nearing retirement (ala "Baby Boomers") and the financial instability of very large US corporations causing downsizing and other such problems.  But the PBGC having a deficit is not new, as in 1996, the single employer fund was $2.9 billion which continued to increase until it reached of $9.7 billion in 2000.  It should be noted that the multiemployer fund had consistently been in a surplus situation since 1982.

The reasons for the deficit to drop and for subsequent years of having a surplus was because of amendments to ERISA that increased termination insurance premiums, and which was partly related to the level of plan underfunding.  The result was a more of an insurance organization through the medium of risk-spreading.  Other factors were the increase in the rates at which past-service costs are amortized, the decline in number of terminations, the small number of very large claims, and a strong economic period.

In 2001, the PBGC started showing annual deficits as a recession loomed and some large companies declared bankruptcy, and at the end of 2002, the single employer fund was under-funded by $3.6 million, with continuing deficit funding in 2003, along with the bankruptcies of large steel companies and because of 9/11, large airlines found themselves in precarious situations.

From the beginning of PBGC through 2002, PBGC had total (gross) claims of $11 billion, with 10 companies accounting for $5.7 billion of this amount, five which were steel companies and 3 were airlines.  Interesting note:  Nearly half of the claims against the single-employer fund since 1975 have been from plans that were less than 50% funded.


In order for the PBGC to do its job, it needs to monitor significant changes in financial conditions.  There are a wide variety of events that need to be reported to the PBGC and they are broken into 15 principal categories of reportable events.  These requirements are so detailed it is outside the scope of this text, but administrators of qualified plans need to be aware of these requirements and to fully comply with them all.  Other than the obvious notification to the Secretary of the Treasury that the plan is no longer qualified, or determination by the Secretary of Labor that the plan is not in compliance with its requirements (Title I), such "red-flag waving" actions as amending a plan by decreasing some or all benefits, a substantial decrease in active participants, a failure to meet minimum funding standards for the year, a large benefit paid to a substantial owner who is still alive, etc., provides the significant changes (event) looked for by the PBGC.  In some cases, the plan sponsor must notify the PBGC within 30 days of such an event, or within 30 days after it has learned of such an event.  The PBGC may access a penalty of $1,000 a day for non-compliance with these and other reporting and notice rules.


For single-employer plan terminations, a plan may be terminated either with or without assets sufficient for the plan to meet all benefits.  The types of terminations have been segregated into three categories and all rules must be complied with strictly, or the plan could be deemed to continue ongoing.

(1) Standard Termination

A termination is considered as "standard" when assets are sufficient to meet benefit liabilities—the benefits of employees and their beneficiaries under the plan, which such benefits are fixed or contingent.410

The termination is initiated when the administrator gives written notice of the intent to terminate to every participant, beneficiary of a deceased participant, alternate payee and employee organizations, such notice given at least 60 but not more than 90 days prior to the proposed termination date.  Other such rules require the administrator to send written notice to each participant or beneficiary specifying  and explaining the amount of his benefit.  During this period of notification, the plan continues to operate as normal, under some restrictions which are designed to protect the financial ability of the plan to pay benefit liabilities.

If the administrator has not received a notice of non-compliance within the prescribed period, he can start the distribution of plan assets as far as they are sufficient to pay plan assets.

Assets are allocated to priority categories according to ERISA rules, which, in essence, first distributes the accrued benefit derived from the employee's contributions as they are not guaranteed by the PBGC.  Then the assets are distributed that are derived from each individual's mandatory contributions—which may or may not meet the criteria for guaranteed benefits.

Benefits payable as an annuity that were in pay status or what would have been in pay status if the participant had retired and elected to commence payments, are distributed next, followed by other guaranteed benefits and benefits that are not guaranteed because of the substantial owner limitation.  In addition, there are several other priority categories to be satisfied in distributing plan assets.  Of particular interest to insurance personnel, ERISA requires that in order to distribute plan assets to participants and beneficiaries, the administrator must purchase annuities from an insurer or otherwise follow the terms of the plan and applicable regulations.411

2. Distress Terminations

A single-employer plan that is not eligible for a standard termination because of insufficient assets, may terminate under a "distress termination" in certain situations.  Both distress termination and standard termination are not available if the termination would violate the terms of a collective bargaining agreement, in which case termination would have to be as the result of an action by the PBGC.

The procedures for distress termination are outlined under ERISA regulations, such regulations are numerous and specific as to the distribution of assets.  Basically, there are notices required, investigative actions following to determine which, if any assets, are available, restrictions placed on the administrator to avoid distributing assets, and limitations on the distributions if it is discovered that assets are or will be insufficient to pay guaranteed benefits.412

3. Underfunding Liability

The basic rule of termination is that if the assets of the plans are sufficient to pay guaranteed benefits, the contributing sponsor and members of the controlled group remain liable to the PBGC for the amount of unfunded benefit liabilities as of the termination date, plus interest.413

Personal liability can occur if the person entered into a transaction, such as selling the business for the employees of which the plan was established, for the purpose of avoiding liability for underfunding.  The rules for the payment of liability to the PBGC are specific, with certain limitations, but in any event, the PBGC can bring civil action in federal district court to enforce any lien arising from underfunded plan asset liability.

The PBGC will pay to participants and beneficiaries in a terminated plan, a percentage of the outstanding amount of benefit liabilities.  The average paid is called the "recovery ratio" which is the average of the percentage of unfunded benefit liabilities recovered by the PBGC.


The PBGC may institute proceedings to terminate a plan if the plan has not met the minimum funding standards, or the PBGC may be required to initiate termination proceedings if the plan does not have assets available to pay benefits currently due.  While the PBGC cannot initiate proceedings in a collective bargaining agreement, such restriction does not apply to collective bargaining agreements in respect to involuntary terminations.

Initially, the PBGC may have a trustee appointed for the terminating plan, and normally, the PBGC becomes the trust.  If there is no agreement as to trustee, the matter may be settled by a federal district court.  The trustee is then responsible for the administrative and asset management for the plan.414

The termination proceedings start with the PBGC petitioning a federal district court for a decree that the plan should be terminated "to protect the interest of the participants or to avoid any unreasonable deterioration of the financial condition of the plan or any unreasonable increase in the liability of the (benefit guaranty) fund."415

Notice is given to interested parties (administrator, participants, employers who may be subject to liability, and employees) as soon as practical.  However, if the administrator consents to the termination, notice to the interested parties is not required, and a hearing is not required.416 

Once the decree has been entered, the court then has exclusive jurisdictions of the plan and its property, and the trustee assumes the power to marshal assets and distribute them to participants.  The trustee has the same duties as would a bankruptcy trustee under Federal law.417 

A contributing sponsor and the members of its controlled group have liabilities to both the trustee and to the PBGC in case of involuntary termination.  The liabilities to the PBGFC for unfunded liabilities are stated in the regulations and the liabilities to the trustee are for the outstanding balance of the accumulated fund deficiency, the outstanding balance of any funding deficiencies that have been waived, plus the outstanding balance or decreases in the accumulated funding deficiency that resulted from extension of amortization periods, such liability due as of the date of termination and payable in cash or securities.418


The PBGC has the power to destroy, it also has the power to restore.  It has the legal authority to halt a termination process based upon its own determination that relevant situations may exist, whereupon it may take what action is necessary to restore the plan to its prior status.  It may restore even if the plan had been terminated if the PBGC determines that such action is "appropriate and consistent with its duties (under Title IV)."419

In some situations, the sponsor has established a "follow-on" plan—a new benefit arrangement of benefits substantially the same as those under the terminated plan—which is combined with the guaranteed benefits under a terminated plan.   The PBGC takes the position that these follow-on plans are abusive because in the past attempts have been made to use the plan termination insurance program to subsidize an ongoing retirement program. 

When the PBGC issues a restoration order (as its power to restore has been upheld by the US Supreme Court) it also issues a payment schedule for the plan sponsor that provides for amortization of applicable and material of charges and credits for a period of time up to 30 years.  Additionally, any amount previously paid by the PBGC for guaranteed benefits and related expenses become a debt of the restored plan  and must be repaid on terms established by the PBGC.



A reversion may occur only if funds remain in the plan after payment of all benefit liabilities.  Surplus funds may occur if investment experience or economic factors are more favorable that those that had been assumed when the plan's funding levels were established.  Another cause of surplus funds is because of the termination procedure, where funding levels necessarily were based on the assumption of an ongoing plan and were related to projected benefits and future salary levels, whereas benefit liabilities at termination are based on currently accrued benefits and current salary levels—which may not be the same.  In some ways, this is like finding a $20 bill in your sofa cushion.  In this case, however, employers, employees and the IRS all stake claims to the "found" money. 

In essence, the employer can claim that plan assets constitute employer money used for a dedicated purpose, plus, the availability of a reversion is an incentive to plan formation, and as frequently offered, employers maintain that plan funds represent payments for services rendered, and that participants have benefit expectations beyond what is determined at termination.

The IRS maintains that since plan funds represent the tax-free accumulation of money for which the employer has already obtained a deduction, the tax benefit with respect to any surplus should be restored.

Obviously, this is a point worth debate, and there actually is no clear solution to the problem of residual assets.  While Treasury regulations limits the amount of the reversion to amounts resulting from "erroneous actuarial computations," it is limited in application.  Interestingly, most of the law developed so far seems to prefer the position of the employer's interest in surplus assets.  There are other regulations as a result of court decisions and the IRS has enacted legislation to discourage reversions and to recover tax benefits by imposing a 20% tax on the amount of reversion, with provisions to where the tax could increase to as much as 50% (if the employer fails to establish a qualified replacement plan or else increase benefits to a prescribed degree).

The end result is that as of this date, there really is nothing of substance to clarify these situations, so until some action is taken by the legislature or the IRS, restorations may continue to end up in the courts.


At the time of termination, assets are usually distributed through the purchase of annuities, as mentioned earlier.  But what happens if an annuity provider—and insurance company—becomes insolvent (happened several years ago when the large annuity provider, Baldwin United, went into receivership, followed by Executive Life of California)?  There are no ERISA provisions in this respect as the problems are left to the state insurance regulators.

This actually makes sense in several ways, including the fact that insurance is regulated by the states, but more importantly the PBGC would be subject to considerable exposure if it were to insure against the failure of insurance companies.  The PBGC has issued regulations that require plan administrators of single-employer plans, when notice is given of standard termination, to include a statement that the PBGC's responsibility ends upon the distribution of the plan's assets and an identification of the insurer from whom annuities will be purchased (if such is the case). 

The PBGC does not pick the insurer, but leaves the selection of an annuity provider to the plan administrator under the Title I fiduciary standards.

The Department of Labor has taken a similar stand—that it is a fiduciary matter.  However, there is concern that an employer-fiduciary may take out the cheapest annuity available, instead of the safest one, in order to maximize the amount of the reversion.  There were suits in this respect, mostly because of the defaults of Executive Life Insurance Company.  Thereupon, in 1994, Congress amended ERISA's enforcement provisions to allow the Secretary of Labor, fiduciaries, and former employees and beneficiaries to bring suit for appropriate relieve where buying annuities or other such insurance contracts, violate fiduciary standards or the terms of the plan.420


The main worry of Title IV in respect to multiemployer plans, is the employer withdrawing from the plan.  Title IV's principal purpose is to make sure that if the plan is withdrawn, an employer contributes its designated share of the amount of plan underfunding.  These rules are very complex and it would be counterproductive to go into details in this text.

Suffice it to say that a participating employer completely and totally withdraws from a multiemployer plan when it permanently stops having an obligation to contribute or permanently stops all covered operations under the plan.  They can partially withdraw if there is a 70% contribution decline or a partial stop of the contribution obligation.  There are special standards for withdrawal with certain industries.

The basic rule is that if an employer withdraws from a plan, it is liable to the plan for its allocable amount of unfunded vested benefits.421There are complicated formulae for determining the "allocable amount of unfunded vesting of benefits," the adjusting of the factors if the withdrawal is partial, etc.

The PBGC is authorized by statute to establish a fund to be used for reimbursing plans for uncollectible withdrawal liability payments, but for some reason, it has never exercised this authority.422




1.  Where the employee can elect to receive payment from the employer, either as cash (usually current compensation) or as a pre-tax contribution to a defined contribution plan, this is a

      A.  "cash or deferred arrangement" plan.

      B.  simple IRA.

      C.  Roth deferred compensation plan.

      D.  qualified distribution program.


2.  Every 401(k) plan must provide

      A.  for compulsory contributions.

      B.  for elective contributions.

      C.  for Cafeteria Plan inclusion.

      D.  for distribution of amounts attributed to contributions prior to age 50.

3.  One of the CODA tests for a plan to be qualified is where the ADP for eligible heavily compensated employees does not exceed 125% of the ADP of all other eligible employees.  "ADP" is

      A.  the annual deferred compensation.

      B.  actual deferral percentage.

      C.  administratively determined participation.

      D.  a dental plan.


4.  When the problem of excess contributions arises with a 401(k) plan as the employer does not have total control of the plan as to how much income he must defer, one simple way to correct the problem is

      A.  return some or all of the amounts contributed to the plan to the employees.

      B.  abide by a formula that uses percentages correlated with those used by similar businesses

            in the general geographical area.

      C.  to set up an escrow plan with the IRS where excess funds go towards future contributions.

      D.  dissolve the CODA plan and start a new plan.


5.  Employer contributions to a plan are tax deductible if

      A.  they are not discriminatory.

      B.  they are ordinary, necessary and reasonable.

      C.  they contribute a percentage of profit that is less than 125% of the total profits for that

            tax year, as reported to the stockholders.

      D.  not more than 85% of the contributions go to no more than 3 employees.


6.  Contributions made to a CODA that are nondeductible for a tax year

      A.  are not allowed a carryover, therefore one year's excess payments, for instance,

            are allowed.

      B.  are subject to a 10% tax each year to the extent that a contribution has not yet been

            deducted under a carryover provision.

      C.  are usually ignored by the IRS, but if it is made in a second consecutive year, it will

            be doubly taxed.

      D.  must automatically be returned to the employer every six months, and once such

            excess contributions have been made, the employer must file a report to the IRS

            on a semi-annual basis.


7.  The IRS requires that any accrued benefits of a CODA plan at time of termination

      A.  such benefits must be sent to the IRS for distribution.

      B.  be absorbed by the plan and distributed among other employee benefits of similar nature.

      C.  be submitted to the Department of Labor as a forfeit.

      D.  must vest, and in some cases, the plan must be permanent and not temporary.

8.  Since a CODA plan can be retroactively disqualified if it terminates and the IRS feels that it was not a bona fide program, causing considerable expense to the employer, if an employer terminates such plan the usual practice is to

      A.  enter into temporary bankruptcy and let the courts sort it out.

      B.  obtain a performance bond to cover any possible obligations that may arise because of

            the termination.

      C.  retroactively increase the compensation of all participants by the amount that they had

            attributed to their account in their 401(k).

      D.  ask for a determination letter from the IRS confirming that the termination has not

            affected its qualified status.


9.  One of the primary objectives of the Pension Benefit Guaranty Corporation (PBGC) is

      A.  the regulating and enforcement of termination regulations.

      B.  the taxation of businesses so that the PBGC can be perpetuated.

      C.  to create a bureaucracy so that large businesses cannot intimidate it.

      D.  to provide funds so that airlines and other transportation giants will not suffer

            financially in case of war or disaster.


10.  The PBGC is very interested in employer's withdrawing from the fund, particularly where there are multiemployer plans.  The basic rule is that an employer withdraws from a plan,

      A.  the entire company will be taken over by the PBGC (or the SEC if its stock is publicly


      B.  it is liable to the plan for its allocable amount of unfunded vested benefits.

      C.  it has no liability as membership in the PBGC is voluntary.

      D.  the PBGC can make the employer continue to contribute to the plan from the assets

            that it has recorded with the IRS for tax purposes.




1A     2B     3B     4A     5B     6B     7D     8D     9A     10B

Insurance and Employee Benefits