The “High 25” and Benefit Restrictions
“My client, a senior partner with an engineering firm, called and was upset because the administrator of his firm’s cash balance plan told him he can’t take a lump distribution, even though the plan document specifically permits lump sums. How can this be? I thought the plan sponsor had to follow the plan document.”
ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.
Highlights of Discussion
- Unfortunately for your client, in certain circumstances, defined benefit (including cash balance) plans, cannot make lump sum distributions to highly compensated employees (HCEs), despite the option being available under the terms of the plan. This restriction, sometimes known as the “High 25” or claw back rule, affects the top 25 highest paid HCEs. The rule is intended to ensure large lump sum distributions made to the top HCEs don’t jeopardize the funding status of the plan and its ability to make benefit payments to other participants.
- Treas. Reg. 1.401(a)(4)-5(b)(3)(ii) states that a plan cannot make certain benefit payments (including a lump sum payment) to an HCE (a restricted employee) who is in the top 25 of employees in terms of compensation unless one of the following is satisfied:
- After taking into account the payment to the restricted employee of all benefits payable to or on behalf of that restricted employee under the plan, the value of plan assets must equal or exceed 110 percent of the value of current liabilities;
- The value of the benefits payable to or on behalf of the restricted employee must be less than one percent of the value of current liabilities before distribution; or
- The value of the benefits payable to the restricted employee must not exceed $5,000 [the amount described in section 411(a)(11)(A) of the Internal Revenue Code (IRC) related to restrictions on certain mandatory distributions].
- Revenue Ruling 92-76  prescribes three workarounds, permitting a lump sum if the client does not wish to take an annuity payment. A lump sum is permitted if
- The distribution is placed in an escrow account;
- A surety bond is obtained for the distributed amount; or
- A letter of credit is secured that allows the plan to recoup all or a portion of the distribution in the event of future funding shortfall.
These rules are complex and expert counsel is necessary to ensure compliance.
When discussing benefit restriction rules for defined benefit plans with your clients, do not forget the well-entrenched benefit restrictions that may apply for the High 25 HCEs in the plan.