Terminating a Cash Balance Pension Plan: The 10 Step Guide


We have spoken at length about the benefits of cash balance plans. But, for a variety of reasons, plans must be terminated. So we have prepared a “how to guide” for terminating a cash balance pension plan.

The self-employed have long enjoyed the tax deductions and significant retirement contributions. But there are many legitimate reasons for plan termination. Often, employers wish to terminate the plan to avoid ongoing exposure. For example, the following reasons may be considered valid reasons for terminating a plan:

  • the company is going out of business;
  • the company has the inability to fund the plan going forward;
  • when partners or shareholders are worried about a growing plan liability;

The IRS would like to see a “business necessity” when it comes to terminating a cash balance pension plan. The desire to get the funds into a participant’s hands to allow them to direct their own investments would not qualify as a business necessity.

Cash balance pension plan termination

A business necessity would normally entail lower business profits, change in shareholders or ownership, or an issue that restricts the company’s ability to continue funding the plan. The IRS has also accepted the adoption of a different retirement plan as a legitimate reason for plan termination. The rules can be complex.

Terminating a Cash Balance Plan

The IRS considers a plan as a permanent company program. The IRS assumes plans will carry on indefinitely or at least for a “few years.” The regulations do not define clearly what a “few years” means.  But practically speaking, the IRS has historically not often questioned a termination that occurred more than 10 years after plan inception. Furthermore, employers that are terminating a cash balance pension plan that has been in existence for 5-10 years do not normally receive push back from the IRS.

Terminating a Cash Balance Pension Plan

So let’s walk through the steps:

  1. Amend the plan

    Amend the plan to establish a termination date and update the plan for all changes in the law or plan qualification requirements effective on the plan’s termination date.

  2. Stop plan contributions

    Ensure the company has ceased plan contributions unless a final contribution is required for qualified participants. This should be carefully coordinated with the investment advisor.

  3. Vest all participants

    Provide full vesting of benefits for all affected employees on the termination date (the plan should already have this provision).

  4. Notify plan participants

    Notify the plan participants about the plan termination. All details should be provided.

  5. Complete rollover notification

    Provide the required rollover notice to plan participants (must be within 15 days of amendment).

  6. Complete vesting

    Vest all “affected participants” 100% (applies to any employees or former employees with an account balance when terminating a cash balance pension plan).

  7. Coordinate distribution

    Coordinate to have the plan distribute all benefits in accordance with plan terms as soon as administratively feasible after the termination date.

  8. Finalize distribution

    Distribute plan assets to participants as soon as feasible (generally within 12 months) after the plan termination date.

  9. Complete termination review

    Do a final review of the plan assets and termination paperwork to make sure that you are all compliant.

  10. File final form 5500

    File any applicable final Form 5500 series return. This could result in a part year filing.
    chairs overlooking blue water

Is it Acceptable to Terminate then Restart a Cash Balance Plan?

However, there is also a concern that the IRS may apply a “step transaction” concept to a termination and restart. That is, if the result of the termination/restart is an otherwise identical plan, the IRS could argue that the plan did not in fact terminate, and that the new plan is simply a continuation of the old plan.

Termination

In such a case, the distributions would be considered prohibited from the old plan. This would result in disqualification of the plan, as well as excessive rollovers (in the case of rollover to an IRA) or receipt of funds from a disqualified plan (in the case of rollover to a 401(k) plan).

Business reason to terminate pension plan

There are many valid reasons for terminating a plan. But just make sure that you do your due diligence and make sure that your efforts are carefully coordinated with your third-party administrator (TPA).

Paul Sundin

Get a FREE 30 Minute Consultation

Reach out to us today and we'll show you our favorite strategies! We can show you how to structure a plan for maximum tax benefit and provide you with a custom plan design.

2 thoughts on “Terminating a Cash Balance Pension Plan: The 10 Step Guide”

  1. I sold my business and consequently discontinued cash balance plan. I have sent the necessary documents to past employees but 6 have yet to return them. Assuming correct address, since mail not returned, how do I get these people to complete forms so I can roll their funds into an IRA? What happens if they’ve moved with no forwarding address? Does cash balance just stay open indefinitely?

    Reply
    • Hi Rick – it is not surprising that a few employees have not replied. You have the option to distribute the funds out to them and then send them a 1099. You will likely have to do this for some folks. You don’t want to keep the cash balance plan open indefinitely because you will have to pay annual fees. But you should be able to get this all done during 2021 so you can shut the plan down this year. Make sure to discuss the issue with your current TPA.

      Reply

Leave a Comment