PLR 1228055: IRS allows return of pension surplus from an erroneous actuarial calculation

Plain-English summary

The IRS considered whether a terminated defined-benefit plan could return surplus assets to its sponsoring taxpayer after purchasing annuity contracts for all plan liabilities. It ruled that the amount could not be returned under the plan’s one-year mistake-of-fact provision because the relevant contributions were made more than one year earlier. It nevertheless concluded that the premium refund resulted from an erroneous actuarial computation and could be returned after all plan liabilities were satisfied. The IRS also ruled that the return would not be an employer reversion subject to the excise tax under IRC § 4980.

Ruling snapshot

• Question: May the plan return a premium refund to the taxpayer without violating the exclusive-benefit rule or triggering the employer-reversion excise tax?
• Outcome: Mixed, the return is allowed under the erroneous-actuarial-computation rule but not under the plan’s one-year mistake-of-fact provision.
• Key authorities: IRC §§ 401(a)(2), 404, 4980, and 6110(k)(3); ERISA §§ 403(c)(2)(A) and 4044; Treas. Reg. §§ 1.401-2 and 1.401(a)-2

Full text (IRS public release)

Significant Index Number 401.03-00

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DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION

FEB 25 2011

SE: TE: EP: RA: A2

Re:

Dear [illegible]:

This letter is in response to your request for a ruling dated February 10, 2010, which
was submitted by your authorized representative, regarding whether returning the Plan's
surplus assets after satisfaction of all benefit liabilities upon termination of the Plan to
the Taxpayer violate section 401(a)(2) of the Internal Revenue Code (“Code”) and if the
return of such assets constitutes an employer reversion that is subject to the excise tax
on reversions of qualified plan assets to an employer under section 4980 of the Code.
The following facts and representations have been submitted:

Taxpayer =

Company 1

Company 2:

Company 3 =

Consultant =

Insurer =

Amount 1 =

Amount 2 =

Amount 3 =

Amount 4 =

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Date 1 =

Date 2 =
Date 3 =
Date 4 =
Date 5 =
Date 6 =
Date 7 =
Date 8 =
Date 9 =

Prior to the sale of its assets, Company 1 sponsored and maintained the Plan, a single-

employer defined benefit plan which was originally adopted by Company 1 effective
Date 1.

On Date 2, Company 1 sold substantially all of its assets to Company 2, a Delaware
corporation. Company 1 and Company 2 were, and are, unrelated. As a result of the
sale Company 1 discontinued the operation of its manufacturing business and
substantially all of its employees became employees of Company 2 on the closing date.
In connection with the sale of its assets to Company 2, Company 2 changed its name to
Company 3 on Date 3. On Date 4, Company 3 was merged into the Taxpayer, an Ohio
limited liability company, which was the surviving entity in the merger.

Company 2 did not wish to continue the Plan following its purchase of the assets of
Company 1 and, therefore, under the asset sale agreement Company 1 (and following
the merger into the Taxpayer, now the Taxpayer) agreed that it would fully fund and
terminate the Plan as soon as practicable following the closing date of the asset sale.
Accordingly the Taxpayer terminated the Plan effective Date 5, and on Date 6, the
Taxpayer filed with the Pension Benefit Guaranty Corporation a Standard Termination
Notice to terminate the Plan effective as of Date 5. The Pension Benefit Guaranty
Corporation has approved the Standard Termination Notice filed by the Taxpayer and
the time period for objecting to such notice has expired without comment or objection
from the Pension Benefit Guaranty Corporation. The Taxpayer has also filed a Form
5310 with the Internal Revenue Service asking for a determination that the termination
of the Plan will not affect the Plan's qualification but has not yet received a ruling.

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In order to facilitate the termination of the Plan, the Taxpayer, with the assistance of the
Consultant prepared a bid specification for the purchase of a single-premium group
annuity contract to cover all of the Plan's liabilities on termination and submitted the
specification to a number of insurance companies for bids. The specification included
information on the participants, the benefits payable to each of the participants as of the
Plan's termination date and the forms of payment available under the Plan.

In response to such bid specification, the Plan's trustee received a number of proposals
including a proposal from the Insurer. After careful review of the proposals, the
Taxpayer and Plan trustee determined to accept The Insurer's proposal.

In its proposal the Insurer agreed to issue a single-premium group annuity contract to
the Plan pursuant to which the Insurer would assume and pay all of the benefits
accrued under the Plan as of the termination date in exchange for the payment of a
single-sum premium in the amount of Amount 1 to be paid on or before Date 7. The
single-sum premium was calculated by the Insurer based upon the participant data
provided in the bid specification and its internal actuarial assumptions with respect to
mortality and estimated rates of return.

The assets held in the Plan were insufficient to pay the single-sum premium and,
therefore, the Taxpayer made an additional contribution of Amount 2 to the Plan on
Date 8, in order to enable the Plan to pay such premium. The single-sum premium of
Amount 1 was paid by the Plan's trustee to the Insurer on Date 7. On Date 9, an
additional Amount 3 premium was paid to The Insurer in order to provide for the
payment of the benefits of two Plan participants whose accrued benefits were adjusted
due to an increase in their credited service under the Plan.

Subsequent to Date 9 and in connection with the finalization of the group annuity
contract, the Insurer discovered certain errors in, and changes to, the participant census
data originally submitted by the Plan which have generated premium refunds from the
Insurer to the Plan totaling Amount 4.

As a result of the issuance of the group annuity contract by the Insurer, all of the
liabilities of the Plan have been satisfied. The sole asset remaining in the Plan's trust is
Amount 4 in premium refunds received from the Insurer, plus earnings thereon, and the
Plan's trustee desires to return such amount to the Taxpayer pursuant to the provisions
of Section 14.3 of the Plan.

Based on the above facts and representations, you, through your authorized
representative, request the following rulings:

1. That the return to the Taxpayer of the Plan's surplus assets will not violate
   section 401(a)(2) of the Code to the extent that such surplus is attributable to the

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premium refund in the total amount of Amount 4 received by the Plan from The
Insurer and the earnings thereon; and

2. That the return to the Taxpayer of the Plan's surplus assets will not constitute an
   employer reversion that is subject to the excise tax on reversions of qualified plan
   assets to an employer under section 4980 of the Code to the extent that such
   surplus is attributable to the aggregate premium refund in the amount of Amount
   4 received by the Plan from the Insurer and the earnings thereon.

Plan Provisions

Section 2.11 provides: The word “Company” shall mean Company 1 or any successor
corporation or business organization which shall assume the obligations of Company 1
under this Trust and Plan.

Section 10.3 of the Plan provides: All contributions made by the Company may be in
cash or other property determined by the Company in its sole discretion. All such
contributions shall be based on the facts then understood by the Company, shall be [illegible]
conditioned upon the Trust and Plan constituting a qualified plan under Section 401 of
the Code, and, unless otherwise specified by the Company, shall be conditioned upon
deductibility of the contributions under Section 404 of the Code in the years for which
each such contributions was made. All such contributions shall be irrevocable and shall
never inure to the benefit of the Company except that:

(a) any contributions which are made under a mistake of fact may be returned
to the Company within one (1) year after the contributions were made;

(b) | any contributions made for years during which the Trust and Plan does not
qualify under said Section 401 may be returned to the Company within
one (1) year after the date of denial of qualification; and

(c) any contributions, which are not in whole or in part, deductible under said
section 404 for the year for which they were made may, to the extent such
contributions were not so deductible, be returned to the Company within
one (1) year after the disallowance of the deduction.

Section 14.3 of the Plan provides: Upon termination of the Trust and Plan, the assets
then held in the trust fund shall be allocated and distributed to Participants in
accordance with the terms and provisions of Section 4044 of ERISA, to provide the
benefits accrued by Participants as of the date of termination.

The assets so allocated to each such Participant shall be distributed in the form of a

retirement benefit commencing on such date on or after the date of termination of the
Trust and Plan, but in any event not later than his Normal Retirement Date, as the

a

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Administrator shall select. Such distribution shall be accomplished through either (i)
continuance of the trust fund or a new trust fund or (ii) purchase of annuity contracts;
provided, however, that the Administrator may direct that the trust fund be continued
with respect to some of the Participants and that annuity contracts be purchased with
respect to other Participants. If any allocation produces a retirement benefit which has a
lump sum Actuarial Equivalent of Three Thousand Five Hundred Dollars ($3,500.00) (or
Five Thousand Dollars ($5,000.00) on and after January 1, 1998) or less, the
Administrator shall pay in lieu of such retirement benefit the lump sum Actuarial
Equivalent value.

Any sums held by the Trustee in the trust fund after satisfaction of, or provision for, all
liabilities with respect to all persons entitled to benefits accrued under this Trust and
Plan as of the date of termination shall be returned to the Company.”

Law

Section 401(a)(2) of the Code provides, in general, that a plan qualified within the
meaning of Code section 401(a) may not at any time prior to the satisfaction of all
liabilities with respect to employees and their beneficiaries under the trust use or divert
any part of the plan's assets for purposes other than the exclusive benefit of the
employees and their beneficiaries. However this paragraph shall not be construed, in
the case of a multiemployer plan, to prohibit the return of a contribution within 6 months
after the plan administrator determines that the contribution was made as a mistake of
fact.

Section 1.401(a)-2 of the Income Tax regulations (“regulations”) provides that section
1.401-2, a regulation promulgated prior to the Employee Retirement Income Security
Act of 1974 (“ERISA”), provides rules under section 401(a)(2) of the Code and that
regulation is applicable unless otherwise provided.

Section 1.401-2 of the regulations provides rules under section 401(a)(2) of the Code
for the impossibility of diversion under the trust instrument. Section 1.401-2(b)(1)
provides that the intent and purpose in section 401(a)(2) of the Code of the phrase
“prior to the satisfaction of all liabilities with respect to employees and their beneficiaries
under the trust” is to permit the employer to reserve the right to recover at the
termination of the trust, and only at such termination, any balance remaining in the trust
which is due to erroneous actuarial computations during the previous life of the trust. A
balance due to an “erroneous actuarial computation” is the surplus arising because
actual requirements differ from the expected requirements even thought the latter were
based upon previous actuarial valuations of liabilities or determinations of costs of
providing pension benefits under the plan and were made by a person competent to
make such determinations in accordance with reasonable assumptions and correct
procedures related to the method of funding.

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Section 403 (c)(2)(A) of the Employee Retirement Income Security Act of 1974
(“ERISA”), as amended, for which there is no parallel provision in the Code, provides
that a contribution which is made by an employer by a mistake of fact may be returned
to the employer within one year after payment of the contribution.

Section 4980(c)(2)(A) of the Code defines the term “employer reversion” to mean the
amount of cash and the fair market value of other property received (directly or
indirectly) by an employer from the qualified plan.

Section 4980(c)(2)(B) of the Code provides in pertinent part that the term “employer
reversion” shall not include (i) except as provided in regulations, any amount distributed
to or on behalf of any employee (or his beneficiaries) if such amount could have been
so distributed before termination of such plan without violating section 401, or (ii) any
distribution to the employer allowable under section 401(a)(2) in the case of a plan other
than a multiemployer plan, by reason of mistake of fact, or (iii) in the case of any plan,
by reason of the failure of the plan to initially qualify or the failure of the contributions to
be deductible.

Revenue Ruling 91-4, 1991-1 C.B. 57, provides that a plan qualified within the meaning
of Code section 401(a) may contain a provision authorizing return of employer
contributions made because of a “mistake of fact” as provided in section 403(c)(2)(A) of
ERISA.

Analysis

With respect to the issue of whether the contributions which are the subject matter of
this ruling request were made as a result of a “mistake of fact”, Amount 2 and Amount 3
were contributed to the Plan in order to effect the standard termination of the Plan.
These amounts were determined by the Insurer based upon the participant data
provided in the bid specification and the Insurer's internal actuarial assumptions with
respect to mortality and estimated rates of return so that annuity contracts could be
purchased for participants under the Plan.

After satisfaction of all liabilities with respect to employees and beneficiaries of the trust,
The Taxpayer has been told by the Insurer that it is entitled to a refund of premiums in
the total amount of Amount 4. According to the Insurer, the reductions in premiums —
totaling Amount 4 are the result of changes in the Plan's participant data that was
originally included in the bid specifications provided to the Insurer. Therefore, in short,
the Insurer's initial reliance on participant data that was later revised was the cause of
the Taxpayer contributing more to the Plan than was required to satisfy all of the Plan's
liabilities with respect to employees and their beneficiaries upon termination of the Plan.
Consequently the revisions in calculations by the Insurer were due to a “mistake of fact”
as contemplated in section 403(c)(2)(A) of ERISA and in this case such revisions in
calculations by the Insurer were made due to a mistake of fact as provided under

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section 4980(c)(2)(B)(ii)(Il) of the Code.

Revenue Ruling 91-4, 1991-1 C.B. 57, provides that a plan qualified within the meaning
of Code section 401(a) may contain a provision authorizing return of employer
contributions made because of a “mistake of fact” as provided in section 403(c)(2)(A) of
ERISA. As noted above, the Plan contains such a provision.

Rulings
Thus, with respect to your ruling requests, we conclude as follows:

1. That although Amount 4 exists because of a “mistake of fact”, Amount 4 arose as
   the result of two contributions made on two separate occasions Date 8 and Date [illegible]
   9, each of which are more than one year prior to the date of this ruling letter.
   Consequently Amount 4 may not be returned to the Taxpayer in accordance with
   section 10.3(a) of the Plan and section 403(c)(2)(A) of ERISA

However Amount 4 is the result of an “erroneous actuarial computation” as
described in section 1.401-2 of the regulations (which arose due to a mistake of
fact) and accordingly may be returned to the Taxpayer subsequent to the
satisfaction of all liabilities with respect to employees and their beneficiaries

under the trust in accordance with section 1.401-2 of the regulations and section
14.3 of the Plan.

2. Section 4980(c)(2)(B)(ii)(II) of the Code provides that the term “employer
   reversion” does not include, in the case of a plan other than a multiemployer plan,
   plan, an amount distributed to the employer by reason of mistake of fact.
   Accordingly Amount 4 is described in section 4980(c)(2)(B)(ii)(II) of the Code and
   thus the return of Amount 4 to the Taxpayer does not constitute an employer
   reversion under section 4980 of the Code.

This ruling only addresses the two issues that we have ruled upon. In particular, we are
not expressing any opinion as to deductibility of any particular contribution to the Plan
under section 404(a) of the Code nor whether the termination of the Plan will affect the
Plan's qualification.

This letter ruling is based on the assumption that the Plan was and is qualified within the
meaning of Code section 401(a) at all times relevant thereto. It also assumes the
correctness of all representations made with respect thereto.

This ruling is directed only to the taxpayer that requested it. Section 6110(k)(3) of the
Code provides that it may not be used or cited by others as precedent.

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We have sent a copy of this letter to your authorized representative pursuant to a power
of attorney on file in this office.

If you require further assistance in this matter, please contact [illegible] at
This ruling is directed only to the taxpayer that requested it.

Sincerely yours,

[illegible]

David M. Ziegler, Manager
Employee Plans Actuarial Group 2