Avoiding excise tax on Keogh Plan reversions.

• Author: Nadel, Alan A.

When a defined benefit plan is terminated, the present value of accrued benefits is distributed to the plan's participants. Any surplus assets are returned to the plan sponsor and are subject to an excise tax of up to 50%. This excise tax is payable to sponsors (including self-employed individuals) of defined benefit Keogh plans, or their estates, on the plan's termination. It can apply even at the sponsor's death if funds remain in the plan after all benefits have been paid. However, with proper planning, the tax can be avoided for minimized).

Sec. 4980 imposes an excise tax of up to 50% on the reversion of surplus pension assets to an employer on termination of a defined benefit pension plan. The purpose of the tax is to discourage employers from terminating their pension plans. Defined benefit plans maintained by self-employed individuals, however, are usually terminated at the death of the individual and/or a spouse, resulting in the excise tax being applied to any remaining assets.

Self-employed individuals have been able to establish similar types of qualified retirement plans as corporations since the passage of the Tax Equity and Fiscal Responsibility Act of 1989,. Plans covering the self-employed (sometimes referred to as Keogh plans) are subject to rules similar to those for corporate plans with respect to contributions and distributions. Many self-employed individuals have established defined benefit plans because they frequently allow for greater annual contributions than available under a defined contribution plan. Under a defined benefit plan, however, a participant's benefit is determined pursuant to a formula, rather than an individual account balance. Asset accumulations greater than that necessary to fund the participant's formula benefit are used by the plan to fund the benefits of other participants or, on plan termination, are returned to the employer. Because the surplus amount is not part of the. participant's promised "accrued benefit," the surplus assets cannot be rolled over to an individual retirement account (IRA) or another qualified plan. As noted, the reversion of surplus assets to an employer is subject to the Sec...