Rev. Rul. 73-3

Advice has been requested whether a distribution, under the circumstances described below, adversely affected the qualification of the plan under section 401(a) of the Internal Revenue Code of 1954.

An employer established a qualified pension plan which contained the restrictions required under section 1.401-4(c)(1) of the Income Tax Regulations. The plan provides that the employees may elect to take their retirement benefits in a lump sum, but employees who are among the 25 highest paid, as mentioned in section 1.401-4(c) of the regulations, must make adequate provision for repayment of any part of the distribution that is in excess of that permitted by section 1.401-4(c).

An employee who was among the 25 highest paid retired before the plan had been in existence for ten years. He received a lump-sum distribution by making the election required by the plan and entering into an agreement to repay any part of the distribution that might be found to exceed that permitted to be distributed by section 1.401-4(c) of the regulations. Security under the agreement consisted of an assignment of the employee's right to receive retirement benefits under a separate nonqualified plan of the employer. These benefits would exceed, unless forfeited, the amount repayable, but they were provided under an unfunded arrangement. The employee's rights under the unfunded plan are not assignable to third parties and will be forfeited if the employee takes a job with a competitor.

Section 401(a)(4) of the Code provides that a plan may qualify if the contributions or benefits do not discriminate in favor of employees who are officers, shareholders, supervisors, or highly compensated.

Section 1.401-4(c) of the regulations provides that, although a qualified plan may provide for termination at will by the employer or discontinuance of contributions thereunder, it must expressly provide that if employer contributions may be used for the benefit of an employee who is among the 25 highest-paid employees of the employer at the time the plan is established and whose anticipated annual pension under the plan exceeds $1,500, the benefits payable within ten years after the establishment of the plan to an employee in the 25 highest-paid category must be limited, as specified, if the plan is terminated within the first ten years, or the current costs of the plan for the first ten years have not been funded.

Revenue Ruling 61-10, C.B. 1961-1, 143, holds that a lump-sum distribution in an amount in excess of that otherwise permitted under section 1.401-4(c) of the regulations may be made, provided there is adequate provision for repayment of any part of the distribution representing the restricted portion in the event of a termination of the plan or a default in payment of the full current costs of the plan within the first ten years after its establishment.

In Revenue Ruling 61-10 the agreement for repayment was secured by the deposit, with an acceptable depository, of property having a fair market value equal to 125 percent of the amount that would have been repayable if the plan had terminated on the date of the distribution by the trust. The employee also agreed that, if the market value of such property fell below 110 percent of the amount that would be repayable if the plan should then terminate, additional property necessary to bring the value up to 125 percent would be deposited.

In the instant case the right to retirement benefits under the nonqualified plan, pledged as security for the repayment agreement, is not acceptable security since the employee's interest under the nonqualified plan is unfunded, subject to a noncompetition agreement, and is not assignable. Hence, the safeguards which were present in the agreement described in Revenue Ruling 61-10 are lacking.

Accordingly, it is held that the qualification on the plan was adversely affected by the lump-sum distribution.