For a business owner with a high-3 wage average above $300,000 and at least 10 years of plan participation, the maximum lump sum reaches roughly $3.6 million at retirement age.

The practical takeaway: every plan sponsor should know their participants' maximum lump sum, and every funding and investment decision should be aimed at keeping plan assets at or below that ceiling.

Reversion: The Worst-Case Scenario

When an overfunded plan terminates and the excess assets cannot be distributed, those assets revert to the plan sponsor. Reverted assets are taxed twice:

 

1. Income tax. The reversion is treated as taxable income to the company in the year of reversion. Depending on the company's tax situation, this is 20% to 48%.

2. Excise tax. A 50% excise tax is assessed on the reverted assets under IRC §4980.

Combined, the IRS takes 70% to 98% of the reverted assets. The plan sponsor keeps 2% to 30%. This is why every solution below is worth considering before letting a plan terminate with overfunding intact.

Solutions, From Simplest to Most Complex

1. Prevention
The cheapest solution is the one you implement before there is a problem. Two habits prevent the vast majority of overfunding situations:

Develop a conservative investment strategy. Every CB plan has an interest crediting rate, typically between 4% and 6%. Plan sponsors should know their crediting rate and work with their financial advisor to build a portfolio that targets that rate, not equity-market returns. A CB plan is not the place to chase yield.

Fund the recommended contribution amount. Each year, Corvus prepares an actuarial valuation that includes the allowable funding range and a recommended contribution amount that fully funds the plan benefits. Sponsors who consistently fund above the recommendation will end up overfunded. The valuation exists for a reason.

2. Pay Plan Fees From Plan Assets
Sponsors are permitted to pay Corvus's administration fees out of the plan rather than out of the company. This is a small lever, but it does two useful things at once: it lowers the company's expenses and it draws down plan assets. For a plan with minimal overfunding, this alone can be enough to keep the situation under control.

3. Wait
The maximum distributable limit increases with each additional year of plan participation, up to 10 years. If the participant has fewer than 10 years of participation, simply continuing to operate the plan increases their ceiling. Doing nothing is sometimes the right move.

4. Increase Wages
Because the maximum lump sum depends on the participant's high-3 average wage, raising wages raises the ceiling. If the participant's historical wages have been below the IRS compensation limit and the company can afford to pay them more, increasing wages for 3 consecutive years establishes a new high-3 average. After that, wages can be brought back down. The increased ceiling stays in place.

5. Add Family Members to the Plan
Business owners can hire spouses, children, parents, or siblings, pay them legitimate wages, and accrue plan benefits for them. This reduces overfunding while building retirement security for family members. The wages and the work performed need to be real and reasonable. The IRS does not look kindly on a "Vice President of Strategic Planning" who is in second grade.

6. Qualified Replacement Plan (QRP)
When the solutions above are not enough, the IRS allows the plan sponsor to roll overfunded assets into a Qualified Replacement Plan. The QRP is a 401(k) plan that covers at least 95% of the participants from the CB plan. The overfunded assets are deposited into an unallocated account in the 401(k) plan and allocated to participants over 7 years.

This requires the sponsor to maintain the 401(k) plan until the unallocated assets are fully distributed. Our office has used this approach more than 20 times. For overfunding under $1M, it is usually the right answer.

7. Business Transaction
When overfunding exceeds $1,000,000 and the solutions above will not close the gap, the remaining option is to include the overfunded plan in a business sale to a non-profit that sponsors an underfunded defined benefit plan.

Here is how it works:

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1. The business owner forms a new business entity and changes the plan sponsor of the CB plan to that new entity.

2. Because the new entity does not employ the original plan participants, those participants can be distributed from the plan.

3. The business owner sells the new entity, along with other business assets, to the non-profit. If no business assets other than the CB plan are included in the sale, the strategy is not allowable under ERISA. This is not optional.

4. The non-profit values the CB plan assets at 70% to 85% of market value, reflecting the difficulty of removing assets from the plan.

5. The sale is structured as a stock sale, so the business owner pays 20% capital gains tax on the proceeds.

The result: The business owner walks away with 56% to 68% of the original overfunding. Compare that to the 2% to 30% they would keep after a reversion. The non-profit, meanwhile, solves part of its underfunding problem at a discount, since non-profits do not get tax deductions for retirement plan contributions and a discounted asset transfer is genuinely valuable to them.

This is a complex transaction. It requires the right counterparty, careful legal structuring, and coordination between the plan sponsor, the non-profit, and the actuarial firm. It is not the first solution to reach for. But when nothing else will close the gap, it is dramatically better than reversion.

Corvus has a network of attorneys, business brokers, and non-profits to facilitate these transactions and has completed 2 of these in the past. 

The Bottom Line

Overfunding is a problem that compounds quietly. By the time a plan sponsor notices, the easy fixes may not be enough. The right approach is to know your maximum distributable limit, fund the recommended contribution, target the interest crediting rate with a conservative investment strategy, and check in on the plan's funded status every year.

If your CB plan is already overfunded, or you are worried it might be heading that way, there is almost always a path that beats reversion. The earlier we look at it, the more options are on the table.