Valuation Requirement

The fair market valuation of 401k assets is essential to compliance with the Internal Revenue Code requirements.

 The valuation of 401k assets must be accurately determined to ascertain

(1)     Prohibited transactions;

(2)     Exclusive benefit violations under IRC 401(a);

(3)     Violations of the limitation on benefits and contributions under IRC 415;

(4)     Excess deductions under IRC 404;

(5)     Violations of the minimum funding requirements under IRC 412; or

(6)     Discrimination violations under IRC 401(a)(4).

In a profit sharing or 401k the valuation of 401k assets will determine the value of a participant’s account, and ultimately, a participant’s distribution.

Solo-k Asset Valuation Formality

(1) Whether a formal valuation is required will depend on the transactions that occur with the plan and the form of the plan.

a. For example, the valuation in a single participant plan, a self-directed account, or frozen plan can be less formal in a year in which the plan or self-directed account receives no contribution and makes no distribution or change in investment.

(2) The reasonableness of the method for valuing plan assets is based on the surrounding facts and circumstances. Except for certain employer securities held by an ESOP, there is no absolute requirement the annual valuation be based on an independent appraisal.

Timing of Solo 401k Asset Valuation

Rev. Rul. 80–155 requires that a defined contribution plan’s assets be revalued at least annually. If the requirements of Rev. Rul. 80–155 are not met, the plan is not qualified.

(1) In a defined contribution plan, Rev. Rul. 80–155, 1980–1 C.B. 84, provides

that since amounts allocated or distributed to a participant must be ascertainable,

the plans must value their trust investments—

(1)     at least once a year,

(2)     on a specified date,

(3)     in accordance with a method consistently followed and uniformly applied.

When employer securities are acquired or sold, the securities must be valued at the time of the transaction.
 

Factors for Consideration in Determining Value

(1) There are a number of factors to consider when determining the value of an

asset, for example:

a. Nature and history of the business issuing the security

b. General economic outlook and the outlook for the specific industry

c. Book value of the securities and the financial condition of the business

d. Company’s earning capacity

e. Company’s dividend paying capacity

f. Goodwill value

g. Recent stock sales

 (2) ERISA 3(18) applies for purposes of some prohibited transaction exemptions under both ERISA and the Code.

(3) ERISA 3(18) defines the term adequate consideration for “assets other than a security for which there is a generally recognized market” as the fair market value of the asset as determined in good faith by the trustee or named fiduciary pursuant to the terms of the plan

(4) DOL Reg. 2510.3–18(b)(2) defines “fair market value” as the price at

which an asset would change hands between a willing buyer and a willing

seller when either party is not under any compulsion to enter into the transaction.

 (5) Rev. Rul. 59–60, 1959–1 C.B. 237, provides guidance for determining the

value of plan assets. Although Rev. Rul. 59–60 provides methods for valuing

shares of stock of closely held corporations for estate and gift tax purposes,

the factors may be used to determine values of assets in qualified plans.

a. The factors in Rev. Rul. 59–60 are not an restricted list of factors for valuing closely-held employer securities. Other factors may be included where appropriate. Also, not all of the listed factors will be relevant to all companies and transactions.

(6) The detail of the asset’s valuation is examined in light of the plan

assets involved.

a. As example, the valuation should contain extensive detail if it values a limited partnership interest or a closely held corporation.

(7) If appropriate, stock values should be discounted due to a lack of marketability and, where appropriate, a control premium should be added to the stock value.

                                   Types of Plan Assets

(1) Plans may invest a portion of their assets in limited partnerships and invest directly in real property, or in mortgages on real property.

(2) Plans may also invest in life insurance contracts. Described below is a safe harbor that may be used when such contracts are distributed.

Partnerships

(1) The partnership itself can invest in virtually any type of asset.

(2) Generally, limited partnership interests are not listed on national securities

exchanges.

(3) The valuation of a plan’s interest in a partnership is especially important in a year in which the plan is making a distribution.

Real Estate

(1) Mortgages valued at cost may be incorrectly valued if based solely on the

purchase price of the real estate.

(2) Under special circumstances, the mortgage’s valuation should reflect the

current value of the real property.

a. For example, if the fair market value of property held for investment by the plan is lower than the indebtedness secured by the property, the value of the mortgage should be marked down. Also, the value of the mortgage is based on the loan balance.

(3) Although a contribution of property to a plan may be a prohibited transaction if it is not subject to an exemption, a contribution need not be paid in cash to be deductible under IRC 404. If overvalued property is contributed to the plan, the employer may have deducted an amount in excess of that allowed under IRC 404.

Life Insurance Contracts

(1) Section 1.402(a)-1(a)(1)(iii) of the Income Tax Regulations provides, in general,that a distribution of property by a qualified plan is taken into account by the distributee at its “fair market value”.

a. In the case of a non-variable life insurance contract, compare the

premiums paid with the value of the contract. Generally, the value of a

non-variable life insurance contract should be close to the premiums paid

under the contract accumulated at a reasonable rate of interest (at least 2

or 3 percent) less reasonable cost of insurance charges (generally, except

for very high ages, less than $5,000 per $1 million of death benefit) less

reasonable policy expenses (generally, less than $1,000 per $1 million of

death benefit).

b. In the case of a variable life insurance contract, the actual investment return should be considered. Generally the value of a variable life insurance contract should be close to the premiums paid under the contract accumulated at the actual investment return rate earned by the contact (which can vary widely because the premiums paid under such contracts are generally invested in mutual fund like instruments) less reasonable cost of insurance charges (generally, except for very high ages, of less than 5,000 per $1 million of death benefit) less reasonable policy expenses (generally, less than $2,000 per $1 million of death benefit).

(2) If assets are valued more frequently than annually in a way that favors distributions to highly compensated employees, prohibited discrimination could occur.

(3) An improper valuation of qualified plan assets can cause a plan to exceed the limitations on benefits and contributions .

a.This could occur, for example, if there was an exempt contribution of undervalued property to a plan and the resulting annual additions to participant accounts based on the improper valuation are within the limits of IRC 415, but the annual additions based on fair market value of the contributed property would exceed the IRC 415 limits.

b. Similarly, there could be excess annual additions if property were sold by the plan for more than fair market value.

(4) In extreme cases, an exclusive benefit violation under IRC 401(a)(2) may

occur if a qualified plan engages in a prohibited transaction in which it acquires property for more than fair market value.

Prohibited Transactions

(1) Under IRC 4975(d)(13) and ERISA 408(e), a plan may acquire and hold qualifying employer securities and qualifying employer real property.

(2) The acquisition of qualifying employer securities or qualifying employer real property is exempt under IRC 4975(d)(13), only if the securities or real

property is sold or acquired for “adequate consideration” as defined under

ERISA 3(18). This requires a proper valuation.