It’s that time of year again…
when retirement plan sponsors need to give their plans the administrative
equivalent of an annual physical exam. There are new limitations to
consider as well as recurring compliance deadlines and fiduciary
responsibilities. All of these matters have become a bit more complicated
by the passage of the Pension Protection Act of 2006.
This newsletter will review the 2007 administrative compliance
requirements and deadlines for qualified plans as well as some of the
newly enacted Pension Protection Act provisions.
New Annual Limits
Participants in 401(k), 403(b) and 457 salary deferral plans should be
notified that the annual deferral dollar limit for 2007 increased to
$15,500, while the additional catch-up contribution, for those age 50 and
over as of the end of the year, remains unchanged at $5,000. The maximum
compensation for plan purposes increased to $225,000. The prior year
compensation level used for determining highly compensated employees
remains at $100,000 while the key employee compensation threshold for
officers increased to $145,000. In defined contribution plans the maximum
annual additions (total contribution allocations) increased to $45,000 per
participant, and the defined benefit plan maximum annual benefit increased
to $180,000.
Reporting of Distributions
Participants who received plan distributions during 2006 must be
furnished with Form 1099-R by January 31, 2007 showing the amount of the
distribution, the taxable portion, any taxes withheld and the appropriate
distribution code. Defaulted loans must also be reported on Form 1099-R.
Copy A of these forms must be submitted to the IRS along with transmittal
Form 1096 by February 28.
Nondiscrimination Testing
Qualified plans must perform annual testing to make sure they don’t
unfairly discriminate in favor of "highly compensated employees" (HCEs).
An employee is an HCE if he owns more than 5% of the company (including
family attribution rules) or has compensation in the prior plan year
exceeding a specified level ($100,000 in 2006).
Plans that don’t cover all employee divisions, classifications or the
employees of a related company, or require participants to work a minimum
number of hours or be employed on the last day of the plan year to share
in allocations, may have to test annually for coverage discrimination.
Salary deferral plans, other than safe harbor plans that meet the
employer contribution and notice requirements, must test at the end of
each plan year to insure that employee deferrals and employer matching
contributions aren’t discriminatory. Generally speaking, if the ADP
(average deferral percentage) and the ACP (average contribution
percentage) for the HCEs are within 2% of the ADP and ACP for the
non-HCEs, the plan is not discriminatory.
The most common method for correcting a failed ADP or ACP test is to
make corrective distributions of the excess contributions plus earnings.
These corrections must be done within 2½ months of the plan year end in
order to avoid a 10% penalty. The final deadline for making corrective
distributions with the penalty is the last day of the following plan year.
If an employee makes excess deferrals in a calendar year above the
annual dollar limit, such excess is not deductible on the employee’s tax
return and should be distributed to the employee by the following April
15. If not, the amount will be subject to double taxation: once in the
year deferred and again when distributed.
Top Heavy Testing
A plan is considered top heavy if more than 60% of the benefits belong
to "key employees," who are defined as more than 5% owners (including
family attribution rules), more than 1% owners earning above $150,000 and
officers earning over a specified amount ($145,000 in 2007). An annual
test must be performed to determine if the key employees have more than
60% of the benefits, after certain adjustments. If so, the plan must meet
the top heavy minimum contribution and vesting requirements.
Census Information
In order for the nondiscrimination and top heavy tests to be performed,
the employer must compile census information for all employees of the
company. The census should include dates of birth, hire and termination,
total compensation, hours worked, whether the employee is an officer or
owner (or a family member of an owner) and contributions made on behalf of
each employee.
Benefit Statements
Under the new law, all plans are required to provide benefit statements
to participants as of the 2007 plan year. Most plans have already been
doing so. The statements must indicate the total accrued benefits and the
vested benefits, if any, or the earliest date on which benefits will
become vested. They must also include an explanation of any permitted
disparity or other offset arrangements used in calculating accrued
benefits.
Individual account plans must provide the statements at least annually.
Where participants direct their own investments, statements must be
provided at least quarterly, although the vesting information need only be
provided once a year. The quarterly statements must also contain an
explanation of any limitations or restrictions on investment direction, an
explanation of the importance of a well-balanced and diversified
portfolio, including a statement that holding more than 20% of a portfolio
in one security may not be adequately diversified, and a notice directing
participants to the Department of Labor (DOL) website for more
information.
Defined benefit plans must provide benefit statements at least once
every three years to active participants with a vested accrued benefit, or
to any participant upon written request (not more often than once a year).
Alternatively, the three-year requirement will be met if at least once a
year participants are provided with a notice of the availability of a
pension benefit statement and the ways in which one may be obtained.
In Field Assistance Bulletin 2006-03, issued in December, the DOL
clarified that benefit statements can be delivered electronically (as can
other employee notices). It also provided a 45-day safe harbor after the
end of the period during which the statements will be considered timely
provided.
While this deadline may be reasonable for the information required on
quarterly statements, it may not be for annual statements. More time may
be needed to update vesting percentages and allocate employer
contributions, which are sometimes not deposited until 8½ months after the
plan year ends. Hopefully, additional guidance from the DOL will be
forthcoming before the end of the year regarding the deadline for issuing
annual benefit statements.
Annual Reports
Almost all retirement plans, except one-participant plans with assets
of $100,000 or less (increased to $250,000 as of the 2007 plan year), are
required to file an annual report, Form 5500, with the DOL. The due date
is the last day of the seventh month after the end of the plan year (July
31 for calendar year plans). The deadline can be extended 2½ months by
filing Form 5558 by the original due date.
Plans that covered 100 or more participants at the beginning of the
year (large plans) must have the plan audited by an independent accountant
and attach the audit report to Form 5500. In a salary deferral plan, all
eligible participants are counted, whether or not they contribute to the
plan.
A summary annual report, which is a brief summary of Form 5500, must be
provided to each participant or beneficiary within nine months of the plan
year end. This deadline is extended 2½ months if an extension was filed
for the 5500.
Bonding Requirement
All fiduciaries who handle plan assets are required to be bonded for at
least 10% of the market value, up to a maximum of $500,000. Small plans
(up to 100 participants) with certain types of investments (such as
limited partnerships) may need additional bonding to avoid being subject
to the audit requirement for large plans discussed above. Fiduciaries
should review the plan asset values at least once a year to determine if
the bond coverage needs to be increased. The amount of the bond in force
is reported on Form 5500.
Plan Notices
Various notices are required to be provided to plan participants
including the following:
- Plans with automatic enrollment provisions must notify participants
at least 30 days before they become eligible and 30 days before each
subsequent plan year of the default participation and investment
options.
- Summary plan descriptions (SPDs) must be distributed to each
participant within 120 days of the adoption of a new plan (or 120 days
of the effective date, if later). Ongoing plans must give an employee
the SPD within 90 days of becoming a participant.
- Safe harbor 401(k) plans must provide a notice between 30 and 90
days before the next plan year begins informing participants that the
plan intends to satisfy one of the safe harbor contribution requirements
in the following year, thereby becoming exempt from ADP/ACP testing.
Alternatively, employers may issue a "maybe" notice stating that the
plan may become safe harbor by making a 3% nonelective contribution next
year. An additional notice must be given out 30 days before the end of
the plan year if the employer decides to actually make the contribution.
Plan Distributions
The new law made numerous changes affecting plan distributions:
- New vesting rules are effective in 2007 for defined contribution
plans. They must now meet one of the top heavy schedules: a six-year
graded or three-year cliff schedule. Plan distributions should be
calculated taking into account the new vesting requirements.
- Hardship distributions were expanded to allow plans to consider the
financial needs of a participant’s primary beneficiary, even if such
beneficiary is not a spouse or dependent.
- Distribution notices containing tax and joint and survivor annuity
information can now be given out from 30-180 days before the
distribution begins. The contents of the notices must be revised to
include additional information.
- Effective in 2007, plans may allow nonspouse beneficiaries to roll
over death benefit distributions to an IRA. But while a spouse can delay
distributions until age 70½, the nonspouse beneficiary must begin
distributions from the IRA immediately.
Conclusion
The Pension Protection Act made numerous changes impacting plan
administration effective in 2007. Plan administrators need to take a
careful look at the changes and make the necessary preparations. New
annual limits should be communicated to participants in salary deferral
plans so they can make educated decisions about their deferral elections.
Census information including all employees should be compiled as soon as
possible after the plan year ends so that discrimination testing can be
performed and any corrective distributions can be made in a timely
manner.
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