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On August 17, 2006, President
Bush signed into law the most widespread retirement plan
changes of the past five years. One goal of the Pension
Protection Act of 2006 ("PPA") is to strengthen ailing
defined benefit pension plans, whose funding
deficiencies and distress terminations have left the
federal Pension Benefit Guaranty Corporation with a
large deficit. But the Act goes much further, impacting
defined contribution plans as well. What follows is an
overview of the most relevant portions of the new law.
EGTRRA Provisions Made Permanent
The Economic Growth and Tax Relief Reconciliation Act
of 2001 ("EGTRRA") contained many advantageous changes
to qualified plan and IRA rules, such as increased
contribution and deduction limits. But the EGTRRA
provisions were scheduled to "sunset," or end, in 2010
due to budgetary concerns. The PPA eliminates the sunset
requirement so that all of EGTRRA’s qualified plan and
IRA provisions are now permanent. This will allow plans
to continue to operate in many ways as they have been
since 2002, without having to revert to the pre-EGTRRA
rules in 2011.
Vesting Schedules
Top heavy plans (where owners and certain officers
have more than 60% of the total benefits) must provide
for, at the very least, full vesting after 3 years of
service or a six year graded schedule providing 20% per
year beginning with the second year of service.
When EGTRRA was enacted in 2001, it extended the top
heavy vesting rules to matching contributions. Under
PPA, all defined contribution plans, such as 401(k) and
profit sharing plans, must vest at least as rapidly as
one of the top heavy vesting schedules. The vesting
change is effective as of 2007 and only applies to
participants who work at least one hour after the
effective date.
Defined benefit plans can still use full vesting
after five years of service or a seven year graded
schedule providing 20% per year beginning with the third
year of service.
Hardship Withdrawals
Under the new law, hardship distributions will be
expanded to meet the financial needs not only of the
participant, his spouse and dependents, but also any
person who is listed as the participant’s beneficiary
under the plan. The change is effective February 13,
2007.
Automatic Enrollment
PPA creates an eligible automatic contribution
arrangement under which salary deferrals to an
applicable employer plan (401(k), 403(b) and 457(b)
plans) will automatically be deducted at a specified
uniform rate unless an employee elects otherwise.
The deferrals will continue until the employee elects
not to have contributions made or elects a different
percentage. The contributions will be invested in
accordance with regulations to be prescribed by the
Department of Labor ("DOL"), and a notice requirement
must be met which:
- Explains the employee’s right to elect not to have
contributions deducted or to elect a different
percentage;
- Gives the employee a reasonable period of time to
make an election; and
- Explains how contributions will be invested in the
absence of an investment election by the employee.
Plans that meet the above requirements are subject to
relaxed rules for making corrective distributions for
failed Average Deferral Percentage ("ADP") and Average
Contribution Percentage ("ACP") tests. The 2½-month
period for making such distributions without a 10%
excise tax is extended to six months. In addition,
timely corrective distributions from all plans will be
taxable in the year received and not the year of the
excess. These provisions take effect in 2008.
PPA also provides that ERISA supersedes any state law
which would prohibit or restrict an automatic enrollment
arrangement. This preemption of state law takes effect
immediately.
Automatic Enrollment Safe Harbor
The new law also creates an optional safe harbor
arrangement that is automatically deemed to satisfy the
ADP, ACP and top heavy requirements. The requirements
for this arrangement are:
-
Each eligible employee who does not elect otherwise
will be deemed to have elected at least a 3%
deferral in his first plan year, 4% in the second,
5% in the third and 6% thereafter, not to exceed 10%
in any year; and
- The
employer makes either a 3% nonelective contribution
for all eligible non-highly compensated employees
(in general, non-owners and those earning less than
$100,000) or a match contribution equal to 100% of
the first 1% deferred and 50% of the next 5%
deferred. These employer contributions must be fully
vested after no more than two years of service.
Investment Advice
A major concern in recent years has been
participants’ ability to prudently invest the assets of
their salary deferral accounts or other accounts under
their control. Plan fiduciaries and others providing
services to the plan have been prevented from dispensing
investment advice to participants for a fee or other
compensation under the prohibited transaction rules.
PPA changes this as of 2007, by creating a statutory
exemption for investment advice provided by a "fiduciary
advisor" under an "eligible investment advice
arrangement." The arrangement must be authorized by an
independent plan fiduciary not providing the advice and
is subject to an annual audit by an independent auditor.
The fiduciary advisor’s fees/commissions cannot vary
among investment options or else a computer model must
be used.
Defined Benefit Plans
Growing concerns over the solvency of defined benefit
plans has led to the enactment of more stringent funding
requirements, as well as increased deduction limits as
of 2008. The calculations of lump sum distributions will
also be altered.
As of 2007, a qualified defined benefit plan will be
allowed to distribute benefits to a participant who has
reached age 62 and is not separated from employment. In
addition, as of 2010, salary deferrals will be allowed
in defined benefit pension plans if certain benefit,
contribution and other requirements are met.
Reporting and Disclosure Requirements
Benefit Statements
As of 2007, all defined contribution plans will have
to provide quarterly benefit statements to participants
who have the right to direct their account investments,
and annually to all other participants. The statements
must include total accrued benefits, vested accrued
benefits (or the earliest date any benefits will vest)
and an explanation of the contribution allocation
formula.
Quarterly statements for directed investment accounts
must also contain:
- The
value of each investment;
- An
explanation of any investment limitation or
restrictions;
- An
explanation of the importance of a well-balanced and
diversified investment portfolio for long-term
retirement security, including a statement of the
risks that holding more than 20% of a portfolio in
the security of one entity may not be adequately
diversified; and
- A
notice directing the participant to the DOL website
for information on investing and diversification.
Defined benefit plans are required to furnish benefit
statements once every three years to each active
employee with a vested benefit, and to all other
participants upon written request. DOL is required to
publish model benefit statements by August 17, 2007.
Changes to Annual Reports (Form 5500)
As of 2007, a simplified annual report will be used
for plans that cover less than 25 employees if certain
parameters are met. One-participant plans eligible to
file form 5500-EZ will not be subject to the filing
requirement until the assets of all plans of the
employer exceed $250,000 (increased from $100,000).
Another change is that even though a 5500-EZ has been
filed, it can be discontinued if assets fall below
$250,000.
Notice and Consent Periods Extended
Plan distributions require written explanations of
the tax consequences, availability of rollover treatment
and qualified joint and survivor annuity ("QJSA") rules
(if applicable). A QJSA waiver form must also be
provided. These materials must be furnished no less than
30 and no more than 90 days before the distribution
begins. In addition, distributions in excess of $5,000
require the participant’s consent within the 90-day
period.
Under the new law, the 90-day provision is extended
to 180 days for the distribution notice and consent
requirements, effective for 2007. The contents of the
notice will also change.
Defined Benefit Funding Notice
An annual funding notice which currently applies only
to multiemployer plans will also be required for
single-employer plans as of 2008. Notices as of that
date must include additional information for both
multiemployer and single-employer plans. DOL is to
publish a model form for such notice.
Additional information will be required on the annual
report (form 5500) for defined benefit plans, but they
no longer will have to distribute a summary annual
report to participants.
Rollover Provisions Modified
Roth Rollovers
Most plan distributions (other than hardship and
required minimum distributions) are eligible to be
rolled over to another qualified plan or a traditional
individual retirement account ("IRA") to avoid current
taxation. As of 2008, Roth IRAs will also be able to
accept rollovers. However, a rollover to a Roth IRA will
not be tax-free, but will be taxed the same as a Roth
IRA conversion. The 10% penalty for early withdrawal
from a qualified plan will not apply.
Rollovers by Nonspouse Beneficiaries
Currently, upon the death of a participant, only a
spouse beneficiary can roll over the benefits to an IRA
to avoid current taxation. As of 2007, any beneficiary
will be able to roll over the deceased’s benefits to an
IRA. But whereas the spouse can delay distributions
until age 70½, the nonspouse beneficiary must begin
distributions immediately.
Conclusion
The PPA makes numerous revisions to the rules
affecting qualified retirement plans. The pension and
IRA provisions of EGTRRA which were scheduled to expire
in 2010 are now permanent. Other changes increase
rollover distribution options, speed up vesting,
increase the availability of investment advice to
participants and provide stricter defined benefit
funding rules.
Overall, the new law should have a positive effect on
the private retirement system, and encourage plan
participation. Each plan will need to be reviewed to
determine how and when the PPA will impact its
operation.
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