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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