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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