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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