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 | IRS REGULATIONS The latest interpretations 1.The Pension Protection Act of 2006 2.The 2006 IRS update on Plan Limits |
1. EGTRRA Permanent Section 811 of the bill would make permanent the EGTRRA provisions relating to pensions and IRAs, and Section 812 of the bill would make the Saver’s Credit under IRC §25B permanent.
II. Minimum Funding Standards
The bill replaces the minimum funding standard account rule and the deficit reduction contribution for certain plans with a single minimum funding calculation.
III. Lump Sum Distributions
Minimum lump sums under IRC §417(e). The bill would replace the current rules under IRC §417(e) (which uses 30-year Treasury rates) under the three-segment approach described above in the minimum funding rules, with a phase-in of 20% a year from 2008-2012 (current rules remain in effect for 2006 and 2007). Interest rate assumption for IRC §415 lump sums. The bill would adopt the PFEA rule with a twist: the interest rate used would be the greatest of: (1) 5.5%; (2) the rate that would provide a benefit of not more than 105% of the benefit that would be provided if the IRC §417(e)(3) rate were used; or (3) the plan’s rate. Note: This is effective in 2006.
IV. PBGC Rules Flat rate premium.
HR 4 makes no changes to the PBGC flat rate premium. The Deficit Reduction Act of 2005 already increased the per-participant flat-rate premium to $30 for single-employer plans and to $8 for multiemployer plans. Variable rate premium. The rules for 2004 and 2005 would continue for 2006 and 2007 and then be amended to reflect the interest rates in the new funding rules.
V. Benefit Accruals Under Hybrid Plans
The rules described below are found in Section 701 of the bill. Age discrimination. The law would clarify that all defined benefit plans (including cash balance and pension equity plans) are not inherently age discriminatory as long as benefits are fully vested after three years of service and interest credits do not exceed a market rate of return. The bill further provides that the age discrimination test is met if a participant’s accrued benefit is not less than the accrued benefit of any similarly situated younger employee.
VI. Deduction Limits Contributions to DB plans.
Beginning in 2008, the maximum deductible contribution would equal (i) the target normal cost; plus (ii) 150% of the applicable funding target; plus (iii) an allowance for future pay or benefit increases; minus (iv) assets. For 2006 and 2007, the deduction limit would be raised to 150% of current liability minus plan assets.
VII. 401(k) Plans Excess contributions.
A plan with an “eligible” automatic enrollment arrangement would be allowed to make ADP/ACP refunds up to six months after the close of the plan year without a 10% excise tax on the employer.
The automatic enrollment arrangement would not have to be a “qualified” automatic enrollment arrangement (i.e., the safe harbor arrangement described below).
• Timing of taxation. Refunds made within the 2½ month correction period (or six-month correction period, in the case of an automatic enrollment arrangement) would be taxed in the year of distribution. • Gap period earnings.
The bill eliminates the need to distribute gap period earnings on corrective distributions for all 401(k) plans.
Automatic enrollment safe harbor.
A 401(k) plan with an automatic enrollment feature would be eligible for safe harbor treatment under the ADP/ACP tests, and would be deemed to meet top heavy requirements, if certain conditions are met. A plan meeting this requirement is a qualified automatic contribution arrangement.
The requirements for this arrangement are:
(1) the automatic enrollment percentage initially must be between 3% and 10%, but no less than 4% in the second year of participation, no less than 5% in the third year of participation, and no less than 6% in any subsequent year of participation
(2) the arrangement would not have to apply to employees already participating (or who have elected not to participate); and
(3) a match of at least 100% of the first 1% deferred and at least 50% of the next 5% deferred, or at least a 3% nonelective contribution would have to be provided.
Vesting on contributions would have to be 100% after no more than two years, rather than the immediate vesting rule for other safe harbor 401(k) plans.
The distribution restrictions under IRC §401(k)(2) would apply to these contributions. An annual notice requirement is included.
Other automatic enrollment rules.
The bill contains special rules concerning a distribution of “erroneous contributions” (i.e., contributions made by automatic enrollment that the employee designates were made erroneously). The employees’ election would have to be made within 90 days after the first payroll period when the automatic enrollment took effect and would apply to all elective deferrals made since the automatic enrollment started.
The amount distributed would not be included in the discrimination test, would not be subject to the 10% penalty, and would be treated as compensation. Distributions of erroneouscontributions would have to be made by April 15 of the following year.
The bill clarifies that ERISA preempts state laws that directly or indirectly prohibit automatic enrollment provisions, provided that the plan provides notice to affected employees within a reasonable period before each year.
DB(k).
An “eligible combined plan” would be permitted to contain a 401(k) component and a DB component. Each component would be subject to its respective rules under the tax code and ERISA. This plan design would be limited to employers with no more than 500 employees. The plan would be subject to a single Form 5500 filing requirement and it would be deemed not to be top heavy.
The DB component will have to be either a 1% of final average pay formula for up to 20 years of service, or a cash balance formula that increases with the participant’s age.
The 401(k) component would have to include an automatic enrollment feature (using 4% as the automatic enrollment rate), and provide for a fully vested match of 50% on the first 4% deferred. Nonelective contributions would be permitted.
All employer-derived benefits under the DB component and nonelective contributions under the DC component would have to be vested after no more than three years of service, and 100% vesting would have to apply to matching contributions.
Nondiscrimination and coverage testing would have to be satisfied without regard to contributions or benefits under another plan and without regard to permitted disparity. The ADP/ACP test would be deemed satisfied. In the case of a cash balance arrangement, it would also have to meet the vesting requirements in IRC §411(a)(13)(B) and the interest credit rules in IRC §411(b)(5)(B)(i), as added by Section 701 of the bill. (See part V of this summary.)
This provision is not effective until plan years beginning in 2010 or later due to revenue considerations. The legislation, as drafted, does not allow for a DB plan and 401(k) plan to constitute a single plan and trust unless they utilize the safe harbors described above.
Matching contributions consisting of employer stock by employers that go bankrupt.
Affected employees would have the right to make additional IRA contributions of three times the normal deduction limit if they were receiving matching contributions (in an amount at least equal to 50% of the employee’s contribution) in the form of employer securities within the six-month period before the employer goes into bankruptcy and the employer is subject to indictment or conviction resulting from business transactions related to the bankruptcy.
These “catch up” IRA contributions could be made only in 2007, 2008 and 2009. See Section 831 of the bill, which adds IRC §219(b)(5)(C).
VIII. Spousal Protection QDROs.
The DOL would be required to issue regulations to clarify that an order does not fail to be a QDRO merely because of the time it is issued, or that it modifies a prior order or QDRO.
QJSA options.
The bill would require a plan to offer a 75% survivor annuity option if the QJSA has a survivor percentage less than 75%, and a 50% survivor annuity option if the QJSA has a survivor percentage that is greater than 75%. Effective for plan years beginning in 2008 or later
IX. Portability
Missing participants under terminated plans.
The PBGC’s missing participant program (ERISA §4050) would be extended to multiemployer plans and to plans not covered by the PBGC (including terminated DC plans and terminated DB plans maintained by professional corporations with 25 or fewer plan participants). The administrators of these plans would not be required to participate in the missing participant program, but would have the option to do so.
Direct rollovers into Roth IRAs.
Plan distributions could be rolled over directly to Roth IRAs (with the taxable portion of the rollover amount taxed at the time of the rollover). These would be subject to the Roth IRA conversion rules (i.e., no more than $100,000 adjusted gross income). This is effective in 2008.
Non-spouse rollovers.
A non-spouse beneficiary would be permitted to roll over benefits to an IRA so that the IRA could satisfy the minimum distribution requirements rather than the existing plan under which the individual is a beneficiary. This is effective for distributions made after 2006.
After-tax amounts.
The bill would expand the portability of after-tax amounts, allowing such rollovers between different types of employer-sponsored plans. . effective after 2006.
Accelerated vesting under DC plans.
The bill would impose the top heavy vesting rules on all DC plan contributions (not just on matching contributions, as was done under EGTRRA), effective for contributions made in plan years beginning in 2007 or later (for employees who have at least one hour of service after the effective date). A later effective date applies to collectively bargained plans.
Permissive service credits.
The rules regarding permissive service credits under state and local governmental plans would be expanded, including the ability to purchase additional credits for years where service credit already has been given.
Unemployment.
States would be prohibited from reducing unemployment compensation for pension distributions that are nontaxable because they are rolled over.
X. Reporting and Disclosure
DB funding notice.
An annual funding notice would be required of all single-employer DB plans, along the lines of the current rules for multiemployer plans, The notice would have to be furnished no later than 120 days after the end of the plan year to which the notice relates. Small plans (100 or fewer participants) would furnish the notice coincident with the filing of the annual report (Form 5500).
Additional disclosures.
Certain additional information would be required on the annual report (Form 5500), pursuant to new ERISA §103(f). Although not drafted correctly, it is intended that defined benefit plans subject to ERISA §101(f) Electronic display of Form 5500 information. The DOL would have to display annual report information in electronic form within 90 days after receiving it, effective in post-2007 plan years. Also, companies that maintain an Intranet Web site maintained for the purpose of communicating with employees, and not the public, would have to display the Form 5500 information on that Web site, in accordance with DOL regulations. This provision modifies a more troublesome requirement for a general Web site posting, Distress and involuntary terminations. In the case of a distress termination under ERISA §4041(c), or involuntary termination under ERISA §4042, the plan administrator or plan sponsor would have to furnish participants the information provided to the PBGC (subject to confidentiality limitations) within 15 days of the filing. It would apply to notices of intent to terminate, or involuntary termination determinations, issued after the enactment date. Notice of right to diversify. Pursuant to new ERISA §101(m), an employee who has a right to diversify out of employer securities, in accordance with ERISA §204(j), would have to receive 30 days advance notice of such right. The Treasury is required to issue a model notice. This is effective for plan years beginning in 2007 or later. .
Benefits statements.
Benefits statements would be required:
(1) quarterly for participant-directed DC plans;
(2) annually for DC plans; and
(3) every three years for DB plans.
The DOL must issue model benefit statements that will satisfy this requirement. The legislation allows statements to be delivered by electronic means. It remains to be seen how this impacts the DOL’s current regulations on electronic communications. Blackout notices. The bill adds an exception to the notice requirement for one-participant plans (including plans that cover the spouse of the owner), and plans that cover only partners in a partnership (or only partners and their spouses). Form 5500-EZ. The bill would exempt filing for one-participant plans with assets not in excess of $250,000 (rather than the present-law $100,000 threshold). This is effective for plan years beginning in 2007 or later. Simplified Form 5500 for smaller plans. A simplified Form 5500 would have to be available for plans with 25 or fewer participants, if the plan meets coverage without being combined with another plan, and no related group members or leased employees are covered by the plan. This is effective for plan years beginning in 2007 or later.
XI. Investment Advice and Other Prohibited Transaction Exemptions
Investment advice. Section 601 of the bill contains a prohibited transaction exemption for advice provided by a “fiduciary adviser” under an “eligible investment advice arrangement.”
An eligible investment advice arrangement must either:
(1) provide that the fees received by the fiduciary adviser do not vary on the basis of which investment options are chosen; or
(2) use a computer model under an investment advice program meeting certain conditions.
An independent fiduciary would have to approve the arrangement. There would be disclosures to participants regarding the fiduciary adviser’s fee arrangement, the adviser’s relationship with the development of the computer model, certain performance statistics and other prescribed information. In addition, the plan sponsor is deemed to have met its fiduciary duties under Part 4 of Title I of ERISA if the conditions of the exemption are met. Definition of fiduciary adviser. A fiduciary may be: (1) a registered investment adviser under the Investment Advisers Act of 1940;
(2) a bank or similar financial institution, but only if provided through a trust department subject to periodic examination and review by federal or state banking authorities;
(3) an insurance company;
(4) a person registered as a broker or dealer under the 1934 Securities Act;
(5) an affiliate of a person described in (1) through (4); or
(6) an employee, agent, or registered representative of a person described in (1) through (5). The person who develops the computer model also may qualify as a fiduciary adviser.
• Restriction of exemption for IRAs.
Investment advisors for IRAs would not be eligible to use the computer model exception, only the fee arrangement exception for an eligible investment advice arrangement. The DOL and the Treasury, however, would conduct a feasibility study to determine if a computer model exists that could allow IRAs to use that exception. If it is determined that the requisite computer model does not exist, the DOL must issue a class exemption for IRAs that will allow for investment advice to be rendered along the lines of the computer model exemption.
• Effective date. This is for advice rendered after December 31, 2006.
Other prohibited transaction exemptions.
• Transactions with service providers. This bill offers relief in that a transaction between a plan and a party-in-interest, who is not a fiduciary, is not a prohibited transaction [under ERISA §406(a)(1)(A), (B) and (D) (i.e., sale or exchange, lease, loan or use of plan assets)] so long as the plan receives no less than, or pays no more than, adequate consideration for the transaction. See Section 611(d) of the bill.
• Block trades. Section 611 of the bill would create exemptions for certain “block trades” (any trade of at least 10,000 shares or a fair market value of at least $200,000), which will be allocated among two or more client accounts of a fiduciary. • Electronic communication networks. An exemption is provided for certain transactions on electronic communication networks. See Section 611(c) of the bill.
• Foreign exchange transactions. An exemption is provided in Section 611(e) of the bill for certain foreign exchange transactions. • Cross-trading. An exemption for certain cross-trading transactions is provided in Section 611(g) of the bill.
• Special correction period. A prohibited transaction involving securities or commodities would be exempt if the correction is completed within 14 days after the fiduciary discovers (or should have discovered) that the transaction was prohibited. This prohibited transaction exemption does not apply to transactions involving employer securities. It also does not apply if, at the time of the transaction, the fiduciary or other party-in-interest (or any person knowingly participating in the transaction) knew (or should have known) that the transaction was prohibited. See Section 612 of the bill. • Effective date. The new exemptions would be effective for transactions occurring after the enactment date. The correction period exemption applies to prohibited transactions that the fiduciary discovers (or should have discovered), after the date of enactment.
XII. Miscellaneous ERISA Issues Bonding.
Bonding relief is provided in Section 611(b) of the bill for any entity that is registered as a broker or dealer and is subject to the fidelity bond requirements of a self-regulatory organization. In addition, the bill increases the maximum bond amount to $1 million for a plan that holds employer securities.
Plan asset definition.
Section 611(f) of the bill would add ERISA §3(42) to adopt the DOL’s 25% threshold for “benefit plan investors” to determine if the underlying assets of an entity are plan assets (for purposes of being subject to Title I of ERISA), immediately after the most recent acquisition of an equity interest in the entity. “Benefit plan investors” would be employee benefit plans subject to Part 4 of ERISA and IRC §4975 of the Code
Mapping investment options.
The bill would provide fiduciary relief under ERISA §404(c)during a blackout period if certain conditions, as prescribed by the DOL, are satisfied. Rules would be provided with respect to the mapping of investments to both new and existing investment options in the case of a change in investments under a participant-directed plan under which participant control is deemed to be retained.
Investment safe harbor.
Section 624 of the bill would require the DOL to issue a fiduciary safe harbor under ERISA §404(c) for the investment of assets in an individual account plan, under which the participant would bedeemed to be exercising investment control. The default would apply only where the participant has failed to make an investment election. An annual notice would be required to explain the default investment and the circumstances under which it would apply.
Safest annuity rule.
Section 625 of the bill requires the DOL to issue regulations under which the selection of an annuity contract as an optional form of distribution under a DC plan:
(1) is not subject to the DOL’s “safest annuity” rule and
(2) is subject to all otherwise applicable fiduciary standards.
Diversification of employer securities investments.
A DC plan would have to permit employees to diversify out of investments in employer securities if the securities are publicly traded. This would not apply to ESOPs that contain no elective deferrals, employee contributions and matching contributions, and would not apply to one-participant plans. A plan could require up to three years of service before diversification rights would apply to employer matching and nonelective contributions. This would be effective starting in 2007, except that, for existing plans, the diversification requirement would be phased in over a three-year period with respect to the portion of the participant’s account that would be subject to the diversification election. Participants would have to receive 30 days advance notice of the diversification right ($100-per-failure penalty).
Coercive interference with ERISA rights.
The bill would increase penalties to $100,000 and imprisonment up to ten years for willful acts of coercive interference. This is effective for violations occurring on or after the enactment date.
Indian tribal governments.
The bill would clarify that a plan is treated as a governmental plan if it is maintained by an Indian tribal government, a subdivision, agency or instrumentality of such government. Also, all of the participants must be employees whose services are substantially in the performance of essential governmental functions, but not in the performance of commercial activities (whether or not it is an essential government function). This is effective for plan years beginning on or after the enactment date.
XIII. Miscellaneous Qualification and Tax Issues
IRC §415(b) limit.
In a DB plan, average compensation may be calculated by taking into account years of service for which the employee was not an active participant in the plan. See IRC §415(b)(3), as amended by Section 832 of the bill. This would continue the rule in the current regulations that the Treasury had proposed to reverse. This is effective for post-2005 years. Also, for church plans, the compensation limit under IRC §415(b)(1)(B) would apply only to highly compensated employees.
Saver’s Credit.
Section 833 of the bill amends IRC §25B to subject the income levels to indexing. Section 812 of the bill makes the Saver’s Credit permanent.
Distribution notice and consent rules.
The 90-day notice period would be expanded to 180 days under Section 1102 of the bill. This is applicable to notice and consent requirements under IRC §402(f) (rollover notice), IRC §411(a)(11) (general consent rules) and IRC §417 (QJSA). This is effective for years beginning in 2007 or later.
Phased retirement.
A DB plan will be permitted to allow for in-service distributions to a participant who has reached age 62, even if normal retirement age is later than age 62. This applies to distributions made in plan years beginning in 2007 or later.
Minimum distributions.
Governmental plans would be subject to a good faith standard under Section 823 of the bill, and the Treasury is directed to issue regulations to this effect.
Hardships.
The bill would require the Treasury to issue regulations that would permit hardship withdrawals for hardships or unforeseeable emergencies of a person who is the participant’s beneficiary under the plan, even if that beneficiary is not the participant’s spouse or dependent.
EPCRS.
Formal authority is given to the IRS to design and modify, and waive income or excise taxes, with respect to the EPCRS or any successor program, to ensure that any tax, penalty, or sanction is not excessive and is commensurate with the nature, extent and severity of the failure. The Treasury is instructed to take into account circumstances and concerns that small employer’s face.
Qualified reservists.
Under the bill, IRAs and 401(k) plans would be able to make distributions to “qualified reservists” called up to active duty for a minimum period. A 10% premature distribution penalty would not apply and a two-year rollover rule would apply following the end of the active duty period. This provision applies only if the reservist is called up between September 11, 2001, and before December 31, 2007, for more than 179 days.
Public safety employees.
Public safety employees would be exempt from the 10% premature distribution penalty for distributions made after a separation from service that occurs on or after age 50 (rather than 55, as under current law). This is effective for distributions made after enactment date. In addition, retired public safety employees could apply distributions from governmental plans to the purchase of health or long-term care insurance and exclude such distributions from gross income (up to $3,000 per year). This is effective for distributions in 2007 or later.
Nondiscrimination testing for governmental plans.
All governmental plans (including federal plans) would be exempt from nondiscrimination testing (only state or local governmental plans are exempt under current law). This is effective for years beginning after enactment date.
Unrelated Business Taxable Income (UBTI). RC §514(c)(9) is amended to extend application of the UBTI exemption for certain leveraged real estate investments to retirement income accounts described under IRC §403(b)(9) (available only to churches).
Transfers to fund retiree health benefits.
The bill would expand the ability to transfer surplus assets under a DB plan to fund retiree health benefits, pursuant to IRC §420. This applies to transfers made after date of enactment. See Section 841 of the bill.
Tax refunds.
A taxpayer could direct a tax refund to be paid directly into an IRA, for taxable years beginning in 2007 or later. IRA limits. The gross income levels for IRA deductions and for Roth IRA contribution limits are made subject to indexing.
Tax-free IRA distributions for charitable giving.
Up to $100,000 could be distributed tax free from an IRA if it is made to a charitable organization, and the IRA owner is at least 70½ years old. This would not apply to distributions from SEP-IRAs or SIMPLE-IRAs. This would apply only to distributions in 2006 and 2007. XIV. Plan Amendments Amendments would be required by the end of the 2009 plan year, with anti-cutback relief. Governmental plans would have an additional two years to amend. See Section 1107 of the bill.
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