Transcript Post-PPA Plan Design Trends Selected Compliance Issues

Plan Design Trends
and Selected Compliance Issues
After the Pension Protection Act
of 2006
Mark L. Lofgren, Principal
Groom Law Group, Chartered
Washington, D.C.
Overview
• Defined contribution plans
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Focus on participation and increased contributions
Automatic enrollment
Employer stock diversification
Other changes related to PPA
403(b) plan compliance update
• Defined benefit plans
– Focus on benefit reductions
– Cash balance/hybrid plan developments
– Other changes related to PPA
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Overview
• Impact of new section 415 regulations
• Update on IRS determination letter
program and related plan amendment
timing rules
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DC Plans – Sponsors Move to
Increase Participation and
Contributions
• Move away from DB plans coordinated with new
emphasis on DC plans
• Common changes to DC plans
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Increased match
New or increased employer non-elective contributions
Safe harbor designs
Automatic enrollment
Automatic employee deferral increases
Enhanced investment and planning tools
Roth 401k?
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Auto-Enrollment
What Is It?
• Automatic deduction from employee’s paycheck that is
contributed to 401(k) savings plan
– Deduction percentage may increase over time
• Employee must affirmatively elect to stop the deduction
• Employer determines where automatic contributions are
to be invested, absent an affirmative election from the
participant
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Auto-Enrollment
Does It Work? (Yes!!!)
• Studies show that individuals are less likely to stop
contributions once they begin
• Helps plans increase participation of non-highly
compensated employees
• Deductions are not perceived as being that onerous,
especially if the deductions:
– Commence when employment commences
– Increase when compensation increases
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Auto-Enrollment
Concerns of Employers
• Administrative hassle
• State laws prohibiting payroll deductions without an
employee’s consent
• Difficulty of returning contributions to employees who
don’t want to contribute
• Employer assumes fiduciary liability for investment of
automatic contributions
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Auto-Enrollment
New PPA Rules
• Encourages automatic enrollment adoption by providing
administrative relief
– New nondiscrimination safe harbor
• Allows limited distribution of amounts automatically
contributed
• Express preemption from state laws
• DOL to develop regulations describing safe harbor
default investment funds – Qualified Default Investment
Alternative (QDIA)
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Auto-Enrollment
Effective Dates
• IRS issues proposed regulations 11/8/07
– Effective for plan years beginning after 1/1/08
– Until regulations are final, can rely on proposed
regulations
• DOL issues final regulations 10/24/07
– Effective 12/24/07
– Limited transition relief for default investments in
principal preservation funds made prior to effective
date
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Auto-Enrollment
Overview of IRS Rules
• Two types of auto-enrollment arrangements
• Eligible Automatic Enrollment Arrangement (“EACA”) –
described in IRC §414(w)
• Qualified Automatic Enrollment Arrangement (“QACA”)
– described in IRC §401(k)(13)
• Not required to be either or both
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Auto-Enrollment
Eligible Automatic Contribution
Arrangements (EACA)
• Plan with an EACA can allow employees to elect to
receive distributions of contributions made under the
EACA
• Default contribution rate must be a uniform percentage
of compensation
• Notice describing the auto-enrollment arrangement must
be provided
• Automatic contributions must be invested in QDIA
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Auto-Enrollment
EACA Withdrawal Rules
• Plan with an EACA can, but is not required, allow
employees to elect to receive distributions of
contributions made under the EACA
– Plan may charge a fee for the distribution, provided
the fee is the same that applies to other distributions
– Distribution is not subject to the notice and consent
requirements for other distributions
• Plan is not required to provide this to all eligible
employees
• Can place requirements on the receiving distributions
– Not permitted to require employee never to participate
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in the plan in order to receive the distribution
Auto-Enrollment
EACA Withdrawal Rules
• Withdrawal election must be made no later than 90 days
after the first contributions would have been included in
income
• Must withdraw all amounts contributed, adjusted for
gains/losses
• If amounts are taxable, they will be taxed in year the
distribution is made, no early distribution tax under §72(t)
and distribution is reported on Form 1099-R
• Any related matching contributions must be forfeited
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Auto-Enrollment
EACA Testing Date Extended
• Distributions of contribution to pass the ADP/ACP tests
can be made up to 6 months after the end of the plan
year with no excise tax
• This provides more time to conduct ADP/ACP tests and
to determine how to pass the tests
• It appears this additional time is available regardless of
whether the plan provides for the distribution of
automatically deferred amounts
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Auto-Enrollment
EACA Notice Requirement
• Must be given to each employee to whom the EACA
applies
• Notice must include:
– Description of distribution rights
– Level of automatic contributions
– Right of employee to decline or elect different
contribution percentage
– Description of default investments
– Description of withdrawal rights
• Can’t satisfy requirements by referring to provisions of
the SPD
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Auto-Enrollment EACA
Notice Requirement
• Notice must be provided a reasonable time before
beginning of each year
– A period of 30 days and no more than 90 days will
comply
– Plans with immediate eligibility can provide notice no
later than the first day the employee becomes eligible
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Auto-Enrollment EACA
Notice Requirement
• EACA Notice can be used to meet the QACA, QDIA and
preemption notice requirements
• Notice can be in writing or delivered electronically
• IRS posted a sample notice on its website on 11/15/07
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Auto-Enrollment
Qualified Automatic Contribution
Arrangement (QACA)
• If a QACA, then the plan automatically meets the ADP
and ACP tests
• Plan must be amended to provide the QACA before the
year in which it will be effective
• Rules are similar to the rules for the IRC §401(k)(12)
safe harbor
– However, no QACA exclusion for early participants
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Auto-Enrollment
QACA Contribution Requirements
• Any eligible employee who has not made an affirmative
election as of the effective date of the QACA must be
subject to automatic enrollment unless he or she
affirmatively elects not to participate
• Minimum contribution must equal 3% of compensation
• Minimum contribution increases by 1% in each
succeeding plan year up to 6% of compensation
• Maximum contribution cannot exceed 10% of
compensation
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Auto-Enrollment
QACA Employer Contributions
• Non-elective contribution of 3% of compensation; or
• Matching contribution of at least:
– 100% of the first 1% of compensation
– 50% of the contributions exceeding 1% and but not
more than 6%
• Employer contribution must be fully vested after 2 years
of service
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Auto-Enrollment
Other QACA Requirements
• Notice requirement – follows EACA notice requirement
• Investment of contribution – no requirement that
amounts be invested in a QDIA
– Given the advantages of EACA’s and the fiduciary
concerns, employers likely to invest amounts in
QDIAs
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Employer Stock Diversification
• PPA added new requirement to allow
participants to diversify plan accounts
invested in publicly-traded employer stock
• Generally, provides full divestment rights
within three years
• Enacted as partial response to Enron
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Employer Stock Diversification
• Generally effective for plan years beginning on
or after 1/1/07
• Special effective date rule for employer
contributions
– 3-year phase in (beginning 2007) for employer
contributions
– no phase in for participants age 55 and 3 years of
service before 2006
• IRS proposed regulations issued 1/3/08, to be
effective 1/1/09
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Employer Stock Diversification
• Rules generally apply to any DC plan that holds
publicly traded employer securities
• Exception for stand-alone ESOPs
• What is publicly traded employer security?
– Readily traded on an established securities market,
foreign exchanges included if officially recognized by
government and has a “ready market”
– “Employer” security determined on 50% controlled
group basis
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Employer Stock Diversification
• Employee money - participants must be
permitted to diversify immediately
• Employer money
– participants must be permitted to diversify after three
years of service
– Service measured under plan’s vesting rules, or third
anniversary of DOH
• Rules extend to alternate payees and
beneficiaries
• Frequency – plan must permit periodic
reasonable opportunities to diversify at least
quarterly
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Employer Stock Diversification
• Generally cannot impose restrictions on
investing in employer stock that do not apply to
other investment options)
• Permissible trading restrictions
– Policies to comply with securities law requirements
– Restrictions that do not apply to stable value funds
– Plan limit on participant holdings (e.g., 10% limit on
company stock allocation)
– Reasonable trading fees
– Restrictions to limit short-term trading
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Employer Stock Diversification
• Plans must offer at least three nonemployer stock investment options with
materially different risk and return
characteristics
• Must provide notice of diversification rights
to participant at least 30 days prior to date
first eligible to diversify
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Other PPA Changes for DC Plans
• Faster vesting of employer contributions – 3 yr cliff/2-6 yr
graded
• Hardship distributions can be extended for hardship of
spouse or dependent
• Expanded rollover rules
• New distribution rules (limited application)
– In-service distributions permitted after 62
– New qualified optional survivor annuity
– New QJSA notice and consent rules
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403(b) Plan Compliance Update
• After 43 years, IRS finally issued comprehensive
regulations
• Some major new requirements, generally effective
1/1/09:
– Written plan containing all material terms
– Financial audit requirement for large plans (100+
participants)
– Restrictions on the exchange of 403(b) contracts and
distributions
– New rules to determine employers under common
control
– New rules for nondiscrimination testing
– Clarifies contribution and funding requirements
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DB Plans – Sponsors Move to
Reduce Future Obligations
• Many companies have announced move away
from DB plan benefits in recent years
• Typical approaches include:
– Complete freeze
– Continuation of accruals only for current employees,
no new participants
– Continue benefit accruals, but at reduced level
– Combination of reduced accruals and restricted
participation
• Renewed interest in hybrid designs
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Cash Balance/Hybrid Plans
• What are they? Defined benefit plan with benefit
expressed as a lump sum value
• Formula typically presents benefit as an account balance
that grows with credits based on pay and interest
• Who has them?
– Common among many large public companies
– Common for smaller professional organizations
• For many years, these plans have been plagued by
class action lawsuits and lack of consistent IRS guidance
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Cash Balance/Hybrid Plans
• Important recent developments are
beginning to clear the air
– Courts are increasingly finding that the cash
balance formula is legal
– The PPA adds specific rules to govern and
legitimize these plans
– IRS issued proposed regulations for PPA
requirements
– IRS recently began to issue favorable
determination letters
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PPA Rules for Cash Balance/Hybrid
Plans
• New age discrimination rules
– Safe harbor for benefit formula
– Interest credits must not exceed a market rate of return
– Conversion amendments after 6-29-05 must protect against
“wear-away”
• Three-year vesting required
• Lump-sum “whipsaw” calculations no longer required
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PPA Rules for Cash
Balance/Hybrid Plans
• New age discrimination safe harbor - “accrued benefit” at
all times is equal to or greater than that of any similarly
situated, younger employee who is or could be a
participant
– For this purpose “accrued benefit” can be expressed as
balance in hypo account, current value of accumulated
percentage of final average pay, or annuity at NRA
– If a plan has multiple formulas, each must be tested
separately
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PPA Rules for Cash Balance/Hybrid
Plans
Limits on interest rates:
• Interest credits must not be based on a rate
greater than a market rate of return
• Principal preservation required over duration of
participation in plan
• IRS has provided limited list of permissible rates,
based on T bills or bond yield
• Reasonable fixed or minimum rates ok, but IRS
still considering limits
• IRS considering equity-based rates
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PPA Rules for Cash Balance/Hybrid
Plans
Special rules for conversions after 6/29/05:
• Accrued benefit of existing participants must not
be less than “A + B” benefit (no “wear-away”) –
– A = Accrued benefit under plan terms for
service prior to conversion
• Must preserve value of early retirement subsidy
• Must preserve optional forms of distribution
– B = Accrued benefit under plan terms for
service after conversion
• Interaction of multiple formulas or plans, and
employee transfers between formulas can
trigger conversion rule
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PPA Rules for Cash Balance/Hybrid
Plans
• 3-year vesting required for any participant
covered by a hybrid benefit formula
– Participant-by-participant determination
– Vesting rule applies to entire benefit even if part
determined under non-hybrid formula, and for greaterof formulas
• Lump sum payments
– “whipsaw” no longer required after 8/17/06
– Advance participant notice may be needed to
eliminate whipsaw
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Other PPA Changes for DB Plans
• New qualified optional survivor annuity required
(eff. 2008)
– If plan’s QJSA has survivor percentage < 75, must
include optional 75% survivor annuity
– If plan’s QJSA has survivor percentage >= 75, must
include optional 50% survivor annuity
• In-service distributions permitted after 62 (eff.
2007) - provides opportunity for “phased
retirement”
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Other PPA Changes for DB Plans
• New lump sum valuation rules to be phased in
over 5 years, beginning in 2008
– New interest rate – 3-segment, corporate bond yield
curve
• Existing timing rules apply (“lookback month” and
“stability period”)
– Mortality table – table prescribed by IRS under new
funding standard rules for single employer plans
– Cut-back relief
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Overview of New Section 415
Regulations
• After many years, IRS provided complete
update of the section 415 contribution and
benefit limits
• New regulations generally effective for
years beginning after June 2007
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Overview of New Section 415
Regulations
New rules for post-severance compensation:
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Amounts payable because of severance generally
excluded – e.g., severance pay
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Certain post-severance “employee” compensation
included if paid by the later of 2 ½ months after
severance from service or by the end of limitation year
in which severance occurred
– Required - Payments that would have occurred if employee had
continued in employment, e.g., regular wages, overtime,
commissions, bonuses
– Optional - Payments for accrued bona fide sick, vacation, or
other leave, if employee would have been able to use the leave
had employment continued
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Overview of New Section 415
Regulations
• Compensation limit of § 401(a)(17) now
applies for § 415 compensation limits;
grandfather rule for prior benefits
• Foreign compensation/nonresident aliens
issues addressed
• Multiple annuity starting dates – new
proposed regs being developed
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IRS Determination Letter and Plan
Amendment Timing Rules
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New 5-year cycle determination letter program based on last digit of
EIN
– 1,6 – 1/31/07, 2,7 – 1/31/08, 3,8 – 1/31/09, 4,9 – 1/31/10, 5,0 1/31/11
– Can use parent’s EIN for subsidiary plans if make timely election
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Timing of non-PPA-related amendments
– Legally required changes by due date of tax return for the year the
change is effective
– Discretionary change by end of the year in which the change is effective
– Exceptions, include (a) to avoid cutback (b) add a CODA, (c) change to
safe harbor 401(k) plan, or (d) other IRS guidance
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PPA-related amendments generally not required until 2009
– General cut-back relief provided, subject to IRS guidance
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Update On IRS Approval of
Prototype and Other Model
Documents
• IRS has completed it review of EGTRRA
model documents
• IRS will shortly (or has just) issued go
ahead to begin adoption process
• Adopting employers will be given two
years to execute
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