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ERISA Conference 2006 September 5 6, 2006


Congress passed Pension Protection Act of 2006 (PPA) on August 3, 2006 ... Bank or similar financial institution, subject to periodic examination and ... – PowerPoint PPT presentation

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Title: ERISA Conference 2006 September 5 6, 2006

ERISA Conference 2006 September 5 6, 2006
July Business Services
Presented by
  • Charles Lockwood
  • ASC Institute
  • Littleton, CO

Pension Protection Act of 2006
  • Congress passed Pension Protection Act of 2006
    (PPA) on August 3, 2006
  • Signed into law by President Bush on August 17,
  • PPA contains numerous changes affecting qualified
    plans and IRAs
  • Over 800 of the 900 total pages of the bill deal
    with pension provisions
  • Bulk of changes deal with funding rules for DB
    plans also contains significant changes
    affecting DC plans
  • PPA becomes effective at various times depending
    on specific provision

Pension Protection Act of 2006
  • Most of the provisions under PPA are designed to
    protect and enhance continued use of defined
    benefit and hybrid plans
  • However, significant provisions apply to defined
    contribution plans, including 401(k) plans
  • Automatic enrollment
  • ADP/ACP testing provisions
  • Default investment provisions
  • Faster vesting for employer contributions
  • Investment education provisions

Pension Protection Act of 2006
  • EGTRRA permanency EGTRRA will no longer sunset
    in 2010
  • Major provisions under EGTRRA affected by
    elimination of sunset
  • Increased deferral/Code 415/IRA limits
  • Catch-up contributions
  • Roth deferrals
  • EGTRRA deduction rules
  • Portability of distributions
  • Simplification of top-heavy rules
  • Loans to owners, partners, sole proprietors
  • Savers Tax Credit due to expire in 2007
  • Repeal of multiple use test

Automatic Enrollment
  • Congress/IRS are encouraging 401(k) plans to add
    automatic enrollment features

Actual results from employees between 3 and 15
months tenure. Study by Professor Brigitte
Madrian, University of Pennsylvanias Wharton
School and Dennis Shea, United Health Group
Automatic Enrollment SH Plan
  • New safe harbor 401(k) plans no ADP/ACP testing
    or top heavy test
  • Must have automatic enrollment provisions
  • Automatic enrollment provisions do not apply to
    EEs who already have affirmative election in
  • Each EE must have opportunity to change
    automatic contribution
  • First year must provide automatic deferral
    between 3 and 10 of compensation
  • 2nd year must be at least 4 of comp
  • 3rd year must be at least 5 of comp
  • 4th year and following must be at least 6 of

Automatic Enrollment SH Plan
  • New safe harbor 401(k) plans no ADP/ACP testing
    or top heavy test
  • ER must make safe harbor contribution
  • 3 nonelective contribution
  • Matching contribution equal to 100 on first 1
    deferred 50 of deferrals between 1 and 6 of
  • Can provide enhanced match 100 on deferrals up
    to 3½ of compensation
  • Can provide additional SH match and not be
    subject to ACP test as long as satisfy
    requirements for ACP safe harbor
  • Cannot match deferrals above 6 of comp
  • No higher rate of match for HCE

Automatic Enrollment SH Plan
  • New safe harbor 401(k) plans no ADP/ACP testing
    or top heavy test
  • Can apply 2-year vesting schedule to safe harbor
  • Presumably cannot have allocation conditions on
    safe harbor contributions
  • Must provide annual notice to participants
  • Effective for 2008 plan year

Automatic Enrollment SH Plan
  • Employers will be required to provide annual
    written notice to participants explaining
  • right to opt out of contributing
  • the method for making or modifying their deferral
    election, and
  • how a participants contributions will be
    invested if the participant fails to make any
    investment election
  • Employer will be treated as complying with ERISA
    404(c) if provide approved default investment

Default Investment Funds
  • PPA requires DOL to issue regulations providing
    fiduciary relief for default investments within 6
  • Will apply to all self-directed plans not just
    automatic enrollment plans
  • If provide adequate notice to participants, no
    fiduciary liability for investment in approved
    default funds
  • Expected guidance is expected to create a new
    Qualified Default Investment Alternative (QDIA)
  • Employer will still retain duty to monitor QDIA

Default Investment Funds
  • QDIA
  • Life-cycle fund, balanced fund or managed account
  • Managed by investment manager or registered
    investment advisor
  • Limitations on employer stock
  • Life cycle / managed account based on
    individuals age, etc.
  • Balanced fund based on plan participants as a

Other Automatic Enrollment Rules
  • Automatic enrollment plan may distribute
    erroneous contributions
  • EE must elect within 90 days after first payroll
    period that automatic enrollment took effect to
    have deferrals distributed
  • Amounts distributed would not be counted in ADP
    test, would not be subject to 10 penalty, and
    would be treated as comp
  • Distributions of erroneous contributions must
    be made by April 15 of following year
  • PPA clarifies that ERISA preempts state laws that
    directly or indirectly prohibit automatic
    enrollment plans

ADP/ACP Testing Provisions
  • Automatic enrollment plans may make ADP/ACP
    refunds up to 6 months after end of PY without
    10 excise tax
  • PPA does not extend this provision to
    non-automatic enrollment plans
  • Automatic enrollment plan must meet default
    investment and notice requirements
  • Refunds made within 2½ correction period are
    taxed in year of distribution
  • No more taxation in prior plan year
  • Also applies to automatic enrollment plans if
    refunds made within 6 months after end of plan


Gap Period Earnings
  • Plan may use any reasonable method for
    determining earnings
  • ADP test Earnings for PY attributable to
    elective deferrals multiplied by
  • excess contributions for PY
  • A/B attributable to deferrals
  • ACP test Earnings for PY attributable to
    match/EE contribution multiplied by
  • excess aggregate contributions for PY
  • A/B attributable to match/EE contributions
  • Include contributions for PY that are contributed
    after close of year


Gap Period Earnings
  • For 2006 PY, corrective distributions must
    include gap period earnings if there is a
    valuation date in gap period
  • Biggest impact on daily valued plans
  • Determining gap period earnings
  • Any reasonable method
  • Alternative method taking into account earnings
    in gap period
  • 7-day safe harbor rule
  • Safe harbor method taking into account 10 of
    earnings earned in prior PY for each month
    during gap period
  • Additional month calculated if distribution made
    after 15th day of month


Gap Period Earnings
  • Final 401(k) regulations require corrective
    ADP/ACP distributions to include gap period
  • Prop. regs issued under Code 402(g) apply same
    rules to corrective distributions of excess
  • Appears that gap period rules are now being
    overridden by PPA rules eliminating gap period
  • PPA elimination of gap period earnings not
    effective until 2008 unless IRS issues
    additional guidance, will have to include gap
    period earnings for 2006 and 2007

ADP/ACP Testing Provisions
  • No gap period earnings required for corrective
    refunds from 401(k) plans
  • Overrides requirement in final 401(k) regulations
    to require gap period earnings
  • Effective date 2008 plan years
  • Gap period income will be required for 2006 and
    2007 corrective refunds
  • Refunds made within 2½ month correction period
    for 2006 and 2007 will be taxed in prior year

Distribution Provisions
  • Hardship distributions can be made available for
    hardship of a beneficiary (e.g., domestic
  • IRS to issue regulations within 180 days
  • Non-spouse rollovers non-spouse beneficiary
    will be able to rollover death distribution to
  • Effective for distributions made after 2006
  • Expands ability to rollover after-tax
    contributions to other plans (e.g., qualified
    plan to 403(b) plan)
  • Must be a direct rollover and other plan must
    maintain separate account

Distribution Provisions
  • Can rollover plan distributions to Roth IRA
    provided qualify for conversion (e.g., AGI below
  • Effective in 2008 beginning in 2010 can convert
    without regard to AGI restrictions
  • Distribution is subject to taxation at time of
  • 10 early distribution penalty does not apply to
    taxable amount (to extent rolled over to Roth
  • Distribution notices and explanations must be
    made between 30 and 180 days prior to
  • Effective for 2007 plan years

Distribution Provisions
  • Pension plans are permitted to make in-service
    distributions after attainment of age 62
  • Effective for plan years beginning after 2006
  • Creates new qualified optional survivor annuity
    in addition to QJSA
  • Annuity for life of participant with survivor
    annuity for life of spouse
  • If survivor annuity under QJSA is less than 75,
    survivor annuity is 75
  • If survivor annuity under QJSA is greater or
    equal to 75, survivor annuity is 50.
  • Effective for plan years beginning after December
    31, 2007

Distribution Provisions
  • Exception to 10 early withdrawal tax for
    qualified reservist distribution
  • Distribution made to reservist called to active
    duty for more than 179 days
  • Distribution must be made during the period
    beginning on date of such order and ending at
    close of active duty period
  • Distribution does not violate 401(k) or 403(b)
    plan distribution restrictions
  • Individual may repay such distribution to an IRA
    within 2 years following active duty
  • Applies to individuals ordered or called to
    active duty between 9/11/2001 and 12/31/2007

Missing Participants
  • Single-employer plans that terminate under
    standard termination must either purchase an
    annuity for missing participants or transfer
    assets to PBGC
  • Under PPA, the missing participants program is
    extended to DC plans and other DB plans not
    subject to PBGC coverage
  • Effective for distributions made after final
    regulations implementing the provision are

Deduction Rules
  • Overall 25 limit on deductions for contributions
    to DB/DC plans applies only to extent such
    contributions exceed 6 percent of compensation
  • Will allow ERs to establish safe harbor 401(k)
    plans along with DB plans to take advantage of
    deductibility of salary deferrals
  • Effective for contributions for taxable years
    beginning after December 31, 2005

Accelerated Vesting
  • PPA subjects all ER contributions to same vesting
    requirements as applies to matching contributions
  • Three-year cliff vesting
  • Six-year graded vesting
  • All YOS, including those before effective date of
    new requirements, must be taken into account
  • Effective for Plan Years beginning after December
    31, 2006
  • Only applies to participants with at least one
    hour of service after effective date

Reporting Requirements
  • IRS is directed to modify the annual return
    filing requirements to raise plan asset
    requirement for 5500-EZ filings to 250,000
  • IRS and DOL are directed to provide simplified
    reporting requirements for with fewer than 25
  • Effective for 2007 plan year filings

Reporting Requirements
  • PPA requires quarterly benefit statements if
    participants are allowed to direct investment
    otherwise only required annually
  • Benefit statements must include
  • Total value of benefits accrued
  • Value of each investment to which assets in the
    participants account are allocated
  • Participants vested accrued benefit
  • Explanation of any limits or restrictions on
    participants right to direct investments
  • Explanation of importance of a well-balanced,
    diversified investment portfolio

Diversification Requirements
  • DC plans must permit participants, including
    beneficiaries, to diversify investments in
    publicly-traded employer securities
  • Applies to deferrals, ER contributions and
    matching contributions
  • Does not apply to ESOPs (unless have
  • Effective for plan years beginning after December
    31, 2006
  • Diversification requirements phase in through
    2009 for participants under age 55

Diversification Requirements
  • Applies to all investments in publicly-traded
    employer securities that are attributable to
    salary deferral or after-tax employee
  • Applies to employer contributions and matching
    contributions only if participant has at least 3
  • Also applies to beneficiaries of such
    participants and beneficiaries of deceased

Diversification Requirements
  • ESOPs are not subject to the diversification
  • ESOP may not hold any contributions used to
    satisfy the ADP or ACP tests (e.g., deferrals or
    matching contributions)
  • If subject to diversification requirements
    overrides ESOP diversification rules
  • ESOPs subject to new diversification requirements
    will not violate primarily invested requirement

Diversification Requirements
  • Plan must provide choice of at least three
    investment options (other than ER securities)
    with materially different risk and return
  • Participants must be able to reinvest at least
    quarterly generally must be given same
    investment election opportunities as other
    investment options under the plan
  • ER must provide notice to participants at least
    30 days before first date participant has right
    to diversify
  • Notice must explain right to diversify and
    importance of diversifying
  • IRS directed to publish model notice


The Changing Landscape
  • More and more providers are taking on some level
    of fiduciary responsibility
  • Companies are beginning to recognize the
    importance of educating their EEs
  • PPA provides new prohibited transaction exemption
    for advice provided by fiduciary adviser under
    an eligible investment advice arrangement
  • Prohibited transaction exemption becomes
    effective with respect to investment advice
    provided after December 31, 2006


PT Exemption for Investment Advice
  • Permits ERs to arrange for investment advice to
    be provided to participants while shielding ER
    from liability for investment advice that is
    actually provided
  • Permits financial service firms who provide
    investment advice to plan participants to market
    their own investment funds to plan participants
    without violating ERISA
  • Permits investment advisors to receive reasonable
    fees for provision of investment advice to


Fiduciary Advisor
  • Registered Investment Adviser (RIA)
  • Bank or similar financial institution, subject to
    periodic examination and review by federal or
    state banking authorities
  • Insurance company
  • Registered broker/dealer
  • An affiliate or employee of above entities
  • Person who develops the computer model


Investment Advice Arrangement
  • Investment Advice Arrangement must meet one of
    two requirements
  • Fees received by fiduciary adviser may not vary
    on basis of which investment options are chosen,
  • Computer model must be used which meets certain
    conditions and must be approved by independent
  • Arrangement must be reviewed each year by
    independent auditor and receive written audit
  • Participants must receive annual written
    notification describing nature of investment
    advice arrangement


Investment Advice Arrangement
  • Written notice must be provided to EEs stating
    (among other things)
  • Past performance and historical rates of return
    of the available investment options
  • All fees or other compensation the fiduciary
    adviser will receive in connection with the
    investment advice
  • Any material affiliation or relationship between
    fiduciary adviser and any security or other
    property involved in a transaction
  • That, by providing investment advice, fiduciary
    adviser is acting as fiduciary
  • That participant may obtain advice from another


Prohibited Distributions
  • Underfunded DB plan may not make prohibited
  • If plans adjusted funding target attainment
    percentage for a PY is less than 60, plan may
    not make any prohibited payments after valuation
    date for the plan year.
  • If plans adjusted funding target attainment
    percentage for a PY is between 60 and 80, plan
    may not make any prohibited payments that exceed
    the lesser of
  • 50 of amount otherwise payable under the plan,
  • present value of maximum PBGC guarantee with
    respect to participant


Prohibited Distributions
  • Prohibited payment is defined as any payment in
    excess of the monthly amount paid under a single
    life annuity or any payment for the purchase of
    an annuity contract
  • Funding target attainment percentage is the
    ratio, expressed as a percentage, that the value
    of the plans assets bears to the plans funding
    target for the year


Prohibited Distributions
  • A plans adjusted funding target attainment
    percentage is presumed to be the same as for
    preceding year until plan actuary certifies the
    plans actual adjusted funding target attainment
    percentage for the current year
  • If the plan actuary has not certified the plans
    actual adjusted funding target attainment
    percentage by the first day of the tenth month of
    the current plan year, the plans adjusted
    funding target attainment percentage is presumed
    to be less than 60

Deduction Rules
  • Increases amount available for deduction under
    single-ER defined benefits plans to 150 of
    unfunded liability (for 2006 and 2007)
  • Can determine deduction limit without regard to
    DB plans covered by PBGC
  • 10 excise tax does not apply to DC plan that
    violates combined limit except for matching
  • ERs may establish SH 401(k) plans along with DB
    plans to take advantage of deductibility of
    salary deferrals
  • Effective for 2008 taxable years


Eligible Combined Plan DB(k)
  • PPA provides for new type of eligible DC/DB
    combined plan
  • Maintained by small employer (less than 500 EEs)
    at time plan established
  • Assets are held in a single trust
  • Must meet certain benefit, contribution, vesting
    and nondiscrimination requirements
  • DB and DC plans treated as separate plans for
    funding, nondiscrimination and distribution rules
  • Plans are treated as single plan for Form 5500
    filing purposes
  • Effective for 2010 plan years


Eligible Combined Plan - DB(k)
  • DB plan must provide each participant with a
    benefit of at least the following percentage of
    final average pay
  • one percent times YOS
  • 20 percent
  • Final average pay uses five consecutive years
    with highest comp
  • Can use cash balance plan that provides a pay
    credit for each year that increases from 2 to 8
    of comp based on age
  • Any contributions to DB plan must be vested after
    3 YOS


Eligible Combined Plan DB(k)
  • DC plan must be an automatic enrollment plan
  • Must have automatic enrollment of at least 4 of
  • Participants must be given annual notice of right
    to elect out of plan
  • Must make matching contribution equal to 50 of
    deferrals up to 4 of comp
  • Additional match and/or ER contributions may be
    made to DC plan
  • Matching contributions must be 100 vested ER
    contributions must vest after 3 years


Eligible Combined Plan - DB(k)
  • DC plan is deemed to satisfy ADP test
  • Matching contributions must satisfy ACP test
    unless satisfy SH ACP rules
  • ER contributions under DC plan and benefits under
    DB plan subject to nondiscrimination rules as
    under present law
  • Both plans are deemed to satisfy top heavy
  • All contributions, benefits, and other rights and
    features must be provided uniformly to all


Lump Sum Interest Rates
  • PPA changes the interest rate and mortality table
    used in calculating the minimum value of certain
    optional forms of benefit, such as lump sums
  • Interest rates are derived from a corporate bond
    yield curve that reflects yields on investment
    grade corporate bonds with varying maturities
  • Thus, the interest rate that applies depends upon
    how many years in the future a participants
    annuity payment will be made
  • Typically, a higher interest rate applies for
    payments made further out in the future


Lump Sum Interest Rates
  • Mortality table that must be used for calculating
    lump sums is based on mortality table required
    for minimum funding purposes under the bill,
    modified as appropriate by the Secretary of
  • The Secretary is to prescribe gender-neutral
    tables for use in determining minimum lump sums
  • Effective for plan years beginning after December
    31, 2007.


Amendment of 415 Rules
  • Under proposed regs, IRS required that only
    compensation while a participant can be taken
    into account in determining average compensation
  • Inconsistent with prior IRS guidance
  • Would have had negative impact on small employers
    where compensation of owners decrease in order to
    fund plan
  • Under PPA, in determining average compensation
    can use pre-participation compensation in
    determining average compensation


Plan Amendments
  • Plan amendments required by end of 2009 plan year
  • Retroactive amendments will not violate
    anti-cutback requirements
  • IRS permitted to prohibit inappropriate
    reductions in contributions or benefits

Qualified Plan Documents
  • Rev. Proc. 2005-16 opened IRS program for
    submission of prototype / volume submitter plans
    for EGTRRA
  • All prototype / volume submitter plans had to be
    submitted to IRS for opinion or advisory letters
    by 1/31/2006
  • Rev. Proc. 2005-66 opened program for
    individually designed plans as of February 1,
  • Plans subject to new staggered amendment procedure


Staggered Amendments
  • Notice 2005-66 creates new staggered amendment
  • Individually designed plans have staggered 5-year
    amendment cycle

Staggered Amendments
  • Prototype/volume submitter plans have six-year
    amendment cycle
  • DC plans
  • Must be submitted to IRS by 1/31/2006
  • IRS will review by 2008
  • ERs must adopt restated plan by 2009-2010
  • DB plans
  • Must be submitted to IRS by 1/31/2008
  • IRS will review by 2010
  • ERs must adopt restated plan by 2011-2012
  • DC plans must be submitted to IRS again by
    January 31, 2012

Eligibility for 6-Year Cycle
  • Employer need not adopt same plan as plan being
  • Must establish association with eligible
    prototype / volume submitter plan
  • Prior adopter adopted MP / VS before 2/17/2005
    (date EGTRRA program opened)
  • New adopter individually designed plan that
    adopts new or interim MP / VS before expiration
    of 5-year cycle
  • Intended adopter completes applicable
    certification (Form 8905) before expiration of
    5-year cycle
  • Replacement adopter MP / volume submitter plan
    is replaced at sponsor level

Form 8905
  • Certification of Intention to Use Pre-Approved
  • Good-faith intention to adopt pre-approved plan
  • Must sign form before end of 5-year cycle
    deadline (i.e., 12/31/2007 for Cycle A plans)
  • Employer can then adopt any plan within 6-year
    cycle need not be same plan identified on Form
  • Appears that any new plan adopted after 2/17/2005
    must use Form 8905

2004 Cumulative List
  • Notice 2004-84 Lists all changes that must be
    included in defined contribution plans submitted
    in 2005
  • No laws enacted after December 14, 2004 will be
    reviewed by IRS unless included in 2004
    Cumulative List
  • Plans still have to comply in operation with law
  • IRS intends to issue new Cumulative List each
    year (e.g. 2005 Cumulative List will be issued
    for 2006 submissions)

2004 Cumulative List
  • Required provisions
  • Loan regulations
  • Gateway requirements for general
    nondiscrimination test
  • Final RMD regulations
  • Direct rollover and automatic rollover rules
  • Final 401(k) regulations and Roth 401(k)
  • Deemed IRAs
  • Faster vesting for matching contributions
  • Catch-up contributions
  • New top heavy rules
  • Charging of expenses to former EEs

2005 Cumulative List
  • Notice 2005-101 lists required amendments for
    Cycle A submitters for both DC and DB plans
  • No laws enacted after December 13, 2005 will be
    reviewed by IRS unless included in 2005
    Cumulative List
  • Plans still have to comply in operation with law
  • EGTRRA remedial amendment period for Cycle A
    plans extended until January 31, 2007
  • Can extend EGTRRA RAP by if submit timely DL

2005 Cumulative List
  • New provisions in 2005 Cumulative List
  • DB/DC combination gateway rules
  • Provisions regarding ESOP dividends and S-Corp
  • Certain top-heavy rules applicable to defined
    benefit plans
  • New rules regarding applicable mortality tables
  • Proposed guidance on post-severance compensation
    under Code 415
  • Retroactive annuity starting date requirements
  • Katrina relief

Plan Amendments
  • Notice 2005-95 sets forth interim amendment
  • Depends on whether amendment is a discretionary
    or a required amendment
  • Discretionary amendments last day of plan year
    for which amendment is effective
  • Required amendments later of end of plan year
    in which amendment is effective or due date (plus
    extensions) for filing ERs tax return for tax
    year which begins in plan year that amendment is
  • Different amendment deadlines may apply under
    statute, regulation, or other published guidance

Interim Plan Amendments
  • Roth Deferrals
  • Final 401(k)/401(m) Regulations
  • Automatic Rollovers
  • Hurricane Katrina Relief
  • Retroactive annuity starting date
  • Pension Funding Equity Act
  • Relative value requirements
  • Pension Protection Act

Plan Amendments
  • Roth Deferrals discretionary
  • Plan amendments required by end of plan year in
    which Roth deferrals first effective
  • For calendar year plans, if permit Roth in 2006
    must amend by 12/31/2006
  • For fiscal year plans, if permit in 2006 (and
    before beginning of 2006 PY) will have to amend
    by end of plan year ending in 2006
  • Example. If have June 30 year end and allow Roth
    1/1/2006, would have to amend by June 30, 2006
  • IRS has issued model amendment only needs to be
    adopted if permit Roth deferrals

Plan Amendments
  • Issues regarding Roth Deferrals
  • Should address distribution provisions e.g.,
    from which account distributions will be made
  • Can limit amendments only to plans that are
    electing Roth deferrals be careful of rollover
  • Can implement Roth Deferrals mid-year
  • Be careful of plans making Roth Deferrals without
    a plan amendment

Plan Amendments
  • Final 401(k)/401(m) regulations
  • If ER implemented regulations prior to 2006
    plan year discretionary amendment
  • Plan must be amended by end of plan year in
    which regulations effective
  • Notice 2005-95 extends earliest required
    amendment date until 12/31/2005
  • If ER does not implement regulations until 2006
    plan year
  • Plan must be amended by later of end of 2006
    plan year or due date for filing tax return for
    tax year beginning in 2006 PY
  • Pre-approved plans 12/31/2006

Plan Amendments
  • Automatic rollover amendments
  • Originally required amendments as of end of plan
    year beginning on or after March 28, 2005
  • Caused many administrative problems for fiscal
    year plans
  • Notice 2005-95 (issued in November) extended
    amendment date until later of December 31, 2005
    or end of March 28 plan year or due date for
    filing tax return for tax year containing March

Plan Amendments
  • Katrina relief
  • End of 2007 plan year
  • IRS may require certain amendments by end of 2006
    plan year
  • Retroactive annuity starting date
  • Notice 2005-95 extended amendment period until
    December 31, 2005
  • Pension Funding Equity Act
  • Defined benefit plans must be amended by end of
    2006 plan year (December 31, 2006 for calendar
    year plans)
  • Pension Protection Act
  • End of 2009 plan year

Hurricane Katrina Relief
  • Announcement 2005-70 Plans may make loan or
    hardship distribution to EE or former EE whose
    principal residence on August 29, 2005 was
    located in Katrina disaster area
  • Plan administrators may rely upon representations
    from EE or former EE as to need for and amount of
    hardship distribution
  • No suspension of deferrals required
  • Plan amendments required by end of 2006 plan year

Hurricane Katrina Relief
  • Gulf Opportunity Zone Act of 2005 (GOZA)
  • Applies to qualified individuals lived in
    hurricane area and suffered economic loss
  • Adds Code 1400Q
  • Extends relief to Katrina, Rita and Wilma
  • Applies to IRAs, qualified plans, 403(b) and 457
  • Plans may rely on reasonable representation of
    qualified individual
  • Allows penalty-free withdrawals of up to 100,000
    through 1/1/07 limit must be tracked at ER
    level similar to 402(g)

Hurricane Katrina Relief
  • Gulf Opportunity Zone Act of 2005 (GOZA)
  • Extends rollover period to 3 years for qualified
    hurricane distributions can roll back into same
  • Taxes on distributions can be spread over 3 years
    (averaging) or paid in year of distribution
  • Distributions not subject to 20 withholding
    even though eligible for rollover
  • Hurricane distributions not subject to
    distribution restrictions (e.g., age 59-1/2
    requirement for 401(k)

Hurricane Katrina Relief
  • Gulf Opportunity Zone Act of 2005 (GOZA)
  • Loan limit increased to 100,000 or 100 of
    vested account balance loan must be taken by
  • Applies to qualified plans and 403(b) plans
  • Loan repayments may be delayed one year
  • DOL will probably issue adequate security
  • Plan amendments to comply with these rules are
    required by end of 2007 plan year (or such later
    date as IRS may prescribe)
  • Do you need to amend plans if have no hurricane

Terminating Plans
  • Must be amended for current guidance at time of
  • Can use latest Cumulative List may have to
    include additional amendments
  • Date of termination (not date of distribution)
  • Can use snap-on amendment

New User Fees
  • DL requests increase for submissions made on or
    after July 1, 2006
  • Individually designed plans (Form 5300) go up to
    1,000 (from 700)
  • Pre-approved plans (Form 5307) go up to 300
    (from 125)
  • User fee remains at 1,000 for pre-approved plans
    asking for special reliance (e.g., average
    benefits test)
  • Plan termination (Form 5310) goes up to 1,000
    (from 125)
  • Does it make sense to request determination
    letter for prototype or volume submitter plans?

Roth 401(k) Deferrals
  • Roth 401(k) deferrals are available in 2006
    also available for 403(b) plans
  • IRS issued final regulations on 12/30
  • IRS issued additional proposed regulations
  • Roth 401(k) deferrals are a type of deferral
    under a 401(k) plan NOT a new type of plan
  • Roth 401(k) deferrals are subject to current
    taxation earnings are not taxable if qualified

What Must be Done?
  • ER must decide if it wishes to allow Roth 401(k)
    deferrals not required
  • May implement Roth deferrals anytime during year
    or next year
  • Employers may want to wait and see whether
    employees want Roth
  • Must revise salary deferral election forms
  • Must revise payroll systems to accommodate
    after-tax deferrals
  • TPA/recordkeeper must be ready to handle Roth
    deferrals separate account

Roth 401(k) Deferrals
  • Must make irrevocable election to treat deferrals
    as Roth deferrals
  • Plan may not provide for Roth only must offer
    both pre-tax and Roth deferrals
  • No AGI limits HCEs can take full advantage of
    Roth deferrals
  • Roth deferrals are subject to same 402(g) limit
    that applies to pre-tax
  • 15,000 limit for 2006 5,000 catch-up limit if
    at least age 50
  • Only one limit applies must aggregate all
    deferrals (pre-tax and Roth) in applying limit

Roth 401(k) Deferrals
  • Roth deferrals are subject to the ADP test, even
    though after-tax
  • Roth deferrals always 100 vested
  • Roth 401(k) deferrals must be held in separate
  • Must track designated Roth deferrals and
    earnings in case distribution is not qualified
    (i.e., subject to taxation)
  • Plan may permit split elections i.e., half in
    Roth, half in pre-tax
  • Plan may require all-or-nothing

Roth 401(k) Deferrals
  • Roth deferrals are subject to required minimum
    distribution rules under Code 401(a)(9)
  • Many practitioners complained because
    inconsistent with Roth IRA rules
  • Participant may rollover to Roth IRA to avoid
    required minimum distribution
  • May delay distribution under Roth IRA until death
  • Roth deferrals may be made under safe harbor
    401(k) plan
  • Roth deferrals eligible for matching contributions

Roth 401(k) Distributions
  • To be tax-free, distribution must be a qualified
  • Must satisfy 5-year rule measured from taxable
    year in which first Roth deferral is made
  • Also must be for qualified purpose age 59½,
    death or disability
  • If not qualified, portion attributable to
    earnings is subject to taxation may avoid
    taxation by rollover
  • Distribution of Roth deferrals is eligible for
    direct rollover to Roth IRA or another Roth plan

Rollover Issues
  • Proposed regs clarify rollover to Roth 401(k)
    must be direct rollover from another Roth 401(k)
    or Roth 403(b)
  • Distributing plan must report 5-year date and
    basis under separate account to recipient plan
  • If not directly rolled over, rollover of
    after-tax moneys may not be put in Roth account
    can put in Roth IRA
  • May be rolled over as after-tax money must be
    held in separate account (basis)
  • Taxable portion could be rolled into Roth 401(k)
    account 5 year period starts new

Rollover Issues
  • Proposed regs clarify if rollover to Roth IRA
    do not carry over 5 year date to Roth IRA
  • If already have Roth IRA Roth IRA date controls
    even for 401(k) rollover amounts
  • Presumably, can accelerate tax-free treatment if
    have existing Roth IRA
  • If qualified distribution from Roth 401(k)
    entire amount treated as basis in Roth IRA
  • Proposed regs clarify that cannot rollover from
    Roth IRA to Roth 401(k) or Roth 403(b)

Taxation of Distribution
  • Proposed regulations confirm Roth distributions
    are taxed under Code 72 treating Roth account as
    separate contract
  • Cannot take basis out first as under Roth IRAs
    if nonqualified distribution
  • Example. EE has 10,000 Roth account (9,400
    Roth, 600 earnings). If EE takes out 5,000 from
    Roth account 300 will be taxable as earnings
  • 9,400/10,000 5,000 4,700
  • 300 is taxable to EE

Other Issues
  • Must report deferrals and distributions on W-2
    and 1099-R
  • Instructions to new 1099-R will require separate
    1099-R for Roth distributions, including basis
    and 5-year period
  • Distributing plan must provide information
    regarding Roth contributions to recipient plan
    (including 5-year period), if non-qualified
  • Reporting rules not effective until 2007 taxable
  • Proposed regulations amend 403(b) regs to address
    Roth deferrals

Employee Communications
  • Going to require modifications to employee
  • Employees already confused about investments
    under 401(k) plans
  • May give employers incentive to hold employee
  • Could reduce amount EEs defer into plan

  • ABC Corp maintains a 401(k) plan with a 50 match
    on deferrals up to 6 of compensation. Sue, age
    20, an NHCE, has never deferred into the plan.
    Jason, age 35, another NHCE, earns 50,000 and
    has historically contributed 8 of his
    compensation to the plan. ABC is considering
    adding a Roth 401(k) feature.
  • Will Roth 401(k) feature entice Susan to
    contribute to the plan?
  • Will Roth 401(k) feature entice Jason to
    contribute to plan?

  • Under current plan Jason contributes 8 of
  • 50,000 8 4,000
  • ADP for Jason 8
  • If add Roth 401(k) feature and Jason decides to
    contribute to Roth instead
  • If Jason wants his compensation reduced by same
    4,000 (after taxes) deferral will only be
    3,125 with 875 of taxes on deferral (assuming
    28 tax bracket)
  • ADP for Jason 6.25 (3,125 / 50,000)

Plan Amendments
  • IRS has issued model amendment
  • Plan amendments to comply with Roth rules are
    required by end of plan year in which Roth
    deferrals first effective
  • For calendar year plans, if permit Roth in 2006
    must amend by 12/31/2006
  • For fiscal year plans, if permit in 2006 (and
    before beginning of 2006 PY) will have to amend
    by end of plan year ending in 2006
  • Example. If have June 30 year end and allow Roth
    1/1/2006, will have to amend by June 30, 2006


New Guidance on Part-Time EEs
  • February 14, 2006 Quality Assurance Bulletin
  • Clarifies plans can be disqualified, even if has
    favorable DL
  • Directs IRS reviewers to examine plans with
    language excluding part-time, seasonal, or
    temporary EEs
  • Clarifies that plans may provide for different
    exclusion for part-time and full-time EEs


  • Corporation X maintains top-heavy 401(k) plan.
    The plan provides for immediate eligibility for
    deferrals but excludes part-time EE. If
    part-time EE actually works more than 1,000 HOS,
    EE will become participant on first semi-annual
    plan entry date following computation period.
  • Allows plan to bring in full-time EEs immediately
    but hold out part-time EEs
  • Part-time EEs need not receive top-heavy
  • Will have to run coverage test two different
    age/service conditions


Plans for Partners
  • IRS examining new comparability plans deemed
    401(k) if have groups for single partner
  • Final 401(k) regulations clarify probably okay
    for sole proprietors
  • May stop issuing determination letters to
    partnership plans with single groups (e.g.,
    everyone in own group)


Compensation for Deferrals
  • Generally, all compensation is taken into account
    under plans definition of compensation
  • IRS position that EEs may not defer on
    compensation paid after EE has terminated
  • Can cause real problems where final paycheck is
    paid in following plan year is EE an eligible
    EE for purposes of ADP test?


Proposed 415 Regulations
  • Clarifies that compensation paid after severance
    from employment is excluded from 415 compensation
  • Exception for compensation payments made within
    2½ months after severance payment must be for
    regular compensation or accrued sick pay,
    vacation or other leave
  • All other payments, even if made within the 2½
    period following severance, are excluded e.g.,
    severance pay is excluded
  • Restrictions on compensation will apply to other
    Code sections e.g., 401(k)
  • 2½ month rule not elective causes problems with
    414(s) and deferral rules


411(d)(6) Regulations
  • Proposed regulations issued as a result of
    Central Laborers opinion
  • DB plan was amended to add restrictions
    applicable to suspension of benefit provisions
  • Supreme Court ruled that plan cannot add
    restrictions (even if allowed under Code or
    regulations) that apply to benefits accrued prior
    to adoption of amendment
  • Plans must operationally comply with Central
    Laborers decision by 1/1/2007 (Rev. Proc.
  • May require retroactive restoration of benefits
  • Proposed regs apply Central Laborers decision to
    other situations


411(d)(6) Regulations
  • Example 1 adding Rule of Parity
  • Cannot add Break in Service rule to benefits that
    accrued prior to date of amendment
  • Example 2 amendment of vesting schedule
  • Cannot apply new vesting schedule to
    pre-amendment benefits, even if comply with Code
  • May be forced to provide greater vesting
    schedule or retain old vesting schedule
  • Retroactive amendment may be required to
    effective date of regs (June 7, 2004)


Relative Value Explanations
  • Final regulations issued 3/24/2006
  • Generally effective for distributions with
    2/1/2006 annuity starting dates
  • For lump sum distributions worth less than QJSA
    (e.g., lump sum does not reflect value of early
    retirement subsidies) regs effective 10/1/2004
  • Good faith reliance permitted 1/1/2007
  • Most requirements apply to DB plans
  • Must disclose relative value and financial effect
    of various options compared to QJSA
  • Can describe as approximately equal to QJSA if
    within 95 to 105 of PV of QJSA


Relative Value Explanations
  • Also applies to DC plans that provide for QJSA
    form of distribution must contain following
  • description of each optional form of benefit
  • eligibility conditions for each optional form
  • financial effect of electing each optional form
  • any other material features of each optional form
  • statement that annuity will be provided by
    purchasing an annuity from insurance company


IRS Compliance Programs
  • Pre-1990 IRS Options
  • Closing Agreement Program
  • Walk-in CAP
  • Voluntary Compliance Resolution (VCR)
  • Administrative Policy Regarding Self-Correction


  • Rev. Proc. 2003-44 simplified the various
    consolidated the various acronyms under the EPCRS
    program and lowered user fees
  • Now have only 3 programs
  • SCP (Self-Correction Program)
  • VCP (Voluntary Correction Program)
  • Audit CAP (Audit Closing Agreement Program)
  • SCP does not require a submission to the IRS


New EPCRS Procedure
  • Rev. Proc. 2006-27
  • Does not make wholesale changes to existing EPCRS
  • Tweaks some of the suggested correction options
  • Provides new fee structure for nonamenders
    discovered through determination letter program
  • Eliminate the requirement for determination
    letter for certain operational corrections


Eligibility Failure
  • Clean Teeth Dental maintains 401(k) plan with one
    year of service eligibility requirement and
    quarterly entry dates. In 2005, three new EEs are
    allowed to participate on date of hire.
  • What is IRS suggested correction method?
  • Currently, IRS suggested correction method is to
    amend plan to include such EEs
  • If Clean Teeth amends plan to allow three EEs to
    participate immediately, must Clean Teeth permit
    other EEs to participate?
  • No, ER may amend plan to specifically include
    only the three EEs could list individuals by


Eligibility Failure
  • If Clean Teeth amends plan to cover the 3 EEs,
    would Clean Teeth have to submit the amendment
    for a favorable DL?
  • Currently, must submit amendment to IRS for
    determination letter. Under new IRS procedure,
    ERs will no longer be required to submit for
    determination letter for insignificant
  • Could Clean Teeth correct the violation through
    use of creative accounting without submitting
    to the IRS?
  • Yes, in year of correction.


Eligibility Failure
  • Jane, a former participant in Clean Teeth plan,
    is rehired on 2/1/05 after being gone for 3
    years. Jane is not allowed to participate until
    July 1, 2006. What is the IRS suggested
  • IRS suggested correction is to make a QNEC to
    the plan on Janes behalf for the missed
    deferrals from 2/1/05 7/1/06. Corrective QNEC
    is based on 50 of average deferral percentage of
    NHCE group for period while Jane was improperly
    held out of plan.
  • Is Jane entitled to matching contribution
    attributable to the missed deferrals?
  • Yes, based on match would have received if full
    missed deferral had been made to plan


Plan Loan Correction Options
  • In 2000, Sally took a participant loan from
    401(k) plan. Sally began making payments on the
    loan through 2003 when she ceased making
    payments. No action was taken with regard to the
    defaulted loan. In 2006, the ER would like to
    correct the failure to report the defaulted loan.
  • Is the failure to report a defaulted loan an
    operational defect that may be corrected under
    the VCP program? SCP program?
  • What if loans fail to comply with Code 72(p)?


Plan Loan Correction Options
  • Deemed distribution may be reported on Form
    1099-R for year of correction, rather than for
    year of failure, but only if such relief is
    requested under VCP.
  • If loan exceeds maximum permissible loan amount,
    correction is to repay excess loan amount (plus
  • Remaining principal balance may be reamortized
    over remaining period of loan
  • If loans made without authorizing plan language
    retroactive plan amendment is permitted


EPCRS Correction Options
  • Correction of defaulted loan due to ER failure
  • Lump sum repayment of amount equal to additional
    repayments affected participant would have made
    to the plan if there had been no failure to
    repay, plus interest
  • Reamortizing the outstanding balance of the loan,
    including interest, over the remaining payment
    schedule of the original term of the loan
  • ER may have to make up additional interest


Application of DOL Program
  • Failure to follow loan program is prohibited
  • Can be corrected under DOL voluntary compliance
    program (VFC)
  • Must be corrected in accordance with EPCRS under
    VCP program can provide EPCRS correction letter
    and proof of payment of penalties to correct
    under DOL program

Safe Harbor 401(k) Plans
  • Final 401(k) regs require plans to designate
    whether plan is providing safe harbor ER or safe
    harbor matching contribution
  • Cannot simply fall out of safe harbor status and
    revert to testing
  • What if miss annual notice?
  • No correction guidance in new procedure


Orphan Plans
  • DOL has issued final regulations providing
    methodology for terminating abandoned plans
  • DOL estimates approximately 1,650 plans with 868
    million and 33,000 participants are abandoned
    each year
  • DOL concerned that assets being diminished by
    administrative costs and participants not able to
    receive distribution of plan benefits
  • Regulations are effective May 22, 2006
  • Regulations allow abandoned plans to be
    terminated by qualified termination administrator


Orphan Plans
  • Determinations of plan abandonment and winding up
    of plan must be performed by a qualified
    termination administrator (QTA)
  • QTA must be eligible to serve as a trustee or
    issuer of an IRA e.g. bank, trust company
    mutual fund company, insurance company, approved
    non-bank trustee
  • QTA must hold assets of the plan on whose behalf
    it will serve as the QTA can be held as
    trustee, custodian, or provider of investments in
    which assets are invested

Orphan Plans
  • Abandonment of plan
  • No contributions to (or distributions from) a
    plan for a continuous 12-month period, or
  • Facts and circumstances known to the QTA (such as
    liquidation under Title 11 or communications from
    plan participants) suggest that plan is abandoned
  • QTA must determine plan sponsor no longer exists,
    cannot be located, or is unable to maintain plan
  • Must try to locate plan sponsor notice of
    abandonment sent to last known address is
    sufficient (regs contain model notice)

Orphan Plans
  • QTA must send notice of abandonment to DOL
  • Plan is deemed terminated on 90th day following
    DOL letter of receipt of notice of abandonment
    (and election to serve as QTA)
  • Regulations contain model amendment
  • DOL may waive some or all of 90-day period