Defined Benefit Plan Funding Obligations
PPA sets up a new scheme for measuring the minimum required
contributions for single employer defined benefit pension plans
beginning with 2008 plan years (multi-employer plans are subject to
slightly different rules). Minimum funding is defined as the
present value of benefits accrued during the current year, plus the
amortized amount of any funding shortfall. There is a transition rule in
the case of small funding shortfalls.
An annual funding notice is now required
to be furnished to all
defined benefit plan participants within 120 days after the end of each plan year and must provide
information about the plan’s funded status, asset allocation and
related issues. The DOL is expected to develop a model notice within the next
year.
PPA changes the calculation of both assets and liabilities for purposes of determining
whether a plan is fully funded. You may still "smooth" asset values, but only over a 24-month
period which essentially creates a reduction in the smoothing period from five years to
three. The resulting asset value must then fall within 90% to 110% of the fair market value of the assets.
The calculation of plan liabilities is also
impacted. PPA directs the Treasury Department to prescribe the mortality table to be used in calculating plan
liabilities and liabilities will also be subject to a new methodology based on a three-segment yield
curve based on a 24 month average of the yield on investment grade
corporate bonds.
Underfunded Plans - Beginning in 2008, plans that are not 100% funded
will have to amortize any shortfall over seven years. If the plan is not subject to the
Deficit Reduction Contribution rules in 2007, the 100% funding target is phased in, starting with a 92% target in 2008, moving to 94% in 2009, 96% in 2010, and ending at 100% in 2011.
Underfunded plans are now also subject to restrictions concerning plan
amendments that increase benefits or accruals, or accelerate payment of
benefits. PPA also changes the assumptions used for
calculating lump sum distributions from defined benefit plans and
restricts the ability to set aside amounts to pay nonqualified deferred
compensation.
At Risk Plans - For "at risk" plans
with funding percentages in the
preceding year less than 80 percent using normal assumptions and
below 70 percent using at risk assumptions, enhanced funding obligations
are being imposed with increased contributions phased in over a five year
period.
PPA will increase the required contributions for such plans by applying
an at
risk assumption that participants who may elect to commence a
benefit within the next 10 years will actually retire and elect the
form of benefit with the highest present value.
Plans that were considered to be at-risk in the current plan year plus two out of the last four years must
also include an additional load charge of 4% of the plan’s funding target plus $700 per plan participant.
Plans with fewer than 501 participants are not subject to the at-risk rules.
Multi-employer Plans - The minimum funding standards for
multiemployer plans include a reduced
amortization period for liabilities resulting from plan amendments that
increase benefits. For multiemployer plans that are severely underfunded
(generally less than 80 percent), PPA will require them
to adopt programs for improving funding over a 10 to 15 year period.
The Act also creates a new annual funding notice requirement for all
defined benefit plans. The notice must be furnished to participants
within 120 days after the end of each plan year and must provide
information about the plan’s funded status, asset allocation and
related issues. The DOL will develop a model notice within the next
year.
Deduction
Limitations
PPA increases the deduction limits for
single-employer plans to 150% of current liability for 2006 and 2007. For subsequent years, plans are permitted to deduct an additional 50% of their funding target for a year.
Plans may also choose to deduct their at-risk liability even if they are not in an at-risk status.
Employers who maintain both a defined benefit and defined contribution plan also have
had their deduction limits eased. Single-employer defined benefit plans that pay PBGC
(Pension Benefit Guaranty Corporation) premiums will not be subject to the overall
limit after 2007.
The limit will apply to contributions to a defined contribution plan only to the extent that the contributions exceed 6% of
compensation for years after 2005. The excise tax on nondeductible contributions will not be applied to matching contributions to a defined contribution plan that are nondeductible solely because of the overall limit.
EGTRRA
Provisions Made Permanent
The Economic Growth and Tax Relief Reconciliation Act of 2001
(EGTRRA) included a number of temporary provisions that were favorable to plan sponsors and plan
participants but it included a sunset provision that would have caused these retirement plan provisions to expire after
2006 and 2010.
Retirement Plans - EGTRRA increased the limits on elective deferrals to 401(k) and other plans, allowed catch-up contributions for workers age 50 and over, authorized Roth 401(k) contributions, repealed the “same desk” rule, and simplified the top-heavy plan
provisions through 2010 and PPA makes all of these changes permanent.
Saver’s Credit - The nonrefundable tax credit up to $2,000 that matched the savings of low-income workers contributing to traditional or Roth IRAs or making elective deferrals to qualified retirement
plans has been made permanent. PPA also indexes the adjusted gross income limits beginning in 2007 and
allows a taxpayer to direct the IRS after 2006 to deposit any tax refund attributable to the saver’s credit into a retirement plan.
Encouraging
Enrollment In Defined Contribution Plans
PPA has made numerous changes in regard to
enrollment and vesting in defined contribution plans in order to encourage
more and higher participation. ERISA has been amended to preempt state wage withholding laws that might otherwise
interfere with the approach of requiring employees to elect out of participating in
a plan.
Vesting - Vesting rules for
non-elective employer contributions
to defined contribution plans are now subject to the same shorter
vesting schedules (a three-year
cliff or six-year graduated vesting) that were implemented for employee matching
contributions under EGTRRA. Beginning for 2007 plan years, PPA has
extended these shorter vesting schedules to
all employer non-elective contributions such as profit sharing
contributions.
Plan Design Safe Harbors. -
Employers can now avoid ADP and ACP nondiscrimination testing with the adoption of new safe harbor automatic enrollment
designs which require the following minimum contributions:
- Employees automatically defer 3% of pay initially as elective contributions
and increase them annually in 1% increments until 6% of pay is reached.
The deferral could also start out at a higher rate as long as it reaches the 6% minimum rate on schedule and does not exceed 10%.
- The employer must match 100% of the first 1% of pay contributed by the employee, plus 50% of the next 5% of pay
or make a 3% of pay non-elective contribution for all eligible employees. Deferrals in excess of 6% may not be matched.
- The employer’s matching or non-elective contributions must be 100% vested after two years of service.
They are still subject to the withdrawal restrictions applicable to elective
deferrals under present law and cannot be withdrawn for hardships.
- 401(k) plans must allow employees to change or elect out of the automatic deferrals and must comply with safe harbor notice requirements. Employers can implement automatic enrollment without applying it to existing employees who have either elected to participate in the plan or elected not to participate in the plan.
90 Day Withdrawal Period -
Employees can now be allowed to withdraw their elective contributions within 90 days of their first
contribution to a 401(k) plan with automatic enrollment . When this withdrawal occurs, the withdrawal will be taxed in the year of distribution, no early distribution tax will be imposed, and the withdrawal will not be treated as violating other restrictions imposed on distributions nor counted in ADP tests.
Investment Advice - PPA amends ERISA’s fiduciary rules to encourage employers to provide investment advice to 401(k) plan participants.
The term “fiduciary advisers” is defined and the role of plan sponsors that select and monitor them is clarified.
Potential conflicts of interest have been addressed with two new prohibited transaction exemptions
in the area of commissions and investment compensation.
Plan sponsors still have fiduciary responsibility for the prudent selection and monitoring of a fiduciary adviser,
but a plan sponsor has no duty to monitor the specific investment advice given by a fiduciary adviser to a particular plan participant.
Employer Stock - For employer non-elective or matching contributions, defined contribution plans must allow participants to diversify out of
publicly traded employer stock with at least three diversified investment
options after three years of vesting service and no waiting period
requirement. Barring unusual circumstances, participants must be given the opportunity to make employer stock investment
changes on the same basis as they can make other investment changes.
The diversification requirement applies only to plans with publicly-traded employer stock and do not apply to stand-alone ESOPs without elective, employee, or matching contributions.
Clarification of Cash Balance Plan Status
The PPA clarifies the status of cash balance plans but actual investment returns are not
individually allocated. A cash balance plan is a
defined benefit pension plan which allows participants to have
hypothetical individual accounts. Cash balance plans have
historically been the
target of lawsuits alleging age discrimination from older employees and
an IRS moratorium on issuing determination
letters for cash balance plans left them in a controversial and
indeterminate state.
Effective for cash balance plan conversions on or after June 29, 2005,
the PPA provides the following:
- No inference of age discrimination arises for
benefits of equal present value regardless of the participants’ ages
- Requires the adoption of a three-year cliff vesting
schedule
- Imposes interest crediting limitations
- Restricts the use of
"wearaway" in plan conversions (a rule under which
participants with large pre-conversion benefits are suspended from
accruing new benefits for a period after the conversion).
It is anticipated that the IRS will begin to review unresolved determination
letter requests in the near future.
The PPA contains hundreds of provisions affecting specific industries
and interests which are beyond the scope of this analysis. Please contact
our office to discuss the implications of the PPA for your retirement plans.
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