HIGHLIGHTS OF THE PENSION PROTECTION ACT OF 2006
Charles F. Rolph, III, Esq.
October 26, 2006
Purpose
The purpose of this article is to furnish our clients and friends with general information, not legal advice, pertaining to the Pension Protection Act of 2006 (the “PPA”) that was enacted August 17, 2006. The PPA is the most comprehensive reform of the ERISA and Internal Revenue Code (“Code”) provisions pertaining to employee benefits since ERISA itself was enacted in 1974. Because the PPA touches so many different types of plans and participants, it is not possible in this limited space to discuss all aspects of the law; therefore, only those provisions affecting most plans and plan sponsors, as well as plan participants, are detailed herein.
Reform of Funding Rules for Defined Benefit Pension Plans
Minimum Funding Rules. For plan years beginning after December 31, 2007, the PPA repeals the present law funding rules and provides a new set of rules for determining minimum required contributions.
Amortization Periods. Employers that sponsor defined benefit plans will have to make sufficient contributions in order to meet a full funding target and ease funding shortfalls over seven years so that all plans are fully funded in seven years under the PPA.
Benefit Limits Under Single-Employer Plans. The PPA includes limits based on the plan's “adjusted funding target attainment percentage,” and generally makes it more difficult to increase benefits under the plan without a corresponding increase; i.e., if the adjusted funding target attainment percentage is below 80% under the PPA, a plan may not implement any benefit increases. Certain other restrictions apply, as do special rules for collectively-bargained plans.
Restrictions on Nonqualified Deferred Compensation. The PPA prevents a publicly-traded employer from accumulating a reserve to fund nonqualified deferred compensation benefits for certain executives if the employer, or a member of its controlled group, is bankrupt, has an at-risk plan (generally less than 80% funded) or a plan that has terminated without having sufficient assets to pay all benefits. If an affected employer funds a nonqualified deferred compensation plan, then the CEO and the other top four executives (if that is the group benefiting) must be treated as incurring immediate income, interest, and a 20% penalty. If the employer grosses up the affected executives’ compensation for the tax and penalty, the gross-up amounts also become subject to immediate taxation.
Multiemployer Plans. These are collectively-bargained jointly trusteed plans that have new funding rules and rules pertaining to the withdrawal liability of employers that want to leave the plan. The changes are effective for withdrawals beginning in 2007.
Interest Rate Assumptions. The PPA introduces new interest rates and computation methods for determining the amount of lump sum distributions from defined benefit plans and for determining the maximum lump sum benefit limits under the plan. The phase-in of the new interest rate assumptions begins in 2008.
PBGC Premiums. The Pension Benefit Guaranty Corporation (“PBGC”) is a “body corporate” established within the U.S. Department of Labor whose purpose it is to provide a minimum level of benefit to the participants in defined benefit plans that are terminated by their employers with insufficient assets to fully fund the benefits promised to the participants under the terms of the plans. Each employer that sponsors or contributes to a defined benefit pension plan [other than a 412(i) or 412(e)(3) fully-insured plan] is required to pay an insurance premium to the PBGC, composed of a fixed and variable rate. The variable rate premiums are determined as $9 per $1,000 of unfunded vested benefits. The PPA introduces changes to the manner in which the unfunded vested benefits are determined. For plans that terminate in a distress termination due to a reorganization in bankruptcy or insolvency proceedings, the PPA indefinitely extends the $1,250 per participant premium that is required for three years after a company emerges from bankruptcy reorganization. Under current law, the $1,250 per participant premium was scheduled not to apply to any plan terminations after December 31, 2010.
Disclosure Provisions
Defined Benefit Plan Funding Notice. The PPA repeals the Notice to Participants of Funding Status (Section 4011 Notice) effective for plan years beginning after December 31, 2006 and repeals the Summary Annual Report requirement and replaces that with a new Annual Plan Funding Notice effective for plan years beginning after December 31, 2007.
Annual Reporting Requirements. The annual reporting requirements are expanded to include additional information for both single employer defined benefit plans and multiemployer defined benefit plans. These changes are effective for plan years beginning after December 31, 2007.
Electronic Display of Annual Report Information. Beginning in plan years after December 31, 2007, certain annual report information must be filed in electronic format with the DOL.
Disclosure of Termination Information to Plan Participants. For distress terminations of defined benefit plans or involuntary terminations initiated by the PBGC after August 17, 2006, participants, beneficiaries, alternate payees, and/or unions may request that the plan administrator provide them the information that was provided to the PBGC.
Plan and Financial Information Filings with the PBGC. The threshold amounts that trigger the filing of the so called “4010 Filing” with the PBGC of certain plan and financial information are adjusted for 2006 and 2007, and then replaced with new triggers for 2008 and beyond.
Periodic Pension Benefit Statements. Effective for plan years beginning after December 31, 2006, a participant in a defined contribution plan who has the right to direct investments must receive a benefit statement once per quarter and a participant in a defined contribution who does not have a right to direct investments must receive a benefit statement once per year. Benefit statements must also be provided on request, but no more than once per year.
Notice of Freedom to Divest Employer Securities. Effective for plan years beginning after December 31, 2006, the PPA requires a new notice in connection with the right of an applicable individual to divest his or her account under an applicable defined contribution plan of employer securities. The PPA also requires the Treasury Secretary to issue a model notice within 180 days of August 17, 2006.
Notice and Consent Requirements. Generally, under present law, an election of a form other than a joint and survivor annuity must be made no earlier than 90 days before the benefit's annuity starting date. The PPA changes the consent period for joint and survivor notices and consents from “no earlier than 90 days” to “no earlier than 180 days” before the benefit's annuity starting date, in the case of distributions from plans may, after December 31, 2006.
Investment Advice, Prohibited Transactions, and Fiduciary Rules
Investment Advice. Effective for investment advice provided after December 31, 2006, the PPA creates a prohibited transaction exemption for investment advice tailored to a recipient and provided by a qualified fiduciary adviser -- an adviser who is fully regulated by applicable banking, insurance, and securities laws -- through an “eligible investment advice arrangement.” An eligible investment advice arrangement includes: (i) one that provides investment advice to a participant or beneficiary of an employer-sponsored retirement plan through a computer model that is certified by an independent eligible investment; and (ii) one that facilitates the providing of investment advice to employer-sponsored plans and IRAs by a qualified fiduciary adviser who charges a flat rate fee (without regard to the investments selected).
Prohibited Transactions Related to Financial Investments. Effective for certain transactions occurring after August 17, 2006, the PPA provides statutory prohibited transaction exemptions for certain transactions involving block trading, regulated electronic communication networks, service providers who are not fiduciaries with respect to the assets involved, foreign exchange transactions, and cross trading.
Correction Period for Securities and Commodities Transactions. Prohibited transactions are subject to an immediate 15% excise tax of the amount involved in the transaction. After August 17, 2006, a 14-day correction period is allowed with respect to transactions involving the purchase, holding, or sale of any commodity or security (but not employer securities) before the excise tax becomes applicable.
Blackout Periods. A plan fiduciary is protected from some liability in self-directed plans. The PPA eliminates the fiduciary's protection during blackout periods when a participant cannot self-direct unless certain specified requirements regarding reasonable blackout periods are satisfied. This provision applies to plan years beginning after December 31, 2007.
Extension of ERISA Section 404(c) Protection. ERISA Section 404(c) protects plan fiduciaries under certain circumstances where the participants direct the investment of the assets in their accounts and the plan fiduciaries meet certain disclosure and reporting requirements. The PPA extends 404(c) protection to plans that use default investment options if the participants fail to direct the investment of their accounts, provided the investments are in line with guidelines to be issued by the DOL. This provision is effective for plan years beginning after December 31, 2006. ERISA Section 404(c) protection is also extended to plan fiduciaries during a blackout period in which investments are being changed if the fiduciaries satisfy their ERISA obligations with respect to the implementation and operation of the blackout period and if certain default investment options and notice requirements are in place. This provision is effective for plan years beginning after December 31, 2007.
Bond Amount. The PPA increases the fiduciary bond requirement from at least $500,000 to $1 million for plans that hold employer securities. This provision is effective for plan years beginning after December 31, 2007.
Penalties for Coercive Interference. The PPA increases the penalties for coercive interference with the exercise of ERISA rights from a $10,000 fine and one year in prison to a $100,000 fine and 10 years in prison.
Cash Balance and Other Hybrid Plans
In response to litigation addressing the application of the age discrimination rules of the Code, ERISA, and the Age Discrimination in Employment Act (“ADEA”) to hybrid defined benefit plans and to the conversion of traditional final-pay plans into hybrid plans, the PPA provides rules for testing defined benefit plans, including hybrid plans, for age discrimination under the Code, ERISA, and ADEA. The provision is generally effective for periods beginning on or after June 29, 2005, but with certain interest credit and vesting requirements becoming applicable to years beginning after December 31, 2007.
Pension Related Revenue Provisions
Deduction Limitations. For taxable years beginning after 2007, in the case of contributions to a single-employer defined benefit pension plan, the maximum deductible contribution amount is equal to the greater of: (i) the excess, if any, of the sum of the plan’s funding target, the plan’s target normal cost, and a cushion amount for the plan year, over the value of plan assets (as determined under the minimum funding rules); and (ii) the minimum required contribution for the plan year.
EGTRRA Provisions Made Permanent. The PPA makes the pension and individual retirement arrangement provisions made under the Economic Growth and Tax Relief Reconciliation PPA of 2001 (“EGTRRA”) permanent, by eliminating the 2010 sunset provided in EGTRRA. The PPA also makes the EGTRRA provisions relating to the Code §25B Saver's Credit permanent by eliminating the sunset after 2006.
Portability, Distributions and Contributions
Rollover of After-Tax Amounts in Annuity Contracts. Effective for taxable years beginning after December 31, 2006, after-tax contributions may be rolled directly (i.e., trustee-to-trustee) from one qualified plan to another, including defined benefit to defined contribution and vice versa, or to a Section 403(b) plan.
Direct Rollovers into Roth IRAs. The PPA allows direct rollovers from tax-qualified retirement plans, Section 403(b), and Section 457 plans to Roth IRAs, subject to the present law rules that apply to rollovers from a traditional IRA to a Roth IRA, effective for tax years beginning after December 31, 2006.
Special Roth IRA Rollover Rules. The Tax Increase Prevention and Reconciliation Act of 2005 amended Code Section 408A(c)(3) for taxable years beginning after December 31, 2009, to eliminate the rule that an individual making a qualified rollover contribution to a Roth IRA from an eligible retirement plan other than a Roth IRA must not have adjusted gross income (“AGI”) that exceeds $100,000 or must not be a married individual filing a separate return. Thus, beginning in the 2010 taxable year, an individual may facilitate a rollover to a Roth IRA without regard to the limitations on AGI that would have prevented rollovers from eligible retirement plans other than Roth IRAs in taxable years prior to 2010. Even though rollovers may be made to Roth IRAs in taxable years beginning after December 31, 2009, without regard to the limitation on AGI, the amount being rolled over is still subject to inclusion in income and the maximum period over which the inclusion amount can be averaged is reduced from four years to two years.
Hardship Distributions. The PPA modifies the hardship regulations by requiring the Secretary of Treasury to issue regulations within 180 days after August 17, 2006, to expand “hardship” to include hardship of a beneficiary under the plan (even if it is not a spouse or dependent).
Distributions to Reservists. The PPA creates a new exception from the 10% premature distribution tax for distributions before age 59 1/2 to a reservist (called up between September 11, 2001, and before December 31, 2007, for more than 179 days), and allows the money to be repaid within two years after the end of active service.
Rollovers by Nonspouse Beneficiaries. The PPA allows nonspouse beneficiaries to roll over to an IRA or other plan structured for that purpose amounts inherited as a designated beneficiary. The inherited amounts are subject to the annual minimum distribution rules requiring distributions over the person's life expectancy (recalculated annually). This provision is effective for distributions made after December 31, 2006.
Direct Deposit of Tax Refunds. The PPA requires the IRS to make available a form for a taxpayer to file with the IRS directing the IRS to send a refund directly to the taxpayer's IRA. The form is to be available for taxable years beginning after December 31, 2006.
Additional IRA Contributions for Certain Employees. The PPA allows individuals who worked for a bankrupt employer whose officers were indicted and whose employer had a least a 50% match in the form of employer stock in its §401(k) plan to make an additional IRA catch-up contribution (three times the otherwise applicable catch-up amount). The contributions can be made for 2007, 2008, and 2009.
Health and Medical Benefits
Ability to Use Excess Pension Assets for Future Retiree Health Benefits. The PPA allows a defined benefit pension plan with assets in excess of 120% of the plan's current liability (or funding target) to transfer two or more years of estimated retiree medical costs to a health account under the plan. The maximum amount that can be transferred is the lesser of 10 years of estimated retiree medical costs or assets in excess of 120% of current liability. For all years for which a transfer has been made, the employer must make contributions sufficient to maintain the plan's 120% funding level (or transfer assets back from the health to the pension account). This provision is effective for transfers made after August 17, 2006.
Special Reserves for Bona Fide Associations. The PPA allows a plan maintained by a bona fide association to accumulate reserves of up to 35% of annual costs for medical benefits (other than post-retirement medical benefits). This provision is effective for taxable years ending after December 31, 2006.
Combined Annuity or Life Insurance Contracts with Long-Term Care Insurance. The PPA permits LTC riders on annuity contracts and provides special tax treatment for the LTC component of a life insurance or annuity contract, including allowing the cash value of such contracts to pay the LTC benefit, making LTC payments to a reduction in basis, allowing tax-free transfers between annuity contracts even if one has a LTC rider (with similar rules for life insurance contracts), and providing special rules that would treat the LTC rider as a separate contract for certain purposes. The PPA also adds new reporting requirements. The provisions are generally effective beginning in 2010.
Corporate-Owned Life Insurance (“COLI”)
Payments of life insurance after the covered party's death generally are not taxable to the recipient. The PPA requires businesses to treat proceeds from COLI policies as income unless the insured was an employee within 12 months of death, or was a director or highly compensated employee or individual at the time the contract was issued, or the proceeds paid to the insured's beneficiary are used to buy back any equity interest owned by the insured at the time of death. The COLI provision also includes notice and consent requirements and adds new reporting requirements. The provision is effective for contracts issued after August 17, 2006.
Increase in Pension Plan Diversification and Participation and Other Pension Provisions
Diversification Requirements for Certain Defined Contribution Plans. The PPA requires a defined contribution plan that holds any publicly-traded employer securities to allow a participant (or any beneficiary entitled to exercise a participant's rights) to divest that portion of the account attributable to employee contributions and elective deferrals invested in employer securities and to reinvest an equivalent amount in other investment options. This provision is generally effective for plan years beginning after December 31, 2006, with special rules for collectively-bargained plans.
Increasing Participation Through Automatic Contribution Arrangements. Effective for years beginning after 2007, the PPA allows a “qualified automatic contribution arrangement” to meet the actual deferral percentage requirements of Code §401(k)(3)(A)(ii) and the matching contribution percentage requirements of Code §401(m)(2).
Eligible Combined Defined Benefit Plans and Qualified Cash or Deferred Arrangements. The PPA allows a small employer (i.e., an employer with an average of at least two but not more than 500 employees) to establish a combined defined benefit and Section 401(k) plan governed by one document and having specific accounting for the defined benefit and defined contribution portions of the trust, effective for years beginning after December 31, 2009.
Faster Vesting of Employer Nonelective Contributions. The PPA applies accelerated three-year cliff vesting or two-to-six-year phased vesting to all employer contributions in a defined contribution plan (nonelective employer contributions as well as matching contributions), effective for contributions in plan years beginning after December 31, 2006.
Distributions During Working Retirement. Under current law, defined benefit plans and money purchase pension plans are prohibited from allowing in-service distributions before normal retirement age. The PPA allows in-service distributions once the participant is age 62, effective for distributions in plan years beginning after December 31, 2006.
Provisions Relating to Spousal Pension Protection
Domestic Relations Orders. The PPA requires the Secretary of Labor to issue regulations not later than August 17, 2007, which clarify that a domestic relations order otherwise meeting the applicable requirements to be a qualified domestic relations order will not fail to be treated as a qualified domestic relations order solely because the order is issued after, or revises, another domestic relations order or qualified domestic relations order.
Requirement for Additional Survivor Annuity Options. Under the PPA, if a pension plan participant elects a waiver of the qualified joint and survivor annuity (“QJSA”) form of benefit or a qualified preretirement survivor annuity (“QPSA”) form of benefit, the participant can elect a qualified optional survivor annuity, defined as an annuity: (i) for the life of the participant with a survivor annuity for the life of the spouse which is equal to the applicable percentage of the amount of the annuity which is payable during the joint lives of the participant and the spouse; and (ii) which is the actuarial equivalent of a single annuity for the life of the participant. Under the PPA, if the survivor annuity percentage is less than 75%, the applicable percentage is 75%, and if the survivor annuity percentage is greater than or equal to 75%, the applicable percentage is 50%. This provision applies to plan years beginning after December 31, 2007.
Administrative Provisions
No Reduction in Unemployment Compensation as a Result of Pension Rollovers. The PPA prohibits states from reducing unemployment compensation for any pension, retirement or retired pay, annuity or similar payment that was rolled over and, thus, is not includible in gross income. This provision applies to weeks beginning on or after August 17, 2006.
Provisions Relating to Plan Amendments. Under the PPA, with respect to any amendment to any pension plan or annuity contract which is made (i) pursuant to any provision under the PPA or any regulation issued by the Secretaries of the Treasury or Labor under the PPA, and (ii) on or before the last day of the first plan year beginning on or after January 1, 2009 (January 1, 2011, for governmental plans as defined in Code Section 414(d)), such pension plan or contract is treated as being operated in accordance with the terms of the plan during the applicable period.
Tax-Free Distributions from IRAs for Charitable Purposes
The PPA provides a limited period [distributions made in taxable years beginning after December 31, 2005 and those beginning before January 1, 2008] in which “qualified charitable distributions” from a traditional or Roth IRA may be excluded from gross income. The exclusion may not exceed $100,000 per taxpayer per year. A “qualified charitable distribution” is any distribution from an IRA directly to a charitable organization described in Code Section 170(b)(1)(A) [other than an organization described in Code Section 509(a)(3) or a donor advised fund, as described in Code Section 4966(d)(2)] and only if the distribution is made on or after the date the IRA owner attains age 70 1/2.
