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September 6, 2006

PPA: Pretty Powerful Act for Pension Protection?

On August 17, 2006, President Bush signed the Pension Protection Act of 2006 (“PPA”, P.L. 109-280).   This law makes significant changes to provisions affecting benefit plans.  The majority of this law relates to defined benefit plans.  However, it includes many changes affecting defined contribution plans, and even a few that affect welfare benefit plans.  Following is a summary of select provisions of the law.

EGTRRA Provisions Permanent

One of the most important provisions of the PPA is that it makes permanent, the pension and individual retirement arrangement provisions of EGTRRA.  These provisions were to sunset in 2010.  It also makes permanent the Saver’s Credit, which would have expired in 2006.  This should come as welcome relief to plan sponsors and plan administrators as it allows them to make plan design decisions without concern that the laws may be repealed.  An example of this would be the inclusion of a Roth provision in a defined contribution plan.

Automatic Enrollment

The law includes provisions allowing a defined contribution plan to include an automatic deferral feature, and it relieves the plan fiduciary from certain liability if the automatic feature is included.

If a plan with an automatic enrollment feature complies with a safe harbor (see below), the plan would be deemed to satisfy the ADP and ACP tests, as well as be exempt from top heavy rules.  And, perhaps most significantly, the law would relieve any liability for state law violations that could occur by virtue of the automatic contribution feature.  Many states prohibit withholding money from an employee’s pay without written authorization.  The PPA preempts these kinds of state laws, as long as the plan complies with the automatic contribution requirement. 

In a nutshell, the automatic contribution requirements provide that a participant, who does not actively elect or decline participation in the plan, would be automatically enrolled at a certain contribution level, as defined by the plan.  The automatic contribution would have to be administered uniformly. 

Safe harbor requirements 

  • The contribution levels would be a percent of compensation from three percent, increasing in annual 1% increments, to 6% of pay.  Plans may provide for automatic increases in contributions up to 10% of pay. 
  • An employer would be obligated to match all contributions in amounts of 100% of the first percent of compensation, 50% of the next 5% of pay, for a maximum match of 3.5% of compensation for each employee.  Alternatively, the employer could make a nonelective 3% contribution for all eligible employees, without regard to whether the employee makes elective contribution. 
  • The PPA provides that participants may opt out within 90 days from the initial payroll reduction, and receive penalty-free return of automatic elective contributions and any earnings thereon.

If contributions are invested in accordance with ERISA Section 404(c) rules, then the plan fiduciary would be relieved of certain liability for investment performance.

Employees would have to be given notice, within a reasonable time preceding the plan year, describing the automatic enrollment features.

Default Investments

When a plan provides for default investments, for example, in the instance where a participant does not make an active investment election, the plan would receive ERISA Section 404(c) protection if it complies with certain requirements, including a notice, which must be provided within a reasonable time prior to the beginning of each plan year.  The notice must explain the right to choose investment options, and give the individual adequate time to make elections.  The Secretary of Labor is to issue regulations on the type of investments that would be deemed appropriate for default investments.

Investment Advice

One of the much debated issues relating to the value of a defined contribution plan as a retirement vehicle is the participant’s ability to invest appropriately.  To this end, the PPA sets forth a prohibited transaction exemption for providing investment advice.  

Investment advice for a fee could be provided in either of two manners, without creating a prohibited transaction:

  1. The investment advice could be provided for a fee that does not vary based on the investment selection (flat fee model). 
  2. The investment advice would be provided using a computer model that:
  • Applies generally accepted investment theories about historical returns and different asset classifications;
  • Uses relevant information about retirement age, life expectancy, risk tolerance, availability of other financial resources, and personal preferences as to investment type;
  • Uses objective criteria;
  • Provides advice in a manner that is not biased in favor of investments offered by the fiduciary advisor, or any other person affiliated with, or in a control group relationship with, the advisor; and
  • Takes into account all investment options.

The computer model must be certified by an independent investment expert, in accordance with rules that are to be prescribed by the Secretary of Labor.  Any modifications made to the computer model would have to be re-certified.  The law makes it clear that the certification must be done by an independent expert.  If these, among other requirements are satisfied, the plan fiduciary would be relieved of liability for individual investment decisions.  The plan fiduciary would be liable for the prudent selection of the investment advisor.

With regard to individual retirement accounts, there is a question as to whether the computer model would work; further study of this issue is indicated.

In the meantime, the flat fee model would be the only model available for providing investment advice to individual type plans, which would include health savings accounts.

Notices

The law makes several changes to notice requirements.  Specifically:

  • Annual Reports.  Form 5500s, including those filed for welfare benefit plans, would have to be posted electronically by the DOL within 90 days of receipt.  Furthermore, the employer would be obligated to post its Form 5500 information on its intranet, if any. 
  • Benefit statements. 
    • Defined contribution plans would be obligated to provide benefit statements annually, or upon request.  If the plan provides participant directed investments, then benefit statements would have to be provided quarterly. The content of each benefit statement must include:
    • Total and accrued benefit and vested percentage;
    • Any Social Security offset or integration; and
    • Value of each investment.

If the plan provides for participant direction, the benefit statement must also include:

    • Any limitations or restrictions on the right to direct investments;
    • An explanation of the importance for long-term retirement security, of a well-balanced and diversified investment portfolio, including a statement of the risk that holding more than 20% of a portfolio in the security of one entity, such as employer securities, may not be adequately diversified; and
    • A notice directing the participant or beneficiary to the DOL’s internet website for sources of information on individual investing and diversification.
  • Defined benefit plans would be required to provide benefit statements once every three years to all current employees with nonforfeitable accrued benefits.  To all others, the benefit statements would have to be provided upon request.  Alternatively, the defined benefit plan could provide, annually, a notice explaining the right to request a benefit statement.

Model Benefit Statement.  The DOL is directed to design a model benefit statement within one year of the law’s enactment date. 

Manner and Method of Providing Benefit Statements.  The benefit statements could be provided in writing, or electronically. 

Employer Securities Diversification

Defined contribution plans holding publicly-traded employer securities must allow participants to diversify employer securities.  If the employer securities are purchased with participant contributions, they must be able to be diversified immediately.  For employer securities purchased with employer contributions, the participant must be able to diversify the investment after three years. 

The plan must offer three alternative investments, in addition to the employer securities; and, these investment alternatives must vary in their risk and return characteristics.

Notice must be given if employer securities are to be in the plan.  Notice must be given at least 30 days prior to the date the securities can be diversified.  The notice must explain the right to divest, and the importance of diversifying the investment of retirement income assets.

This law does not apply to traditional ESOPs.

Defined Contribution Plan -  Nonelective Contributions

Under current law, matching contributions must be vested either in a 3-year cliff, or in a 6-year graded schedule in which 20% of the account is vested in each year, beginning in Year 2, becoming fully vested in Year 6.  These are the only vesting schedules now permitted for all employer contributions.

Rollovers

The law allows non-spouse beneficiaries to roll over distributions directly into an individual retirement account. 

Hardship Distributions

The law requires regulations to be issued that would expand the rules relating to hardship distributions to include a hardship distribution of a beneficiary under the plan, even if he/she is a non-spouse or dependent.

Relief from 10% early distribution penalty for Military Personnel.  Reservists called to active duty between September 11, 2001 and December 31, 2007, whose service lasts longer than 179 days can take distributions from qualified plans without being subject to the 10% early distribution penalty.  The distribution must be repaid within the later of two years after the end of active service, or enactment date of the law.

IRA Rollovers

The law allows non-spouse designated beneficiaries to roll over amounts from qualified plans, 403(b) plans and IRAs to another plan or IRA.  If the non-spouse beneficiary is required by the plan to take an immediate distribution, the non-spouse beneficiary can delay immediate taxation through the rollover.

Transfer of excess defined benefit plan assets to retiree medical accounts

The law increases the amount that can be transferred from a defined benefit plan into a retiree medical account.

Public safety employees

Public safety retirees can withdraw $3,000 from retirement each year on a tax-favored basis to purchase health or long term care insurance.

Qualified Long Term Care

The law makes more attractive, certain aspects of qualified long term care (LTC).  Specifically, it would allow qualified LTC riders to be a part of life insurance, endowment, and annuity contracts. It would allow the cost of qualified LTC to be purchased from the cash value of life insurance, on a tax-advantaged basis.  And, it allows IRC Section 1035 exchanges from life insurance, endowment, or annuity products to qualified LTC. 

COLI

The rules relating to corporate owned life insurance (COLI) are changed such that the death benefit would be taxable, unless:

  • The insured was an employee within 12 months preceding the death;
  • The employee was a director or highly compensated individual at the time the contract was issued; or
  • The proceeds were paid to the beneficiary, unless the proceeds are used to buy back an equity interest owned by the insured at the time of death. 

The COLI provisions include a notice and consent requirement, as well as reporting requirements.

Effective Dates

There are varying effective dates throughout this law, although many of the provisions become effective for plan years beginning on or after January 1, 2007.

 

The information contained in this Benefit Beat is not intended to be legal, accounting, or other professional advice, nor are these comments directed to specific situations.

 

As required by U.S. Treasury rules, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this Benefit Beat is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed by the Internal Revenue Service.

 

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