Article by Rick Arenburg, Armin Brecher , Paul Concannon, Ed Emerson, Cass Hollis , Chris Rylands, Steve Schaffer and Stacey Stewart
The Pension Protection Act of 2006 ("PPA"), which was signed into law on August 17, 2006, made many significant changes to laws affecting defined contribution plans. This Client Alert briefly describes the PPA changes applicable to defined contribution plans that plan sponsors should consider now for implementation in 2007.
Accelerated Vesting. Employer contributions for plan years beginning after 2006 must vest at least as rapidly as either a threeyear cliff vesting schedule (100% vested after three years of service) or a six-year graded vesting schedule (20% vesting for each year of service beginning with the second year of service). These vesting schedules are already required for employer matching contributions. Special rules apply to collectively bargained plans and to leveraged employee stock ownership plans ("ESOPs") that have an outstanding acquisition loan as of September 26, 2005.
Right to Diversify Employer Securities and Diversification Notice Requirements. For plan years beginning after 2006, defined contribution plans of publicly traded companies that hold publicly traded employer securities must allow participants to diversify account balances that are invested in employer securities. Generally, the new rules provide that participants must be able to immediately diversify the investment of elective deferrals and after-tax contributions. Participants who have completed three years of service must be permitted to diversify the investment of any employer contributions (subject to certain transition rules). Plans must offer at least three diversified investment options other than employer securities to which amounts can be directed and plans must permit diversification elections to be made at least quarterly. Defined contribution plans that already permit greater diversification of employer securities than imposed by these new requirements are not exempt from these new rules or the diversification notice requirement described below. The diversification and notice requirements, however, do not apply to an ESOP if the ESOP (i) does not hold any 401(k) contributions, after-tax contributions or employer matching contributions, and (ii) the ESOP is a separate plan.
The IRS recently issued IRS Notice 2006-107, which provides transitional guidance to assist plan sponsors in complying with the new requirements. For the period from January 1, 2007 through March 30, 2007, a plan will not be deemed to be in violation of the new requirements if the plan restricts diversification rights with respect to employer securities pursuant to a plan provision that was in effect on December 18, 2006. Other more limited transitional guidance is also available for certain investments under IRS Notice 2006- 107.
In general, plans are required to provide notice to participants of their right to diversify at least 30 days before the date the participants become eligible to diversify. IRS Notice 2006-107 provides limited transition relief for the diversification notice for plans with plan years beginning on or after January 1, 2007, but before February 1, 2007. In IRS Notice 2006-107, the IRS indicated that the DOL has advised the Treasury and the IRS that ERISA does not require plans to furnish the diversification notice before January 1, 2007. This means that calendar year plans (and other plans with plan years beginning before February 1, 2007) must provide the diversification notice no later than January 1, 2007. The DOL may assess a penalty of up to $100 a day per participant for failure to provide the diversification notice. IRS Notice 2006-107 also includes a model diversification notice.
Automatic Enrollment and Preemption of State Law. Certain state wage and hour laws have restricted or precluded deductions from employees’ wages pursuant to an automatic enrollment feature. The PPA amends ERISA, effective upon enactment (August 17, 2006), to explicitly provide that ERISA preempts any state wage and hour law that directly or indirectly prohibits or restricts an automatic enrollment feature in defined contribution plans, provided that certain requirements are met. To qualify for ERISA preemption, however, the plan sponsor must notify employees of their rights and obligations under the automatic enrollment arrangement, including their right to opt out of the arrangement or to elect to have contributions made at a different percentage. Employers must give employees a reasonable amount of time, after receipt of the notice and before the first elective contribution is made, to make such election. The notice must also describe default investment options for the automatic contributions. The PPA has also added a new optional nondiscrimination safe harbor plan design using automatic enrollment effective for plan years beginning after 2007.
Changes in Notice and Consent Requirements for Distributions. Prior to the PPA, the notice and consent rules for distributions required that distribution notices had to be given to the participant no less than 30 and no more than 90 days before the distribution commenced. Beginning in 2007, the 90-day period has been extended to 180 days. In addition, the PPA provides that the notice must describe the consequences of the failure to defer receipt of the distribution.
Default Investment Alternatives. As we reported in our October 20, 2006 Client Alert, the PPA has added a new fiduciary safe harbor under Section 404(c) of ERISA for certain default investments, effective for plan years beginning after December 31, 2006. The Department of Labor ("DOL") has issued proposed regulations which define default investment guidelines; however, the regulations will not become effective until after the DOL issues final regulations.
Direct Rollovers for Non-Spouse Beneficiaries. For distributions made after 2006, the PPA allows non-spouse beneficiaries to elect a direct rollover to an IRA. The IRA will be treated as an "inherited IRA" and the inherited IRA minimum distribution rules will apply.
Expansion of Hardship Rules. The PPA directs the IRS to modify the rules for hardship distributions to provide that if an event would constitute a hardship under the plan if it happened to the participant’s spouse or dependent, the event must, to the extent permitted under the plan, constitute a hardship if the event occurs to the participant’s beneficiary under the plan.
New Benefit Statement Requirements. Plans which provide participants the right to direct their own investments must provide benefit statements to participants at least once each calendar quarter. Other plans may still provide benefit statements annually. This requirement generally is effective for plan years beginning on or after January 1, 2007. The benefit statements must include information about the participant’s total account balance and the portion of the account that is vested (and the earliest date that amounts will become vested), the value of each investment to which assets in the participant's account have been allocated (including employer securities), an explanation of any limitation or restriction on the right to direct investments and the importance of diversification, including a warning of the risk of holding more than 20% in the security of one entity. In addition, the participant must be directed to the DOL’s Web site for additional information on investing and diversification. The DOL has been directed to issue a model benefit statement.
EGTRRA Provisions. The PPA made permanent the provisions under the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") which are currently effective for defined contribution plans. Some of these provisions increased annual contributions limits, catch-up contributions, and increased portability between eligible retirement plans. These provisions were scheduled to sunset for plan years after 2011.
If you have any questions or would like our assistance in complying with the new PPA requirements, please contact any member of our Employee Benefits and Executive Compensation group.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.