EGTRRA PLAN RESTATEMENT

As you know, over the past decade, Congress, the IRS and the DOL have made numerous changes to retirement plan rules.  All of these changes must be incorporated in your plan documents. 

Your plans have already been amended for many of these changes – including the GUST restatement in 2001-2003, the EGTRRA good faith amendment in 2002-2003, the final 401(a)(9) regulations for defined contribution plans (Post-EGTRRA amendment) in 2003, the automatic rollover amendment in 2005 and the final 401(k)/401(m) regulations amendment in 2006.  These have all been legally required amendments.

The way the process works is that Congress passes laws, and years later, the IRS and DOL finally decide what specific language must be included in retirement plans to meet the various requirements of the legislation. From 2005 through 2007, the IRS issued guidance as to the more detailed EGTRRA language it will require to be included in defined contribution plans.  Our base plan document has been updated for these EGTRRA changes and has been submitted to the IRS for its approval.  We do not expect to receive formal IRS approval until the first or second quarter of 2008.

Sometime between 2008 and 2010, after the IRS approves the EGTRRA documents, all 401(k) and other defined contribution plans will have to be completely restated to incorporate the changes from the 2001 EGTRRA legislation and other post-EGTRRA laws and regulations.  This restatement will consolidate the "good faith" amendments described above and also add the additional, legal language required by the IRS. 

Over the last year, we have been developing internal procedures for handling this restatement with the least possible inconvenience to you.  We are currently in the process of sending out individual correspondence describing the restatement process and the related fees. As always, we remain committed to providing high-quality, cost-effective service.

 PARTIAL TERMINATION OF PLAN

In the summer of 2007, the IRS issued guidance (Rev. Rul. 2007-43) relating to "partial terminations" of qualified retirement plans.  The guidance provides that a partial termination is presumed to occur whenever the "turnover rate" for the plan is at least 20% during a plan year.  This is important because if a partial termination occurs, all participants who terminated during the plan year will become 100% vested in their account balance/accrued benefits.

Under the IRS guidance, the turnover rate is determined by dividing the number of participants who have an "employer-initiated" termination during the plan year by the total number of active participants during the plan year.  An "employer-initiated" termination is defined to include generally any termination other than on account of death, disability or retirement on or after normal retirement age.  However, the employer may provide evidence (such as a written letter of resignation) that a termination was purely voluntary and thus not "employer-initiated".

Not every situation resulting in at least a 20% turnover rate will trigger a partial termination – it is a facts and circumstances test.  Factors such as the turnover rate for the employer during prior years and the extent to which terminated employees were replaced, whether the new employees performed the same functions, had the same job classification and title, and received comparable compensation, are all relevant factors to consider when determining whether a partial termination has occurred.

Because this is a fact-specific analysis, your plan administrative firm may ask you to provide additional information on any terminations reported on your census.  If you have any questions about these rules, please feel free to contact us.   

NORMAL RETIREMENT AGE

In May 2007, the IRS issued final regulations defining the permissible normal retirement age (NRA) for a pension plan (or for pension assets in a profit sharing or 401(k) plan).  The NRA cannot be earlier than age 62, or if earlier, the earliest age that is "reasonably representative of the typical retirement age for the industry in which the covered workforce is employed".  The regulations are generally effective for plan years beginning on or after July 1, 2008, that is, January 1, 2009 for calendar year plans.  Existing plans with NRAs lower than age 55 will have to be amended.  It is uncertain at this time how the rules will be applied to existing plans with NRAs between 55 and 62.  We will continue to monitor developments and contact you and your financial advisors as needed.

PENSION PROTECTION ACT OF 2006

As we noted last year, the Pension Protection Act  of 2006 (PPA) contains a number of wide-ranging changes. The summary below focuses on significant changes for 2007 and 2008.

For 2007 plan years, the maximum permitted deductible amounts for defined benefit pension plans have, in many cases, been increased to 150% of current liabilities, less plan assets.  Where an employer or affiliated employer group sponsors and contributes both to defined benefit and 401(k)/profit sharing plans, the deduction limit has been increased generally to the greater of (1) 31% of compensation of the participants benefiting under the plans or (2) the required defined benefit funding amount plus the amount contributed to the 401(k)/profit sharing plan up to 6% of compensation.  Salary deferral amounts are deductible in addition to this limit. 

Also for 2007 plan years: (1) If a plan permits participant direction of investments (even if participants do not actually choose to direct their investments), then the plan must prepare and distribute quarterly statements.  If your plan allows participant direction of investments, you should contact your plan administrative firm and investment advisor to be sure that these statements are being provided.  The penalty for failure to provide the statements can be up to $110 per day per participant. (2) The DOL and IRS are required to implement simplified Form 5500 reporting for plans with fewer than 25 participants.  However, this simplified reporting will not apply where the plan sponsor is part of an affiliated service/control group or uses leased employees. (3) Non top-heavy defined contribution plans must adopt one of the two basic top-heavy vesting schedules. (4) A non spouse beneficiary (including a trust) may rollover a distribution from a qualified plan directly to a rollover IRA.  Distributions from that rollover IRA are then treated like an "inherited IRA" under the minimum required distribution rules. 

For 2008 plan years, many new rules apply to defined benefit plans.  As of this date, it is unclear how some of these rules will actually be applied.  (1) Between 2008 and 2012, the interest rates used in calculating the present value of a participant's benefit in a defined benefit plan will change.  (2) Required funding contribution amounts will likely increase.  (3) Generally, if the value of plan assets is less than 80% of the plan's current liabilities, there will be restrictions on the payment of benefits in forms other than annuities, e.g. lump sums.  Further, neither benefit levels nor the value of benefits can be increased.  More stringent rules apply if the value of assets is less than 60% of the current liabilities.

We will continue to provide more information on the various PPA provisions in future newsletters.  If you have specific questions about any of these provisions, feel free to contact us.

 REHIRED EMPLOYEES

In virtually all plans, if you rehire an employee who previously worked for your business (or a predecessor or related business), her prior employment is counted in determining her eligibility for the plan.  This applies even if the prior employment occurred before the plan existed. This also applies even if the employee is only rehired on a "fill-in", temporary or part-time basis.  Normally, a rehired employee who had previously met the eligibility requirements is eligible immediately as of her date of re‑employment. 

The following examples illustrate this.  All examples assume a plan with 12 month/1000 hour eligibility requirement. 

 ·   Employee Betty worked for your business from 1990 through 1994 (and had over 1000 hours in a 12‑month period).  You established a retirement plan in 2003.  If you rehire Betty on October 1, 2007, she is eligible to participate in the plan immediately on October 1, 2007, her date of rehire. 

 ·   Employee Leslie was hired April 1, 2002 and worked until December of 2002.  When she quit, she had worked over 1000 hours.  If she is rehired on May 1, 2007, she is eligible to participate in the plan immediately on May 1, 2007, her date of rehire.  This is because more than 12 months has passed since her original hire date and she worked more than 1000 hours before she quit in 2002.

 ·   Employee Karen was previously a participant in the plan.  She terminates in March 2006 to stay home and take care of her children.  From June 1 through August 31, 2007, she comes back to work to fill-in for another employee who is out on temporary leave.  She is eligible to re-enter the plan on June 1, her date of rehire.  It does not matter that she is only employed on a fill-in basis. 

If a rehired employee is eligible and you have a safe harbor 401(k) plan, you must give her the Safe Harbor Notice and Salary Reduction Agreement form on her date of rehire.  You will also need to give her a copy of the current Summary Plan Description.  If you fail to do so, you will be required to make corrective contributions for the rehired employee in accordance with the IRS program known as Employee Plans Compliance Resolution System (EPCRS). These contributions will be immediately 100% vested.

For any rehired employees, we recommend that you contact your plan administrative firm or us immediately upon rehire to determine exactly when they will be eligible to participate.

 ROTH 401(K) PROVISIONS

Most of you who sponsor a 401(k) plan are now familiar with the Roth tax-planning feature that first became available in 2006.  Under the Roth feature, a participant may have an additional Roth 401(k) Account within your existing 401(k) plan.

 A.         Designated Roth Contributions

If your 401(k) plan has been amended to add the Roth feature, then Roth 401(k) Accounts are available to all participants.  A participant can prospectively designate that all or a portion of her salary deferrals will be made to a Roth 401(k) Account.  These deferrals are called "designated Roth contributions" or "DRCs". 

Like Roth IRAs, DRCs are made with after‑tax dollars.  DRCs are immediately 100% vested.  Any portion of salary deferrals that the participant does not designate as DRCs will be traditional pre‑tax 401(k) deferrals.  DRCs and pre-tax 401(k) deferrals are aggregated for purposes of the 402(g) limit (see discussion of 401(k) limit on page 4). 

 B.         Qualifying Distributions

If a distribution of a participant's balance in a Roth 401(k) Account is "qualified", then investment earnings are tax‑free.  This means that the participant will not pay any federal income tax (or capital gains) when she withdraws her Roth 401(k) Account balance from the plan. 

A distribution must satisfy two requirements in order to be "qualifying" - (1) the distribution must occur after attainment of age 59½, death or disability; and (2) the distribution must occur at least 5 years after the participant contributes her first DRC.  For example, if the participant made her first DRC in 2006, then the earliest "qualifying" distribution can be made on or after January 1, 2011 (assuming the first requirement is also satisfied).

Qualifying distributions can be taken in cash or rolled over to an individual Roth IRA or to a Roth 401(k) Account in another 401(k) plan.  Be aware that participants who roll out their total account balance under the plan will potentially have to establish two IRAs to receive the rollover - (1) a traditional IRA for pre-tax 401(k) deferrals and employer contributions and (2) a Roth IRA for DRCs.

If a distribution is "non-qualifying", then the investment earnings are subject to tax (though the participant may defer the tax by rolling over her Roth 401(k) Account as discussed above).  The IRS has issued regulations addressing how this tax will be calculated.  Any participant who is considering taking a "non-qualifying" distribution should consult a tax professional to review the tax consequences.

 C.         Administrative Requirements

There are many additional administrative steps that are involved in accounting for DRCs.  To highlight just a few:

First, participants must make a written election to designate their deferrals as DRCs in advance, before the wages are earned.  Normally, this would be done on the Salary Reduction Agreement form.  Participants can change their election in accordance with the plan's rules, but once deposited, pre-tax deferrals must stay in the pre-tax deferral account and DRCs must stay in the Roth 401(k) Account.  

Second, a participant's DRCs must be separately accounted for under the plan.  This is a separate "source" account maintained by the plan administrative firm and not a separate investment account.  A participant's Roth 401(k) Account must be maintained on the plan's records until it is fully distributed.  No other contributions or forfeitures can be allocated to the participant's Roth 401(k) Account.

 D.         Form W-2 Reporting

DRCs must be separately reported on a participant's Form W-2.  The IRS has instructed preparers to report DRCs in box 12 with code AA (pre-tax deferrals are reported with code D).  In addition, because DRCs are made with after-tax dollars, they should also be included in the amount of taxable compensation reported in box 1 of the Form W-2.

Because it is the employer who is responsible for the complete and accurate reporting of income on the Form W-2 (even if another entity actually prepares the W-2s), the employer should review with its payroll company or other tax professional that DRCs are being properly reported.  If incorrect information is reported on a Form W-2, the employer is subject to fines, which can be substantial, particularly since this might be considered to be tax fraud. 

 SAFE HARBOR NOTICE FOR 401(k) PLANS

The Safe Harbor Notice is the key document in the annual operation of a safe harbor 401(k) plan.  The notice describes in simple terms the major provisions of the plan.

A new participant must be given the Safe Harbor Notice (and preferably also the Summary Plan Description and Salary Reduction Agreement form) 30 to 90 days before her plan entry date.  Check your Summary Plan Description to identify the entry dates for your plan.  For most plans, the plan entry dates are the first day of the plan year and the first day of the 7th month of the plan year on or after the date the employee completes the eligibility requirements.  For calendar year plans, those entry dates are January 1 and July 1.  So, if a new participant will enter the plan on July 1, 2008, you should give her the Safe Harbor Notice sometime between April 2 and June 1 of 2008. 

In addition to providing the initial notice, a Safe Harbor Notice must be given annually to all plan participants.  The notice must be given 30 to 90 days before the plan year begins (thus, between approximately October 2 and December 1 for a calendar year plan).  Your plan administrative firm will assist you in providing this notice.

 CONSEQUENCES OF FAILURE TO GIVE NOTICE TIMELY

If you do not give an eligible employee (including a rehired employee) the Safe Harbor Notice timely and allow salary deferrals to be made, you have caused, at the very least, an operational error which should be corrected under the IRS program known as Employee Plans Compliance Resolution System (EPCRS).  This will result in increased funding costs and administrative and legal expenses to you.

 401(k) SALARY DEFERRAL (AND OTHER) LIMITS

The dollar limits for making salary deferrals to 401(k) plans (called the 402(g) limit) and the new "catch-up" rules continue to increase.  The catch-up rules allow plan participants who are 50 or older at any time during the year to make additional "catch‑up" salary deferrals.  For 2007, the 402(g) limit and catch-up limit are $15,500 and $5,000, respectively.  After 2007 the limits are indexed for inflation.

The IRS recently released the 2008 dollar limits:

402(g) limit                                                  $15,500

catch-up limit                                                $5,000

annual compensation limit                          $230,000

limit for defined contribution plan

     annual additions                                     $46,000

defined benefit plan dollar limit                  $185,000

 DEPOSITING 401(k) DEFERRALS

The assets of your 401(k) plan include the amounts that participants have requested your business withhold from their wages to defer into the plan.  DOL regulations state that participant salary deferrals (including DRCs, if applicable) must be transmitted (i.e., deposited into or a check mailed) to the plan trust account as of the earliest date on which it is reasonably possible to do so. 

We continue to recommend that you transmit participant salary deferrals as soon as practical after they are withheld from the participants' paychecks, but in no event later than 7 days after the pay date.  Please give your financial advisor, plan administrative firm or us a call if you have any questions.

Please be aware that the DOL is taking a much more proactive role in policing the late deposit of salary deferral amounts.  Thus, you may receive a letter from the DOL regarding salary deferral amounts that have been reported as late on Form 5500.  Generally, the DOL letter will invite you to participate in a voluntary correction program.  However, in some cases, plan sponsors are being notified that their plan has been selected for an audit.  If you are contacted by the DOL, we recommend that you contact your plan administrative firm or us immediately.

 NON-TRADITIONAL INVESTMENTS

There are many legal issues that arise in connection with any "non-traditional" investments.  Basically, this includes any investment that is not in publicly traded stocks, bonds, mutual funds or qualified group pooled trusts. Examples include real estate investments, partnership interests, non-publicly traded stocks or loans.  With respect to plan investments, we see three legal issues that often require analysis - fiduciary duties, prohibited transaction rules and plan asset regulations.  In addition, there are administrative issues concerning valuation and reporting of the non-traditional asset.

 If you are considering investing plan assets in a "non-traditional" investment, please contact your financial advisor or us for a general review of the legal issues.  In certain circumstances, we may also advise a more thorough analysis of your specific facts and circumstances.

 CHANGES IN YOUR BUSINESS OPERATION AND/OR CONTACT INFORMATION

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This newsletter contains general information and should not be used to resolve legal questions regarding specific fact situations.