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PENSION PROTECTION ACT OF 2006
Since 2006 our newsletters have described various
provisions of the massive legislation known as the Pension Protection Act
(PPA). The PPA rules continue to have
substantial impact on the operation of plans, particularly on defined benefit
plans - both as to required funding and making distributions.
In virtually all cases there is a range of
deductible funding each year, with a minimum and maximum funding amount. This will often allow employers to
contribute and deduct certain amounts in advance of the benefits actually being
earned (this is referred to as a "cushion amount").
A plan's funded status is determined annually by
calculating plan liabilities and comparing that to the value of the plan
assets. The plan actuary must
formally "certify" the funding status by the 1st day of the fourth
month of each plan year (i.e., April 1 for a calendar year plan). If plan liabilities exceed assets, the
plan has an asset "shortfall".
Where there is an asset shortfall, a contribution must be made to
pay off the shortfall, normally over a seven-year period. This shortfall funding amount is in
addition to the minimum required funding amount which equals the cost of the
benefits earned by participants during the year and is required even if the plan benefits have been frozen. Where 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.
As you can see, these funding rules are complicated
and the plan's funding status can have dramatic ramifications. Because of this, it is very important
to keep in touch with your financial advisor, us and your administrative firm
if your financial situation changes.
Even though the various PPA provisions have become
effective over the last several years, the IRS did not require qualified plans to
adopt "good faith" amendments to comply with PPA until the last day
of the 2009 plan year (i.e., December 31, 2009 for a calendar year plan). We have prepared those amendments for
all of our clients. If you have specific questions about your
PPA amendment or any of the PPA provisions, feel free to contact us.
EGTRRA PLAN
RESTATEMENT
For the past several years we have kept you apprised
about the required restatement of all qualified retirement plans to incorporate
the 2001 EGTRRA legislation and various post-EGTRRA laws and regulations. The deadline for restating (and filing,
if applicable) all 401(k) and other defined contribution
plans is
April 30, 2010. However, because
of the PPA amendment described above, we encouraged plan sponsors to adopt the
EGTRRA restatement before December 31, 2009, and in fact, most of our clients
have now adopted this required restatement.
It is now time to shift our focus to defined
benefit plans. Sometime between 2010 and 2012, after the
IRS approves our EGTRRA base plan document, all defined benefit plans (including
frozen plans) will have to be completely restated for EGTRRA. As with the defined contribution plans,
this restatement will consolidate the "good faith" amendments that
have been adopted over the last several years and also add the additional, legal
language required by the IRS.
Over the next year, we will be reviewing all
defined benefit plans and sending out individual correspondence describing the
restatement process and the related fees. As
always, we remain committed to providing high-quality, cost-effective service.
DISTRIBUTIONS
AND INTERIM VALUATIONS
Over the past two years, we have experienced
unusual and unsettling financial times.
We have seen heightened focus on plan fiduciaries and their investment
and other plan management decisions.
Both the plan administrator and trustee(s) are fiduciaries. As such, they must operate the plan in
the best interests of all participants and beneficiaries.
We continue to believe that a key issue for
fiduciaries involves the impact to the plan whenever a participant is to be
paid out of the plan, either on account of termination of employment or as an
in-service distribution. In plans
with pooled investments, the plan assets are generally valued annually. Any distribution from the plan is based
on the value of the plan assets as of the latest valuation. Considering all of the facts, it may
not be prudent to make distributions based on the prior year's annual valuation
(e.g., the prior December 31 value of the participant's account for a calendar
year plan). Whenever a participant
is eligible to receive a distribution from the plan, the plan fiduciaries
should consider whether an interim valuation of the plan is warranted in order
to avoid a disproportionate share of the extraordinary investment losses (or
gains) being allocated to the remaining participants in the plan.
We recommend
that you contact your plan administrative firm and your financial advisor to
discuss this option prior to making any substantial distribution from the plan.
DOCUMENTATION
OF FAMILY ON PAYROLL
In many small businesses family members provide
personal services to the business.
Like other employees, they can be compensated for their services and
contributions to the business' retirement plans can be made on their behalf. That compensation and any plan
contributions are legitimate deductions for the business, but only so long as the services are ordinary and necessary to the
business and the total compensation is reasonable for the personal services
provided.
It is important to document that the rate of
compensation for any family member on the payroll is comparable to the rates
paid to other employees performing similar functions. We also believe it is important to maintain a personnel file
for any family members/employees and keep track of the hours they spend performing
services related to the business by maintaining an accurate time log. If
you have questions about this, we recommend that you contact your tax and/or
financial advisor.
PARTIAL
TERMINATION OF PLAN
Many of our clients have now had some experience
with the "partial termination" rules applicable to qualified
retirement plans. IRS guidance provides that a partial
termination is presumed to occur whenever 20% or more of the active
participants in the plan terminate employment during a plan year. These rules are important because if a
partial termination occurs, according to the IRS guidance, all participants who terminate during the plan year will become
100% vested in their account balance/accrued benefits.
The partial termination rules are only concerned
with "employer-initiated" terminations. An "employer-initiated" termination is defined to
include generally any termination other than on account of death,
disability or retirement on or after the plan's normal retirement age. However, the employer may provide
evidence that a termination was purely voluntary and thus not
"employer-initiated".
Because of this, we recommend that you obtain a written letter of
resignation whenever possible, or in the absence of such written notice, that
you document the participant's personnel file with detailed information
regarding the reason for the termination.
Not every situation in which at least 20% of the
participants terminate employment will trigger a partial termination – it
is a facts and circumstances test.
Factors such as turnover 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 received
comparable compensation, are all relevant factors to consider when determining
whether a partial termination has occurred.
Because it 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 questions about these rules, please feel free to contact us.
REHIRED
EMPLOYEES
Rehired
employees continue to provide challenges for our clients and their plans. In virtually all plans, if you rehire
an employee who previously worked for your business (or a predecessor or
related business, such as a prior sole proprietorship), 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 and would
enter the plan on that date. She
does not have to wait until the next regular entry date.
If a
rehired employee is eligible and you have a 401(k) plan, you must give her the
Salary Reduction Agreement form on her date of rehire (safe harbor plans must
also provide the Safe Harbor Notice for the current year on the same
date). 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.
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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. Generally, your plan administrative
firm will assist you in providing this notice.
If
you do not timely distribute the annual Safe Harbor Notice to all
participants, including each newly
eligible employee and rehired employees, and allow salary deferrals to be
made, you have caused, at the very least, an operational error which must be
corrected. The IRS program known
as the Employee Plans Compliance Resolution System (EPCRS) sets out an
appropriate correction method and involves making corrective contributions for
the affected employee(s). This
will result in increased funding costs and administrative and legal expenses to
you. If you have
questions about which employees are eligible to participate in the plan, we
recommend you contact your financial advisor, plan administrative firm or us
for assistance.
ROTH 401(k) PROVISIONS
If you sponsor a 401(k) plan with the Roth
(after-tax) feature, then a participant is able to 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".
Any portion of salary deferrals that the participant does not designate
as DRCs will be traditional pre‑tax deferrals.
Distribution
Rules: Because the tax
consequences of a distribution from a participant's Roth 401(k) Account are
different from those of the participant's other plan accounts, the IRS has
adopted special rules applicable to distributions from Roth 401(k)
Accounts. These rules establish
whether a Roth distribution is "qualified", meaning the investment
earnings are tax‑free, or
"non‑qualifying", meaning the investment earnings are subject
to tax. These rules also establish
certain procedures that must be followed whenever a participant's distribution
involves rolling over her Roth 401(k) Account to an individual Roth IRA or to a
Roth 401(k) Account in another 401(k) plan.
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. 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.
401(k)
SALARY DEFERRAL (AND OTHER) LIMITS
The IRS establishes annual
limits on amounts that can be contributed to retirement plans. Because the government cost of living
index declined during 2008-2009, most of these limits did not increase for
2010. For 2009, the dollar limits
for making salary deferrals to 401(k) plans (called the 402(g) limit),
including "catch-up" contributions, are $16,500 and $5,500,
respectively. These limits apply to a participant's combined pre-tax deferrals and
DRCs, if applicable. "Catch-up"
contributions are additional deferrals that participants who are age 50 or
older at any time during the year can
make to a 401(k) plan.
The 2010 dollar limits as
published by the IRS are below. These limits are indexed for inflation after
2010.
402(g) limit $16,500
Catch-up limit
$5,500
Annual compensation limit $245,000
Defined contribution plan
dollar limit $49,000
Defined benefit plan
dollar limit $195,000
DEPOSITING 401(k) DEFERRALS
The assets of your 401(k) plan include
participants' salary deferrals (including DRCs, if applicable). Department of Labor (DOL) regulations
state that such deferrals must be
separated from the assets of the employer (i.e., transmitted to the plan
trust account) as of the earliest date on which it is reasonably possible to do so.
As discussed in last year's newsletter, the DOL
issued guidance in 2008 establishing a safe harbor to meet the "earliest
date" standard. Consistent
with our prior recommendations, the DOL considers participant salary deferrals
to be timely separated if transmitted to an account of the plan no later
than 7 business days after the pay date. This safe harbor also
applies to loan payments (see next article) withheld from a participant's pay. It is important to remember that this
DOL guidance establishes a "safe harbor" for timeliness;
it does not override the general rule.
Thus, while we recommend you meet the 7 business day standard
whenever possible, just because an amount is deposited outside of the safe harbor
time period does not necessarily make the deposit late. As is always the case with the DOL, it
is a facts and circumstances determination.
Please be aware that the DOL continues to take a
proactive role in policing the late deposit of salary deferral (and loan
payment) amounts. Thus, you may
receive a letter from the DOL regarding salary deferral amounts that have been
reported as late on the plan's 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.
PLAN LOANS TO PARTICIPANTS
Some plans allow loans to
be made to participants. The
Internal Revenue Code and IRS regulations place many precise rules and
restrictions on the making and repayment of loans. If any of the loan restrictions are violated, the entire
loan could be treated as a taxable distribution to the borrower
participant. Because of the complexities and
serious consequences of improper loans, you must contact your plan
administrative firm to prepare the documentation for any loans from the plan.
Repayment
of a participant loan must begin within
90 days of the date it is made, according to the repayment schedule. The trustee(s) of the plan is
responsible for collecting the payments on a timely basis. If payments are not made according to
the loan terms, the entire outstanding balance of the loan, plus accrued
interest, will be in default and considered to be a taxable distribution to the
borrower. This means that it will be reported as
current taxable income subject to tax at the participant's current tax rate and
an additional 10% penalty tax may also be assessed. In addition, the
loan may still have to be repaid.
The only way to avoid these adverse tax consequences once a loan is in
default is for the plan sponsor to file a costly and timely application with
the IRS under its voluntary correction program which is part of the Employee
Plans Compliance Resolution System.
NON-TRADITIONAL
INVESTMENTS
Several legal issues can arise where
"non-traditional" investments are made by qualified plans. 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 the investment decision, we have identified
three broad legal issues that often
require analysis - fiduciary duties, prohibited transaction rules and plan
asset regulations. In addition,
non-traditional investments raise administrative issues concerning valuation
and reporting of the non-traditional asset and the required coverage amount
under the plan's ERISA bond.
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
Any change in your business structure
(incorporation, new partner, split in partnership, etc.) or establishment or purchase
of an interest in another business may impact your qualified retirement
plan. Please let us know about any purchase of a business interest or change
in your business structure as soon as possible. Also, please notify us of any changes regarding your office,
mailing or email address, your telephone or fax number (including area code), or
your plan advisors so that we may keep our records up to date.
This newsletter contains general information and
should not be used to resolve legal questions regarding specific fact
situations.
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