ERISA Conference 2006 September 5 6, 2006

1
ERISA Conference 2006September 5 6, 2006
July Business Services
Presented by

• Charles Lockwood
• ASC Institute
• Littleton, CO
• clockwood_at_asc-net.com

2
Pension Protection Act of 2006

• Congress passed Pension Protection Act of 2006
  (PPA) on August 3, 2006
• Signed into law by President Bush on August 17,
  2006
• PPA contains numerous changes affecting qualified
  plans and IRAs
• Over 800 of the 900 total pages of the bill deal
  with pension provisions
• Bulk of changes deal with funding rules for DB
  plans also contains significant changes
  affecting DC plans
• PPA becomes effective at various times depending
  on specific provision

3
Pension Protection Act of 2006

• Most of the provisions under PPA are designed to
  protect and enhance continued use of defined
  benefit and hybrid plans
• However, significant provisions apply to defined
  contribution plans, including 401(k) plans
• Automatic enrollment
• ADP/ACP testing provisions
• Default investment provisions
• Faster vesting for employer contributions
• Investment education provisions

4
Pension Protection Act of 2006

• EGTRRA permanency EGTRRA will no longer sunset
  in 2010
• Major provisions under EGTRRA affected by
  elimination of sunset
• Increased deferral/Code 415/IRA limits
• Catch-up contributions
• Roth deferrals
• EGTRRA deduction rules
• Portability of distributions
• Simplification of top-heavy rules
• Loans to owners, partners, sole proprietors
• Savers Tax Credit due to expire in 2007
• Repeal of multiple use test

5
Automatic Enrollment

• Congress/IRS are encouraging 401(k) plans to add
  automatic enrollment features

Actual results from employees between 3 and 15
months tenure. Study by Professor Brigitte
Madrian, University of Pennsylvanias Wharton
School and Dennis Shea, United Health Group
6
Automatic Enrollment SH Plan

• New safe harbor 401(k) plans no ADP/ACP testing
  or top heavy test
• Must have automatic enrollment provisions
• Automatic enrollment provisions do not apply to
  EEs who already have affirmative election in
  place
• Each EE must have opportunity to change
  automatic contribution
• First year must provide automatic deferral
  between 3 and 10 of compensation
• 2nd year must be at least 4 of comp
• 3rd year must be at least 5 of comp
• 4th year and following must be at least 6 of
  comp

7
Automatic Enrollment SH Plan

• New safe harbor 401(k) plans no ADP/ACP testing
  or top heavy test
• ER must make safe harbor contribution
• 3 nonelective contribution
• Matching contribution equal to 100 on first 1
  deferred 50 of deferrals between 1 and 6 of
  compensation
• Can provide enhanced match 100 on deferrals up
  to 3½ of compensation
• Can provide additional SH match and not be
  subject to ACP test as long as satisfy
  requirements for ACP safe harbor
• Cannot match deferrals above 6 of comp
• No higher rate of match for HCE

8
Automatic Enrollment SH Plan

• New safe harbor 401(k) plans no ADP/ACP testing
  or top heavy test
• Can apply 2-year vesting schedule to safe harbor
  contributions
• Presumably cannot have allocation conditions on
  safe harbor contributions
• Must provide annual notice to participants
• Effective for 2008 plan year

9
Automatic Enrollment SH Plan

• Employers will be required to provide annual
  written notice to participants explaining
• right to opt out of contributing
• the method for making or modifying their deferral
  election, and
• how a participants contributions will be
  invested if the participant fails to make any
  investment election
• Employer will be treated as complying with ERISA
  404(c) if provide approved default investment
  option

10
Default Investment Funds

• PPA requires DOL to issue regulations providing
  fiduciary relief for default investments within 6
  months
• Will apply to all self-directed plans not just
  automatic enrollment plans
• If provide adequate notice to participants, no
  fiduciary liability for investment in approved
  default funds
• Expected guidance is expected to create a new
  Qualified Default Investment Alternative (QDIA)
• Employer will still retain duty to monitor QDIA

11
Default Investment Funds

• QDIA
• Life-cycle fund, balanced fund or managed account
  
• Managed by investment manager or registered
  investment advisor
• Limitations on employer stock
• Life cycle / managed account based on
  individuals age, etc.
• Balanced fund based on plan participants as a
  whole

12
Other Automatic Enrollment Rules

• Automatic enrollment plan may distribute
  erroneous contributions
• EE must elect within 90 days after first payroll
  period that automatic enrollment took effect to
  have deferrals distributed
• Amounts distributed would not be counted in ADP
  test, would not be subject to 10 penalty, and
  would be treated as comp
• Distributions of erroneous contributions must
  be made by April 15 of following year
• PPA clarifies that ERISA preempts state laws that
  directly or indirectly prohibit automatic
  enrollment plans

13
ADP/ACP Testing Provisions

• Automatic enrollment plans may make ADP/ACP
  refunds up to 6 months after end of PY without
  10 excise tax
• PPA does not extend this provision to
  non-automatic enrollment plans
• Automatic enrollment plan must meet default
  investment and notice requirements
• Refunds made within 2½ correction period are
  taxed in year of distribution
• No more taxation in prior plan year
• Also applies to automatic enrollment plans if
  refunds made within 6 months after end of plan
  year

14

Gap Period Earnings

• Plan may use any reasonable method for
  determining earnings
• ADP test Earnings for PY attributable to
  elective deferrals multiplied by
• excess contributions for PY
• A/B attributable to deferrals
• ACP test Earnings for PY attributable to
  match/EE contribution multiplied by
• excess aggregate contributions for PY
• A/B attributable to match/EE contributions
• Include contributions for PY that are contributed
  after close of year

15

Gap Period Earnings

• For 2006 PY, corrective distributions must
  include gap period earnings if there is a
  valuation date in gap period
• Biggest impact on daily valued plans
• Determining gap period earnings
• Any reasonable method
• Alternative method taking into account earnings
  in gap period
• 7-day safe harbor rule
• Safe harbor method taking into account 10 of
  earnings earned in prior PY for each month
  during gap period
• Additional month calculated if distribution made
  after 15th day of month

16

Gap Period Earnings

• Final 401(k) regulations require corrective
  ADP/ACP distributions to include gap period
  earnings
• Prop. regs issued under Code 402(g) apply same
  rules to corrective distributions of excess
  deferrals
• Appears that gap period rules are now being
  overridden by PPA rules eliminating gap period
  earnings
• PPA elimination of gap period earnings not
  effective until 2008 unless IRS issues
  additional guidance, will have to include gap
  period earnings for 2006 and 2007

17
ADP/ACP Testing Provisions

• No gap period earnings required for corrective
  refunds from 401(k) plans
• Overrides requirement in final 401(k) regulations
  to require gap period earnings
• Effective date 2008 plan years
• Gap period income will be required for 2006 and
  2007 corrective refunds
• Refunds made within 2½ month correction period
  for 2006 and 2007 will be taxed in prior year

18
Distribution Provisions

• Hardship distributions can be made available for
  hardship of a beneficiary (e.g., domestic
  partner)
• IRS to issue regulations within 180 days
• Non-spouse rollovers non-spouse beneficiary
  will be able to rollover death distribution to
  IRA
• Effective for distributions made after 2006
• Expands ability to rollover after-tax
  contributions to other plans (e.g., qualified
  plan to 403(b) plan)
• Must be a direct rollover and other plan must
  maintain separate account

19
Distribution Provisions

• Can rollover plan distributions to Roth IRA
  provided qualify for conversion (e.g., AGI below
  100,000)
• Effective in 2008 beginning in 2010 can convert
  without regard to AGI restrictions
• Distribution is subject to taxation at time of
  distribution
• 10 early distribution penalty does not apply to
  taxable amount (to extent rolled over to Roth
  IRA)
• Distribution notices and explanations must be
  made between 30 and 180 days prior to
  distribution
• Effective for 2007 plan years

20
Distribution Provisions

• Pension plans are permitted to make in-service
  distributions after attainment of age 62
• Effective for plan years beginning after 2006
• Creates new qualified optional survivor annuity
  in addition to QJSA
• Annuity for life of participant with survivor
  annuity for life of spouse
• If survivor annuity under QJSA is less than 75,
  survivor annuity is 75
• If survivor annuity under QJSA is greater or
  equal to 75, survivor annuity is 50.
• Effective for plan years beginning after December
  31, 2007

21
Distribution Provisions

• Exception to 10 early withdrawal tax for
  qualified reservist distribution
• Distribution made to reservist called to active
  duty for more than 179 days
• Distribution must be made during the period
  beginning on date of such order and ending at
  close of active duty period
• Distribution does not violate 401(k) or 403(b)
  plan distribution restrictions
• Individual may repay such distribution to an IRA
  within 2 years following active duty
• Applies to individuals ordered or called to
  active duty between 9/11/2001 and 12/31/2007

22
Missing Participants

• Single-employer plans that terminate under
  standard termination must either purchase an
  annuity for missing participants or transfer
  assets to PBGC
• Under PPA, the missing participants program is
  extended to DC plans and other DB plans not
  subject to PBGC coverage
• Effective for distributions made after final
  regulations implementing the provision are
  published

23
Deduction Rules

• Overall 25 limit on deductions for contributions
  to DB/DC plans applies only to extent such
  contributions exceed 6 percent of compensation
• Will allow ERs to establish safe harbor 401(k)
  plans along with DB plans to take advantage of
  deductibility of salary deferrals
• Effective for contributions for taxable years
  beginning after December 31, 2005

24
Accelerated Vesting

• PPA subjects all ER contributions to same vesting
  requirements as applies to matching contributions
• Three-year cliff vesting
• Six-year graded vesting
• All YOS, including those before effective date of
  new requirements, must be taken into account
• Effective for Plan Years beginning after December
  31, 2006
• Only applies to participants with at least one
  hour of service after effective date

25
Reporting Requirements

• IRS is directed to modify the annual return
  filing requirements to raise plan asset
  requirement for 5500-EZ filings to 250,000
• IRS and DOL are directed to provide simplified
  reporting requirements for with fewer than 25
  participants
• Effective for 2007 plan year filings

26
Reporting Requirements

• PPA requires quarterly benefit statements if
  participants are allowed to direct investment
  otherwise only required annually
• Benefit statements must include
• Total value of benefits accrued
• Value of each investment to which assets in the
  participants account are allocated
• Participants vested accrued benefit
• Explanation of any limits or restrictions on
  participants right to direct investments
• Explanation of importance of a well-balanced,
  diversified investment portfolio

27
Diversification Requirements

• DC plans must permit participants, including
  beneficiaries, to diversify investments in
  publicly-traded employer securities
• Applies to deferrals, ER contributions and
  matching contributions
• Does not apply to ESOPs (unless have
  deferrals/match)
• Effective for plan years beginning after December
  31, 2006
• Diversification requirements phase in through
  2009 for participants under age 55

28
Diversification Requirements

• Applies to all investments in publicly-traded
  employer securities that are attributable to
  salary deferral or after-tax employee
  contributions
• Applies to employer contributions and matching
  contributions only if participant has at least 3
  YOS
• Also applies to beneficiaries of such
  participants and beneficiaries of deceased
  participants

29
Diversification Requirements

• ESOPs are not subject to the diversification
  requirements
• ESOP may not hold any contributions used to
  satisfy the ADP or ACP tests (e.g., deferrals or
  matching contributions)
• If subject to diversification requirements
  overrides ESOP diversification rules
• ESOPs subject to new diversification requirements
  will not violate primarily invested requirement

30
Diversification Requirements

• Plan must provide choice of at least three
  investment options (other than ER securities)
  with materially different risk and return
  characteristics
• Participants must be able to reinvest at least
  quarterly generally must be given same
  investment election opportunities as other
  investment options under the plan
• ER must provide notice to participants at least
  30 days before first date participant has right
  to diversify
• Notice must explain right to diversify and
  importance of diversifying
• IRS directed to publish model notice

31

The Changing Landscape

• More and more providers are taking on some level
  of fiduciary responsibility
• Companies are beginning to recognize the
  importance of educating their EEs
• PPA provides new prohibited transaction exemption
  for advice provided by fiduciary adviser under
  an eligible investment advice arrangement
• Prohibited transaction exemption becomes
  effective with respect to investment advice
  provided after December 31, 2006

32

PT Exemption for Investment Advice

• Permits ERs to arrange for investment advice to
  be provided to participants while shielding ER
  from liability for investment advice that is
  actually provided
• Permits financial service firms who provide
  investment advice to plan participants to market
  their own investment funds to plan participants
  without violating ERISA
• Permits investment advisors to receive reasonable
  fees for provision of investment advice to
  participants

33

Fiduciary Advisor

• Registered Investment Adviser (RIA)
• Bank or similar financial institution, subject to
  periodic examination and review by federal or
  state banking authorities
• Insurance company
• Registered broker/dealer
• An affiliate or employee of above entities
• Person who develops the computer model

34

Investment Advice Arrangement

• Investment Advice Arrangement must meet one of
  two requirements
• Fees received by fiduciary adviser may not vary
  on basis of which investment options are chosen,
  or
• Computer model must be used which meets certain
  conditions and must be approved by independent
  fiduciary
• Arrangement must be reviewed each year by
  independent auditor and receive written audit
• Participants must receive annual written
  notification describing nature of investment
  advice arrangement

35

Investment Advice Arrangement

• Written notice must be provided to EEs stating
  (among other things)
• Past performance and historical rates of return
  of the available investment options
• All fees or other compensation the fiduciary
  adviser will receive in connection with the
  investment advice
• Any material affiliation or relationship between
  fiduciary adviser and any security or other
  property involved in a transaction
• That, by providing investment advice, fiduciary
  adviser is acting as fiduciary
• That participant may obtain advice from another
  adviser

36

Prohibited Distributions

• Underfunded DB plan may not make prohibited
  payment
• If plans adjusted funding target attainment
  percentage for a PY is less than 60, plan may
  not make any prohibited payments after valuation
  date for the plan year.
• If plans adjusted funding target attainment
  percentage for a PY is between 60 and 80, plan
  may not make any prohibited payments that exceed
  the lesser of
• 50 of amount otherwise payable under the plan,
  or
• present value of maximum PBGC guarantee with
  respect to participant

37

Prohibited Distributions

• Prohibited payment is defined as any payment in
  excess of the monthly amount paid under a single
  life annuity or any payment for the purchase of
  an annuity contract
• Funding target attainment percentage is the
  ratio, expressed as a percentage, that the value
  of the plans assets bears to the plans funding
  target for the year

38

Prohibited Distributions

• A plans adjusted funding target attainment
  percentage is presumed to be the same as for
  preceding year until plan actuary certifies the
  plans actual adjusted funding target attainment
  percentage for the current year
• If the plan actuary has not certified the plans
  actual adjusted funding target attainment
  percentage by the first day of the tenth month of
  the current plan year, the plans adjusted
  funding target attainment percentage is presumed
  to be less than 60

39
Deduction Rules

• Increases amount available for deduction under
  single-ER defined benefits plans to 150 of
  unfunded liability (for 2006 and 2007)
• Can determine deduction limit without regard to
  DB plans covered by PBGC
• 10 excise tax does not apply to DC plan that
  violates combined limit except for matching
  contributions
• ERs may establish SH 401(k) plans along with DB
  plans to take advantage of deductibility of
  salary deferrals
• Effective for 2008 taxable years

40

Eligible Combined Plan DB(k)

• PPA provides for new type of eligible DC/DB
  combined plan
• Maintained by small employer (less than 500 EEs)
  at time plan established
• Assets are held in a single trust
• Must meet certain benefit, contribution, vesting
  and nondiscrimination requirements
• DB and DC plans treated as separate plans for
  funding, nondiscrimination and distribution rules
• Plans are treated as single plan for Form 5500
  filing purposes
• Effective for 2010 plan years

41

Eligible Combined Plan - DB(k)

• DB plan must provide each participant with a
  benefit of at least the following percentage of
  final average pay
• one percent times YOS
• 20 percent
• Final average pay uses five consecutive years
  with highest comp
• Can use cash balance plan that provides a pay
  credit for each year that increases from 2 to 8
  of comp based on age
• Any contributions to DB plan must be vested after
  3 YOS

42

Eligible Combined Plan DB(k)

• DC plan must be an automatic enrollment plan
• Must have automatic enrollment of at least 4 of
  compensation
• Participants must be given annual notice of right
  to elect out of plan
• Must make matching contribution equal to 50 of
  deferrals up to 4 of comp
• Additional match and/or ER contributions may be
  made to DC plan
• Matching contributions must be 100 vested ER
  contributions must vest after 3 years

43

Eligible Combined Plan - DB(k)

• DC plan is deemed to satisfy ADP test
• Matching contributions must satisfy ACP test
  unless satisfy SH ACP rules
• ER contributions under DC plan and benefits under
  DB plan subject to nondiscrimination rules as
  under present law
• Both plans are deemed to satisfy top heavy
  requirements
• All contributions, benefits, and other rights and
  features must be provided uniformly to all
  participants

44

Lump Sum Interest Rates

• PPA changes the interest rate and mortality table
  used in calculating the minimum value of certain
  optional forms of benefit, such as lump sums
• Interest rates are derived from a corporate bond
  yield curve that reflects yields on investment
  grade corporate bonds with varying maturities
• Thus, the interest rate that applies depends upon
  how many years in the future a participants
  annuity payment will be made
• Typically, a higher interest rate applies for
  payments made further out in the future

45

Lump Sum Interest Rates

• Mortality table that must be used for calculating
  lump sums is based on mortality table required
  for minimum funding purposes under the bill,
  modified as appropriate by the Secretary of
  Treasury
• The Secretary is to prescribe gender-neutral
  tables for use in determining minimum lump sums
• Effective for plan years beginning after December
  31, 2007.

46

Amendment of 415 Rules

• Under proposed regs, IRS required that only
  compensation while a participant can be taken
  into account in determining average compensation
• Inconsistent with prior IRS guidance
• Would have had negative impact on small employers
  where compensation of owners decrease in order to
  fund plan
• Under PPA, in determining average compensation
  can use pre-participation compensation in
  determining average compensation

47

Plan Amendments

• Plan amendments required by end of 2009 plan year
• Retroactive amendments will not violate
  anti-cutback requirements
• IRS permitted to prohibit inappropriate
  reductions in contributions or benefits

48
Qualified Plan Documents

• Rev. Proc. 2005-16 opened IRS program for
  submission of prototype / volume submitter plans
  for EGTRRA
• All prototype / volume submitter plans had to be
  submitted to IRS for opinion or advisory letters
  by 1/31/2006
• Rev. Proc. 2005-66 opened program for
  individually designed plans as of February 1,
  2006
• Plans subject to new staggered amendment procedure

49

Staggered Amendments

• Notice 2005-66 creates new staggered amendment
  procedure
• Individually designed plans have staggered 5-year
  amendment cycle

50
Staggered Amendments

• Prototype/volume submitter plans have six-year
  amendment cycle
• DC plans
• Must be submitted to IRS by 1/31/2006
• IRS will review by 2008
• ERs must adopt restated plan by 2009-2010
• DB plans
• Must be submitted to IRS by 1/31/2008
• IRS will review by 2010
• ERs must adopt restated plan by 2011-2012
• DC plans must be submitted to IRS again by
  January 31, 2012

51
Eligibility for 6-Year Cycle

• Employer need not adopt same plan as plan being
  restated
• Must establish association with eligible
  prototype / volume submitter plan
• Prior adopter adopted MP / VS before 2/17/2005
  (date EGTRRA program opened)
• New adopter individually designed plan that
  adopts new or interim MP / VS before expiration
  of 5-year cycle
• Intended adopter completes applicable
  certification (Form 8905) before expiration of
  5-year cycle
• Replacement adopter MP / volume submitter plan
  is replaced at sponsor level

52
Form 8905

• Certification of Intention to Use Pre-Approved
  Plan
• Good-faith intention to adopt pre-approved plan
• Must sign form before end of 5-year cycle
  deadline (i.e., 12/31/2007 for Cycle A plans)
• Employer can then adopt any plan within 6-year
  cycle need not be same plan identified on Form
  8905
• Appears that any new plan adopted after 2/17/2005
  must use Form 8905

53
2004 Cumulative List

• Notice 2004-84 Lists all changes that must be
  included in defined contribution plans submitted
  in 2005
• No laws enacted after December 14, 2004 will be
  reviewed by IRS unless included in 2004
  Cumulative List
• Plans still have to comply in operation with law
  changes
• IRS intends to issue new Cumulative List each
  year (e.g. 2005 Cumulative List will be issued
  for 2006 submissions)

54
2004 Cumulative List

• Required provisions
• Loan regulations
• Gateway requirements for general
  nondiscrimination test
• Final RMD regulations
• Direct rollover and automatic rollover rules
• Final 401(k) regulations and Roth 401(k)
  regulations
• Deemed IRAs
• Faster vesting for matching contributions
• Catch-up contributions
• New top heavy rules
• Charging of expenses to former EEs

55
2005 Cumulative List

• Notice 2005-101 lists required amendments for
  Cycle A submitters for both DC and DB plans
• No laws enacted after December 13, 2005 will be
  reviewed by IRS unless included in 2005
  Cumulative List
• Plans still have to comply in operation with law
  changes
• EGTRRA remedial amendment period for Cycle A
  plans extended until January 31, 2007
• Can extend EGTRRA RAP by if submit timely DL
  application

56
2005 Cumulative List

• New provisions in 2005 Cumulative List
• DB/DC combination gateway rules
• Provisions regarding ESOP dividends and S-Corp
  ESOPs
• Certain top-heavy rules applicable to defined
  benefit plans
• New rules regarding applicable mortality tables
• Proposed guidance on post-severance compensation
  under Code 415
• Retroactive annuity starting date requirements
• Katrina relief

57
Plan Amendments

• Notice 2005-95 sets forth interim amendment
  requirements
• Depends on whether amendment is a discretionary
  or a required amendment
• Discretionary amendments last day of plan year
  for which amendment is effective
• Required amendments later of end of plan year
  in which amendment is effective or due date (plus
  extensions) for filing ERs tax return for tax
  year which begins in plan year that amendment is
  effective
• Different amendment deadlines may apply under
  statute, regulation, or other published guidance

58
Interim Plan Amendments

• Roth Deferrals
• Final 401(k)/401(m) Regulations
• Automatic Rollovers
• Hurricane Katrina Relief
• Retroactive annuity starting date
• Pension Funding Equity Act
• Relative value requirements
• Pension Protection Act

59
Plan Amendments

• Roth Deferrals discretionary
• Plan amendments required by end of plan year in
  which Roth deferrals first effective
• For calendar year plans, if permit Roth in 2006
  must amend by 12/31/2006
• For fiscal year plans, if permit in 2006 (and
  before beginning of 2006 PY) will have to amend
  by end of plan year ending in 2006
• Example. If have June 30 year end and allow Roth
  1/1/2006, would have to amend by June 30, 2006
• IRS has issued model amendment only needs to be
  adopted if permit Roth deferrals

60
Plan Amendments

• Issues regarding Roth Deferrals
• Should address distribution provisions e.g.,
  from which account distributions will be made
• Can limit amendments only to plans that are
  electing Roth deferrals be careful of rollover
  provisions
• Can implement Roth Deferrals mid-year
• Be careful of plans making Roth Deferrals without
  a plan amendment

61
Plan Amendments

• Final 401(k)/401(m) regulations
• If ER implemented regulations prior to 2006
  plan year discretionary amendment
• Plan must be amended by end of plan year in
  which regulations effective
• Notice 2005-95 extends earliest required
  amendment date until 12/31/2005
• If ER does not implement regulations until 2006
  plan year
• Plan must be amended by later of end of 2006
  plan year or due date for filing tax return for
  tax year beginning in 2006 PY
• Pre-approved plans 12/31/2006

62
Plan Amendments

• Automatic rollover amendments
• Originally required amendments as of end of plan
  year beginning on or after March 28, 2005
• Caused many administrative problems for fiscal
  year plans
• Notice 2005-95 (issued in November) extended
  amendment date until later of December 31, 2005
  or end of March 28 plan year or due date for
  filing tax return for tax year containing March
  28

63
Plan Amendments

• Katrina relief
• End of 2007 plan year
• IRS may require certain amendments by end of 2006
  plan year
• Retroactive annuity starting date
• Notice 2005-95 extended amendment period until
  December 31, 2005
• Pension Funding Equity Act
• Defined benefit plans must be amended by end of
  2006 plan year (December 31, 2006 for calendar
  year plans)
• Pension Protection Act
• End of 2009 plan year

64
Hurricane Katrina Relief

• Announcement 2005-70 Plans may make loan or
  hardship distribution to EE or former EE whose
  principal residence on August 29, 2005 was
  located in Katrina disaster area
• Plan administrators may rely upon representations
  from EE or former EE as to need for and amount of
  hardship distribution
• No suspension of deferrals required
• Plan amendments required by end of 2006 plan year

65
Hurricane Katrina Relief

• Gulf Opportunity Zone Act of 2005 (GOZA)
• Applies to qualified individuals lived in
  hurricane area and suffered economic loss
• Adds Code 1400Q
• Extends relief to Katrina, Rita and Wilma
• Applies to IRAs, qualified plans, 403(b) and 457
  plans
• Plans may rely on reasonable representation of
  qualified individual
• Allows penalty-free withdrawals of up to 100,000
  through 1/1/07 limit must be tracked at ER
  level similar to 402(g)

66
Hurricane Katrina Relief

• Gulf Opportunity Zone Act of 2005 (GOZA)
• Extends rollover period to 3 years for qualified
  hurricane distributions can roll back into same
  plan
• Taxes on distributions can be spread over 3 years
  (averaging) or paid in year of distribution
• Distributions not subject to 20 withholding
  even though eligible for rollover
• Hurricane distributions not subject to
  distribution restrictions (e.g., age 59-1/2
  requirement for 401(k)

67
Hurricane Katrina Relief

• Gulf Opportunity Zone Act of 2005 (GOZA)
• Loan limit increased to 100,000 or 100 of
  vested account balance loan must be taken by
  1/1/2007
• Applies to qualified plans and 403(b) plans
• Loan repayments may be delayed one year
• DOL will probably issue adequate security
  relief
• Plan amendments to comply with these rules are
  required by end of 2007 plan year (or such later
  date as IRS may prescribe)
• Do you need to amend plans if have no hurricane
  distributions?

68
Terminating Plans

• Must be amended for current guidance at time of
  termination
• Can use latest Cumulative List may have to
  include additional amendments
• Date of termination (not date of distribution)
  controls
• Can use snap-on amendment

69
New User Fees

• DL requests increase for submissions made on or
  after July 1, 2006
• Individually designed plans (Form 5300) go up to
  1,000 (from 700)
• Pre-approved plans (Form 5307) go up to 300
  (from 125)
• User fee remains at 1,000 for pre-approved plans
  asking for special reliance (e.g., average
  benefits test)
• Plan termination (Form 5310) goes up to 1,000
  (from 125)
• Does it make sense to request determination
  letter for prototype or volume submitter plans?

70
Roth 401(k) Deferrals

• Roth 401(k) deferrals are available in 2006
  also available for 403(b) plans
• IRS issued final regulations on 12/30
• IRS issued additional proposed regulations
  1/26/06
• Roth 401(k) deferrals are a type of deferral
  under a 401(k) plan NOT a new type of plan
• Roth 401(k) deferrals are subject to current
  taxation earnings are not taxable if qualified
  distribution

71
What Must be Done?

• ER must decide if it wishes to allow Roth 401(k)
  deferrals not required
• May implement Roth deferrals anytime during year
  or next year
• Employers may want to wait and see whether
  employees want Roth
• Must revise salary deferral election forms
• Must revise payroll systems to accommodate
  after-tax deferrals
• TPA/recordkeeper must be ready to handle Roth
  deferrals separate account

72
Roth 401(k) Deferrals

• Must make irrevocable election to treat deferrals
  as Roth deferrals
• Plan may not provide for Roth only must offer
  both pre-tax and Roth deferrals
• No AGI limits HCEs can take full advantage of
  Roth deferrals
• Roth deferrals are subject to same 402(g) limit
  that applies to pre-tax
• 15,000 limit for 2006 5,000 catch-up limit if
  at least age 50
• Only one limit applies must aggregate all
  deferrals (pre-tax and Roth) in applying limit

73
Roth 401(k) Deferrals

• Roth deferrals are subject to the ADP test, even
  though after-tax
• Roth deferrals always 100 vested
• Roth 401(k) deferrals must be held in separate
  account
• Must track designated Roth deferrals and
  earnings in case distribution is not qualified
  (i.e., subject to taxation)
• Plan may permit split elections i.e., half in
  Roth, half in pre-tax
• Plan may require all-or-nothing

74
Roth 401(k) Deferrals

• Roth deferrals are subject to required minimum
  distribution rules under Code 401(a)(9)
• Many practitioners complained because
  inconsistent with Roth IRA rules
• Participant may rollover to Roth IRA to avoid
  required minimum distribution
• May delay distribution under Roth IRA until death
  
• Roth deferrals may be made under safe harbor
  401(k) plan
• Roth deferrals eligible for matching contributions

75
Roth 401(k) Distributions

• To be tax-free, distribution must be a qualified
  distribution
• Must satisfy 5-year rule measured from taxable
  year in which first Roth deferral is made
• Also must be for qualified purpose age 59½,
  death or disability
• If not qualified, portion attributable to
  earnings is subject to taxation may avoid
  taxation by rollover
• Distribution of Roth deferrals is eligible for
  direct rollover to Roth IRA or another Roth plan

76
Rollover Issues

• Proposed regs clarify rollover to Roth 401(k)
  must be direct rollover from another Roth 401(k)
  or Roth 403(b)
• Distributing plan must report 5-year date and
  basis under separate account to recipient plan
• If not directly rolled over, rollover of
  after-tax moneys may not be put in Roth account
  can put in Roth IRA
• May be rolled over as after-tax money must be
  held in separate account (basis)
• Taxable portion could be rolled into Roth 401(k)
  account 5 year period starts new

77
Rollover Issues

• Proposed regs clarify if rollover to Roth IRA
  do not carry over 5 year date to Roth IRA
• If already have Roth IRA Roth IRA date controls
  even for 401(k) rollover amounts
• Presumably, can accelerate tax-free treatment if
  have existing Roth IRA
• If qualified distribution from Roth 401(k)
  entire amount treated as basis in Roth IRA
• Proposed regs clarify that cannot rollover from
  Roth IRA to Roth 401(k) or Roth 403(b)

78
Taxation of Distribution

• Proposed regulations confirm Roth distributions
  are taxed under Code 72 treating Roth account as
  separate contract
• Cannot take basis out first as under Roth IRAs
  if nonqualified distribution
• Example. EE has 10,000 Roth account (9,400
  Roth, 600 earnings). If EE takes out 5,000 from
  Roth account 300 will be taxable as earnings
• 9,400/10,000 5,000 4,700
• 300 is taxable to EE

79
Other Issues

• Must report deferrals and distributions on W-2
  and 1099-R
• Instructions to new 1099-R will require separate
  1099-R for Roth distributions, including basis
  and 5-year period
• Distributing plan must provide information
  regarding Roth contributions to recipient plan
  (including 5-year period), if non-qualified
  distribution
• Reporting rules not effective until 2007 taxable
  years
• Proposed regulations amend 403(b) regs to address
  Roth deferrals

80
Employee Communications

• Going to require modifications to employee
  communications
• Employees already confused about investments
  under 401(k) plans
• May give employers incentive to hold employee
  meetings
• Could reduce amount EEs defer into plan

81
Example

• ABC Corp maintains a 401(k) plan with a 50 match
  on deferrals up to 6 of compensation. Sue, age
  20, an NHCE, has never deferred into the plan.
  Jason, age 35, another NHCE, earns 50,000 and
  has historically contributed 8 of his
  compensation to the plan. ABC is considering
  adding a Roth 401(k) feature.
• Will Roth 401(k) feature entice Susan to
  contribute to the plan?
• Will Roth 401(k) feature entice Jason to
  contribute to plan?

82
Example

• Under current plan Jason contributes 8 of
  compensation
• 50,000 8 4,000
• ADP for Jason 8
• If add Roth 401(k) feature and Jason decides to
  contribute to Roth instead
• If Jason wants his compensation reduced by same
  4,000 (after taxes) deferral will only be
  3,125 with 875 of taxes on deferral (assuming
  28 tax bracket)
• ADP for Jason 6.25 (3,125 / 50,000)

83
Plan Amendments

• IRS has issued model amendment
• Plan amendments to comply with Roth rules are
  required by end of plan year in which Roth
  deferrals first effective
• For calendar year plans, if permit Roth in 2006
  must amend by 12/31/2006
• For fiscal year plans, if permit in 2006 (and
  before beginning of 2006 PY) will have to amend
  by end of plan year ending in 2006
• Example. If have June 30 year end and allow Roth
  1/1/2006, will have to amend by June 30, 2006

84

New Guidance on Part-Time EEs

• February 14, 2006 Quality Assurance Bulletin
  (QAB)
• Clarifies plans can be disqualified, even if has
  favorable DL
• Directs IRS reviewers to examine plans with
  language excluding part-time, seasonal, or
  temporary EEs
• Clarifies that plans may provide for different
  exclusion for part-time and full-time EEs

85

Example

• Corporation X maintains top-heavy 401(k) plan.
  The plan provides for immediate eligibility for
  deferrals but excludes part-time EE. If
  part-time EE actually works more than 1,000 HOS,
  EE will become participant on first semi-annual
  plan entry date following computation period.
• Allows plan to bring in full-time EEs immediately
  but hold out part-time EEs
• Part-time EEs need not receive top-heavy
  contribution
• Will have to run coverage test two different
  age/service conditions

86

Plans for Partners

• IRS examining new comparability plans deemed
  401(k) if have groups for single partner
• Final 401(k) regulations clarify probably okay
  for sole proprietors
• May stop issuing determination letters to
  partnership plans with single groups (e.g.,
  everyone in own group)

87

Compensation for Deferrals

• Generally, all compensation is taken into account
  under plans definition of compensation
• IRS position that EEs may not defer on
  compensation paid after EE has terminated
  employment
• Can cause real problems where final paycheck is
  paid in following plan year is EE an eligible
  EE for purposes of ADP test?

88

Proposed 415 Regulations

• Clarifies that compensation paid after severance
  from employment is excluded from 415 compensation
• Exception for compensation payments made within
  2½ months after severance payment must be for
  regular compensation or accrued sick pay,
  vacation or other leave
• All other payments, even if made within the 2½
  period following severance, are excluded e.g.,
  severance pay is excluded
• Restrictions on compensation will apply to other
  Code sections e.g., 401(k)
• 2½ month rule not elective causes problems with
  414(s) and deferral rules

89

411(d)(6) Regulations

• Proposed regulations issued as a result of
  Central Laborers opinion
• DB plan was amended to add restrictions
  applicable to suspension of benefit provisions
• Supreme Court ruled that plan cannot add
  restrictions (even if allowed under Code or
  regulations) that apply to benefits accrued prior
  to adoption of amendment
• Plans must operationally comply with Central
  Laborers decision by 1/1/2007 (Rev. Proc.
  2005-76)
• May require retroactive restoration of benefits
• Proposed regs apply Central Laborers decision to
  other situations

90

411(d)(6) Regulations

• Example 1 adding Rule of Parity
• Cannot add Break in Service rule to benefits that
  accrued prior to date of amendment
• Example 2 amendment of vesting schedule
• Cannot apply new vesting schedule to
  pre-amendment benefits, even if comply with Code
  411(a)(10)
• May be forced to provide greater vesting
  schedule or retain old vesting schedule
• Retroactive amendment may be required to
  effective date of regs (June 7, 2004)

91

Relative Value Explanations

• Final regulations issued 3/24/2006
• Generally effective for distributions with
  2/1/2006 annuity starting dates
• For lump sum distributions worth less than QJSA
  (e.g., lump sum does not reflect value of early
  retirement subsidies) regs effective 10/1/2004
• Good faith reliance permitted 1/1/2007
• Most requirements apply to DB plans
• Must disclose relative value and financial effect
  of various options compared to QJSA
• Can describe as approximately equal to QJSA if
  within 95 to 105 of PV of QJSA

92

Relative Value Explanations

• Also applies to DC plans that provide for QJSA
  form of distribution must contain following
  information
• description of each optional form of benefit
• eligibility conditions for each optional form
• financial effect of electing each optional form
• any other material features of each optional form
• statement that annuity will be provided by
  purchasing an annuity from insurance company

93

IRS Compliance Programs

• Pre-1990 IRS Options
• Closing Agreement Program
• Walk-in CAP
• Voluntary Compliance Resolution (VCR)
• Administrative Policy Regarding Self-Correction
  (APRSC)

94

EPCRS

• Rev. Proc. 2003-44 simplified the various
  consolidated the various acronyms under the EPCRS
  program and lowered user fees
• Now have only 3 programs
• SCP (Self-Correction Program)
• VCP (Voluntary Correction Program)
• Audit CAP (Audit Closing Agreement Program)
• SCP does not require a submission to the IRS

95

New EPCRS Procedure

• Rev. Proc. 2006-27
• Does not make wholesale changes to existing EPCRS
  procedures
• Tweaks some of the suggested correction options
• Provides new fee structure for nonamenders
  discovered through determination letter program
• Eliminate the requirement for determination
  letter for certain operational corrections

96

Eligibility Failure

• Clean Teeth Dental maintains 401(k) plan with one
  year of service eligibility requirement and
  quarterly entry dates. In 2005, three new EEs are
  allowed to participate on date of hire.
• What is IRS suggested correction method?
• Currently, IRS suggested correction method is to
  amend plan to include such EEs
• If Clean Teeth amends plan to allow three EEs to
  participate immediately, must Clean Teeth permit
  other EEs to participate?
• No, ER may amend plan to specifically include
  only the three EEs could list individuals by
  name

97

Eligibility Failure

• If Clean Teeth amends plan to cover the 3 EEs,
  would Clean Teeth have to submit the amendment
  for a favorable DL?
• Currently, must submit amendment to IRS for
  determination letter. Under new IRS procedure,
  ERs will no longer be required to submit for
  determination letter for insignificant
  amendments.
• Could Clean Teeth correct the violation through
  use of creative accounting without submitting
  to the IRS?
• Yes, in year of correction.

98

Eligibility Failure

• Jane, a former participant in Clean Teeth plan,
  is rehired on 2/1/05 after being gone for 3
  years. Jane is not allowed to participate until
  July 1, 2006. What is the IRS suggested
  correction?
• IRS suggested correction is to make a QNEC to
  the plan on Janes behalf for the missed
  deferrals from 2/1/05 7/1/06. Corrective QNEC
  is based on 50 of average deferral percentage of
  NHCE group for period while Jane was improperly
  held out of plan.
• Is Jane entitled to matching contribution
  attributable to the missed deferrals?
• Yes, based on match would have received if full
  missed deferral had been made to plan

99

Plan Loan Correction Options

• In 2000, Sally took a participant loan from
  401(k) plan. Sally began making payments on the
  loan through 2003 when she ceased making
  payments. No action was taken with regard to the
  defaulted loan. In 2006, the ER would like to
  correct the failure to report the defaulted loan.
  
• Is the failure to report a defaulted loan an
  operational defect that may be corrected under
  the VCP program? SCP program?
• What if loans fail to comply with Code 72(p)?

100

Plan Loan Correction Options

• Deemed distribution may be reported on Form
  1099-R for year of correction, rather than for
  year of failure, but only if such relief is
  requested under VCP.
• If loan exceeds maximum permissible loan amount,
  correction is to repay excess loan amount (plus
  interest)
• Remaining principal balance may be reamortized
  over remaining period of loan
• If loans made without authorizing plan language
  retroactive plan amendment is permitted

101

EPCRS Correction Options

• Correction of defaulted loan due to ER failure
• Lump sum repayment of amount equal to additional
  repayments affected participant would have made
  to the plan if there had been no failure to
  repay, plus interest
• Reamortizing the outstanding balance of the loan,
  including interest, over the remaining payment
  schedule of the original term of the loan
• ER may have to make up additional interest
  payments

102

Application of DOL Program

• Failure to follow loan program is prohibited
  transaction
• Can be corrected under DOL voluntary compliance
  program (VFC)
• Must be corrected in accordance with EPCRS under
  VCP program can provide EPCRS correction letter
  and proof of payment of penalties to correct
  under DOL program

103
Safe Harbor 401(k) Plans

• Final 401(k) regs require plans to designate
  whether plan is providing safe harbor ER or safe
  harbor matching contribution
• Cannot simply fall out of safe harbor status and
  revert to testing
• What if miss annual notice?
• No correction guidance in new procedure

104

Orphan Plans

• DOL has issued final regulations providing
  methodology for terminating abandoned plans
• DOL estimates approximately 1,650 plans with 868
  million and 33,000 participants are abandoned
  each year
• DOL concerned that assets being diminished by
  administrative costs and participants not able to
  receive distribution of plan benefits
• Regulations are effective May 22, 2006
• Regulations allow abandoned plans to be
  terminated by qualified termination administrator
  (QTA)

105

Orphan Plans

• Determinations of plan abandonment and winding up
  of plan must be performed by a qualified
  termination administrator (QTA)
• QTA must be eligible to serve as a trustee or
  issuer of an IRA e.g. bank, trust company
  mutual fund company, insurance company, approved
  non-bank trustee
• QTA must hold assets of the plan on whose behalf
  it will serve as the QTA can be held as
  trustee, custodian, or provider of investments in
  which assets are invested

106
Orphan Plans

• Abandonment of plan
• No contributions to (or distributions from) a
  plan for a continuous 12-month period, or
• Facts and circumstances known to the QTA (such as
  liquidation under Title 11 or communications from
  plan participants) suggest that plan is abandoned
  
• QTA must determine plan sponsor no longer exists,
  cannot be located, or is unable to maintain plan
• Must try to locate plan sponsor notice of
  abandonment sent to last known address is
  sufficient (regs contain model notice)

107
Orphan Plans

• QTA must send notice of abandonment to DOL
• Plan is deemed terminated on 90th day following
  DOL letter of receipt of notice of abandonment
  (and election to serve as QTA)
• Regulations contain model amendment
• DOL may waive some or all of 90-day period