Employee Benefits & Executive Compensation

Pension Protection Act Provisions Affecting Employee Benefit Plans in 2007

02.23.2007

The Pension Protection Act was signed into law on August 17, 2006. The Act contains numerous provisions (with varying effective dates) affecting employee benefit plans. This Perkins Coie Update highlights recently released guidance addressing certain Pension Protection Act provisions that are effective prior to and in 2007.

For more information about these developments, contact one of the individuals listed at the end of this Update. For more information regarding the Act's provisions that generally affect defined contribution plans, click here to read our August 8, 2006 Update.

DOL Field Assistance Bulletin No. 2006-03 — Pension Benefit Statements

The Pension Protection Act supplemented the pension benefit statement requirements for both individual account plans and defined benefit plans. Such statements must now include:

The total benefits accrued;
The nonforfeitable benefits that have accrued or the earliest date on which they will become nonforfeitable (this information must be provided at least annually and may be provided separately);
An explanation of any permitted disparity under Code Section 401(l) or any floor-offset arrangement that is applied in determining accrued benefits;
For individual account plans, the value of each investment as of the most recent valuation date, including the value of any assets held in employer securities; and
For individual account plans subject to participant direction of investment, (a) an explanation of any limitations or restrictions on any right to direct investments; (b) an explanation of the importance of a well-balanced and diversified investment portfolio, including a statement of the risk of holding more than 20% of a portfolio in the security of one entity; and (c) a notice directing the participant or beneficiary to the U.S. Department of Labor ("DOL") Web site for sources of information on individual investment and diversification.

In addition to the above content requirements, the Act established an affirmative obligation to automatically furnish pension benefit statements, with the specific timing depending on the plan type. These changes are applicable to plan years beginning after December 31, 2006, with special rules for plans maintained pursuant to collective bargaining agreements.

DOL Field Assistance Bulletin No. 2006-03 (the "FAB") establishes a good faith compliance standard for these requirements until regulations are issued. There is a penalty of up to $100 per day per participant for failure to furnish benefit statements. Relevant provisions of the FAB are:

Multiple documents or sources may be used for benefit statement information, provided participants and beneficiaries receive notice of how and when the required information will be furnished or made available.
Pension benefit statements may be furnished electronically, provided such statements are furnished in accordance with the provisions of Treasury Regulation Section 1.401(a)-21.
For individual account plans that permit participants and beneficiaries to direct investments, calendar year plans must furnish the first pension benefit statement within 45 days after the quarter ending March 31, 2007 (i.e., May 15, 2007).
For individual account plans that do not provide participants and beneficiaries the right to direct investments, plans must furnish the first pension benefit statement within 45 days following December 31, 2007 (i.e., February 15, 2008).
Defined benefit plans must furnish the first pension benefit statement for the 2009 plan year.
For individual account plans that allow participants and beneficiaries to direct investments, pension benefit statements must include the following content:
Participants and beneficiaries in plans conferring new diversification rights as of January 1, 2007, should be furnished information concerning diversification rights and the importance of maintaining a diversified portfolio as soon as possible following January 1, 2007.
For individual account plans that provided participants and beneficiaries diversification rights at least equal to those required by the Pension Protection Act prior to January 1, 2007, compliance with the periodic benefit statement requirements will be treated as satisfying the notice of diversification rights requirement.

In addition, pension benefit statements should be written in a manner calculated to be understood by the average plan participant. Plan sponsors should begin preparing pension benefit statements as soon as possible in order to ensure that such statements will include all of the required information or should ensure that a plan service provider is doing so. Click here to read the full text of Field Assistance Bulletin No. 2006-03.

IRS Notice 2007-7 — IRS Guidance on Certain Provisions of the Pension Protection Act

Interest Rate Assumptions for Lump-Sum Distributions (Defined Benefit Plans)

The Pension Protection Act amended Code Section 415 to provide that the interest rate assumption for purposes of adjusting a benefit payable in a form that is subject to the minimum present value requirements of Code Section 417(e)(3) must not be less than the greatest of (i) 5.5%, (ii) the rate that provides a benefit of not more than 105% of the benefit that would be provided if the applicable interest rate (as defined in Code Section 417(e)(3)) were the interest rate assumption, or (iii) the rate specified under the plan. These changes apply to distributions made in plan years beginning after December 31, 2005 (but they do not apply to plans terminated on or before August 17, 2006). Notice 2007-7 provides that a plan will not violate the anti-cutback rules if it is amended retroactively to comply with these changes, provided that the amendment is adopted on or before the last day of the first plan year beginning on or after January 1, 2009 (2011 in the case of a governmental plan) and that the plan is operated as if such amendment were in effect as of the first date the amendment is effective.

Notice 2007-7 also outlines three methods for correcting an excess distribution for plans that made a distribution in a plan year beginning in 2006 that satisfied the old limitations of Code Section 415, but is in excess of the new limitations of Code Section 415. Additionally, a special correction method is available for an excess distribution made prior to September 1, 2006, if the correction is completed by March 15, 2007.

Hardship Distributions

The Pension Protection Act modified the rules relating to distributions from Code Section 401(k), Code Section 403(b), Code Section 409A, and Code Section 457(b) plans on account of a participant's hardship or unforeseeable financial emergency to permit such plans to treat a participant's primary beneficiary under the plan the same way as the participant's spouse or dependent in determining whether the participant has incurred a hardship or unforeseeable financial emergency. This change affects hardship withdrawals relating to medical, tuition and funeral expenses for a primary beneficiary under the plan. Notice 2007-7 establishes that, for this purpose, a "primary beneficiary under the plan" is an individual who is named as a beneficiary under the plan and has an unconditional right to all or a portion of the participant's account balance under the plan upon the death of the participant. Additionally, Notice 2007-7 confirms that a plan that adopts these expanded hardship provisions must still satisfy all the other requirements applicable to hardship distributions, such as the requirement that the distribution be necessary to satisfy the financial need.

Rollovers for Nonspouse Beneficiaries

After December 31, 2006, a direct trustee-to-trustee transfer of any portion of a distribution from an eligible retirement plan made to an individual retirement plan described in Code Section 408(a) or (b) (an "IRA") that is established for the purpose of receiving the distribution on behalf of a designated beneficiary who is a nonspouse beneficiary will be treated as a direct rollover of an eligible rollover distribution for purposes of Code Section 402(c). The IRA of the nonspouse beneficiary will be treated as an inherited IRA within the meaning of Code Section 408(d)(3)(C).

Notice 2007-7 states that the IRA must be established in a manner that identifies it as an IRA with respect to a deceased individual and also identifies the deceased individual and the beneficiary, for example, "Tom Smith as beneficiary of John Smith." Notice 2007-7 also clarifies that plans are not required to offer a direct rollover of a distribution to a nonspouse beneficiary, but if a plan does offer direct rollovers to nonspouse beneficiaries, such rollovers must be offered on a nondiscriminatory basis.

The Notice describes the general rule for determining required minimum distributions (amounts not eligible for rollover) in the case of a nonspouse beneficiary rollover. It provides that the rules for determining required minimum distributions under a plan with respect to a nonspouse beneficiary also apply to an IRA. If a participant dies before his or her required beginning date, the required minimum distributions for purposes of determining the amount eligible for rollover with respect to a nonspouse beneficiary are determined under either the five-year rule described in Code Section 401(a)(9)(B)(ii) or the life expectancy rule described in Code Section 401(a)(9)(B)(iii). Notice 2007-7 also describes a special rule that is an exception to this general rule. This exception states that if, under a plan, the five-year rule applies for determining required minimum distributions, a nonspouse beneficiary may, nevertheless, treat the plan as using the life expectancy rule, provided that the rollover into the IRA is made prior to the end of the year following the year of the participant's death. Thus, despite a plan provision for the five-year rule, the nonspouse beneficiary is permitted to treat the plan as using the life expectancy rule both for determining the amount eligible for rollover and for determining the required minimum distributions under the IRA, but only if the rollover is made prior to the end of the year following the year of the participant's death.

Notice 2007-7 also describes how the required minimum distribution is determined if the participant dies on or after his or her required beginning date.

Vesting of Nonelective Contributions

For contributions after December 31, 2006, a defined contribution plan satisfies the minimum vesting requirements with respect to employer nonelective contributions if it has a three-year cliff vesting schedule or a two- to six-year graded vesting schedule (e.g., 20% after two years of service, plus 20% per year thereafter). Notice 2007-7 provides that a plan can apply its existing vesting schedule for employer nonelective contributions made on account of plan years beginning before January 1, 2007, with the new vesting schedule applying to plan years beginning after December 31, 2006, provided that the plan separately accounts for the contributions made under the separate vesting schedules.

Notice and Consent Period for Distributions

After December 31, 2006, a distribution notice required to be provided under Code Section 402(f), Code Section 411(a)(11), or Code Section 417 may be provided to a participant as much as 180 days (instead of 90 days) before the annuity starting date. The notice of a participant's right to defer a distribution must include a description of the consequences of failing to defer receipt of a distribution. A plan will not be treated as failing to meet the new requirements if the plan administrator makes a reasonable attempt to comply within 90 days of the issuance of regulations. Notice 2007-7 establishes a "safe harbor" under which a plan administrator will be considered to have made a "reasonable attempt" at compliance with the requirements. Under this safe harbor, distribution notices must be written in a manner reasonably calculated to be understood by the average participant and must include the following information: (a) in the case of a defined benefit plan, a description of how much larger the benefits will be if the commencement of distributions is deferred; (b) in the case of a defined contribution plan, a description indicating the investment options available under the plan (including fees) that will be available if distributions are deferred; and (c) the portion of the summary plan description that contains any special rules that might materially affect a participant's decision to defer. For purposes of clause (a), a plan administrator can use a description that includes the financial effect of deferring distributions based solely on the normal form of benefit.

Click here to read the full text of Notice 2007-7. The Pension Protection Act may be found in two parts. Click here for Part 1, and click here for Part 2. Click here to read a Technical Explanation of H.R. 4 from the U.S. House of Representatives Joint Committee on Taxation.