WHAT'S NEW— QUALIFIED PLAN UPDATE

Posted by admin on: 2007-08-01 18:02:16

WHAT'S NEW QUALIFIED PLAN UPDATE
(Including Pension Protection Act)

Prepared For:
Durig Capital
Luncheon Meeting
August 1, 2007

By: Ray R. Benner
Benner & Associates, P.C.
121 SW Morrison, Suite 1010
Portland, Oregon 97204
(503) 224-5039

All Rights Reserved

WHAT'S NEW QUALIFIED PLAN UPDATE

INDEX

WHAT'S NEW QUALIFIED PLAN UPDATE 1

I. PENSION PROTECTION ACT OF 2006 1

II. IRS REVISED 401(k) POST TERMINATION PAY RULE 13

III. PAYMENT OF PLAN EXPENSES FROM TERMINATED PARTICIPANT'S ACCOUNTS - SIGNIFICANT DETRIMENT? 13

IV. NEW FEDERAL BANKRUPTCY LAW. 14

V EXPANDED ROTH IRA CONVERSIONS 15

WHAT'S NEW QUALIFIED PLAN UPDATE

I. PENSION PROTECTION ACT OF 2006 - Effective 2007 through 2010

A. Defined Contribution Plan Provisions :

1. Effective - 2007

a. EGTRRA provisions scheduled to expire after 2010 made permanent:

(i). Higher contribution limits.

(ii) 401(k) age 50 catch-up contributions

(iii) Roth 401(k) contributions

(iv) Savers credit

b. Faster vesting for nonelective Employer contributions: 3 year cliff or 2 to 6 year graded schedule. Similar to top-heavy and 401(k) matching contributions. If Employer elects to use the automatic rollover provisions, 2 year cliff vesting is required. Effective 2007. A plan amendment made to satisfy the PPA vesting rules must require that there is no reduction of the pre-amendment vested percentage and affording an election of schedules to participants with 3 or more years of service. A plan may elect to provide for bifurcated vesting with the PPA schedule applying only to nonelective contributions made for post-2006 plan years and the pre-PPA schedule continuing to apply to pre-2007 plan year contributions.

c. Tax Refund IRA gives taxpayers the option to choose to deposit a portion of their federal income tax refund directly into an IRA. Effective 2007.

d. Company Stock Diversification rights would be expanded for participants in DC plans that hold publicly traded company stock, including ESOPs that have 401(k) features or matching contributions. All participants would be allowed to diversify their employee contribution accounts. Participants with at least three years of service would be allowed to diversify their employer contribution accounts. Generally, effective in 2007, with a delayed effective date for collectively bargained plans. For company stock acquired before 2007 with matching or nonelective employer contributions, the diversification requirements would phase-in over three years (33%, 66% and 100%), but the phase in would not apply to participants age 55 or older with at least 3 years of service. This provision does not apply to employee stock ownership plans (ESOPs) that have no elective deferrals, after tax employee contributions, or matching contributions and do not form part of another qualified plan. All ESOPs remain subject to the existing, less stringent diversification requirements.

Plan administrators are required to notify participants of their diversification rights and the importance of diversifying their retirement plan investments at least 30 days prior to the date that they are first eligible to exercise such rights.

e. Tax Notices - 90 day notice now a 180 day notice. PPA changed the timing requirements for distribution notices describing the tax and other consequences of distributions. Previously these notices could not be sent more than 90 days before the annuity starting date. Under PPA, these notices may be sent a early as 180 days before the annuity starting date.

PPA also requires that IRS issue regulations expanding the content of the distribution notice to include a description of a participant's right, if any, to defer receipt of a distribution and the consequences of failing to defer such receipt.

The new rules apply to notices provided (as opposed to distributions made) in plan years that begin after December 31, 2006.

Additional Content Requirement

The content of distribution notices must be revised for all notices issued in 2007. Under PPA, plan will not be treated as failing to meet the new content requirements . . . if the plan administrator makes a reasonable attempt to comply with the new requirements with respect to distribution notices provided prior to the 90th day after the issuance of regulations . . . Notice 2007-7 provides a safe harbor for pre-regulation notices as follows:

A description that is written in a manner reasonably calculated to be understood by the average participant and that includes the following information is a reasonable attempt to comply with the requirements: (a) in the case of a defined benefit plan, a description of how much larger 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 © the portion of the Summary Plan Description that contains any special rules that might materially affect a participant's decision to defer.

f. Investment Advice - The Act creates a new prohibited transaction exemption permitting plan fiduciaries to be compensated for giving participants investment advice, subject to rules intended to limit the possibility of abuse. Different rules apply for employer sponsored plans and IRAs.

For ERISA covered employer sponsored plans, a fiduciary that is a registered investment company, bank, insurance company or registered broker dealer will be allowed to give investment advice to participants without engaging in a prohibited transaction if either (1) its fee does not vary depending on the investment choices that participants make or (2) its recommendations are based on a computer model certified by an independent third party. Under either approach, several safeguards are required, including an annual audit of the arrangements. This exemption is available for advice provided after December 31, 2006.

A similar exemption is provided for IRAs, except that advice based on computer models will be exempted only if the model complies with guidelines to be developed by the DOL. If the DOL determines that no suitable computer programs are available, it is directed to develop an alternative prohibited transaction class exemption that will permit disqualified persons to render investment advice to IRA owners under conditions designed to prevent abuse.

g. Small Plan Reporting Simplification.

The Department of Labor is directed to issue a simplified annual report (Form 5500) for retirement plans with fewer than 25 employees (on the first day of the plan year) if: (1) the plan meets the minimum coverage requirements without aggregation; (2) does not cover a business that is a member of an affiliated, controlled group or group of businesses under common control, and (3) doe not cover a business that leases employees. [Act Section 1103(b)]

h. Pension Plan Post Age 62 In-Service Distributions.

Money purchase pension plans may provide for distributions to be made to a participant who attains age 62 and has not terminated employment.

i. Non Spouse Beneficiary Rollovers. The Pension Protection Act of 2006 contains provisions permitting non-spouse beneficiaries to rollover plan death benefits to IRAs. Prior to the law change, only a surviving spouse could rollover a plan death benefit.

Beginning with distributions made after December 31, 2006, a plan may provide that a beneficiary of a death benefit under a qualified plan who is not the surviving spouse of the plan participant, may rollover the death benefit to an Inherited IRA's and avoid being currently taxed on the distribution.

An Inherited IRA differs from a regular rollover IRA. The non-spouse beneficiary will not have the option of delaying distributions from the IRA until he or she reaches age 70'Â½. Under an Inherited IRA for a non-spouse beneficiary the IRA balance either will have to be distributed in installments over the life or life expectancy of the non-spouse beneficiary commencing by the end of the calendar year after the participant's death, or else will have to be distributed in full by the end of the fifth calendar year following the year the participant died.

Under the new rule for 2007, non-spouse designated beneficiaries, e.g. children, brothers, sisters, parents, domestic partners, significant others and even friends may rollover their distribution to an Inherited IRA and avoid being taxed until they receive distribution from the IRA. The rollover must be in the form of a direct rollover (a trustee-to-trustee transfer).

j. Benefit Statements. Prior to PPA, it was not required to provide participants with benefit statements unless the participant requested one. PPA contains new rules for benefit statements effective January 1, 2007.

Under PPA plan sponsors must provide individual benefit statements automatically to participants and beneficiaries at least:

Quarterly (for defined contribution plans that allow participant-directed investments.

Annually (for defined contribution plans that do not allow participant-directed investments.

Every three years (for all defined benefit plans to active or vested participants only). Alternatively, defined benefit plans may distribute annual notices telling participants that benefit statements are available and how they can get them.

Any participant can also request and receive a benefit statement once a year, as was generally the case before PPA.

Participants must also be provided with increased information. In addition to the value of an individual's account balance and the portion that is vested, defined contribution plan statements must also include the value of each investment in an individual's account as of the most recent valuation date. Defined contribution plans that permit participant-directed investments must also describe the importance of investment diversification. The DOL has issued temporary guidance under Field Advisory Bulletin 2006-03. The DOL Bulletin includes the following:

Defined Benefit Plans Are Not Required to Provide Statements Until 2009 Defined benefit plans, which must provide benefit statements every three years, are not required to issue initial benefit statements until the 2009 plan year. In other words, the triennial statement period can start with two zero-notice years.

Statements Must Be Provided 45 Days After Period End A benefit statement for a period (quarter, year or three years, depending on plan type) must be given by 45 days after the end of the period. For example, the initial quarterly statements for calendar year 401(k) plans that permit participant-directed investments would be due no later than May 15, 2007.

Information May Be Provided on Web Site PPA provides that benefit statements may be delivered in written, electronic or other reasonably accessible form. The DOL clarifies that a sponsor that continuously makes available, through one or more secure Web sides, the same information that would be provided on the benefit statements meets the benefit statement requirements as long as participants and beneficiaries are notified of how to access the information and offered the same information in hard copy, for free, if they choose. Benefit statements may also be provided electronically as long as this method meets the Internal Revenue Service (IRS) rules for electronic plan notices and elections.

Model Investment Principles and Diversification Language Defined contributions plans that allow participant-directed investments must include language on the importance of long term retirement security, and of a well balanced and diversified investment portfolio, including a statement that holding more than 20 percent of a portfolio in one entity (e.g. company stock) may not be adequately diversified. The DOL guidance provides model language to meet this disclosure obligation. (Note that plans that offer employer securities as an investment option have additional disclosure obligations).

Right to Direct Investments For defined contribution plans that permit all participants to direct investments, the statements must also describe any plan limitations or restrictions on those rights. These might include plan limits on timing or frequency (e.g. participants must provide investment directions by the 15th of the month or cannot change investment directions more than twice a month) or plan limits on investments subject to direction (e.g. participants can direct no more than 50 percent of their accounts to a certain fund.

2. Effective - 2008

a. Direct Rollovers to Roth IRAs (2008).

A plan participant may rollover a plan distribution directly into a Roth IRA (treated as a taxable conversion). Effective 2008.

b. Fiduciary Bond Increased for Certain Plans.

The required amount of the ERISA Fiduciary bond is increased from $500,000 to $1,000,000 for plans holding employer securities. Effective 2008.

c. Automatic enrollment.

B. Automatic Enrollment

1. General

Employer sponsors of 401(k) plans desire to find ways to increase participation by non-highly compensated employees (NHCEs) in order to allow highly compensated employees (HCEs) to defer larger amounts. The negative election approach may accomplish this.

The notice and election procedure preserves the character of the cash or deferred election, so that the amount deferred is not taxable to the employee. The employee is also notified annually of his or her current deferral percentage and the right to elect not to make deferrals.

The rulings also permit the use of automatic enrollment where there is a waiting period before an employee is eligible to make elective deferrals.

When the plan chooses to use negative elections, the employee is automatically enrolled in the plan at a specified percentage of salary deferral contribution, unless the employee affirmatively elects not to participate. Under the typical Section 401(k) plan enrollment process, an employee must elect to participate. Under a negative election, an employee is deemed to have elected to participate at a default rate unless the employee affirmatively elects not to participate. This method usually has the effect of increasing participation in the plan by NHCEs.

2. IRS Approval

The IRS has approved negative elections in Rev. Rul. 98-30, Rev. Rul. 2000-8 and a General Information Letter in 2004. In the rulings, the negative election is set at 3 percent of the employee's compensation. The 2004 General Information Letter indicates that it could be lower or higher than 3%. The Final Regulations provide that there is no limit on the amount of the default election. The employee must have an effective opportunity to elect cash instead of deferral by informing them of their right to opt-out prior to the date they are eligible to participate in the and be allowed to cease automatic deferrals at any time. Subject to current law limitations on contributions and limits on elective deferrals, a plan can designate a different amount of compensation as the automatic deferral. The rulings require that the employee be given an effective opportunity to receive the stipulated amount in cash rather than as a deferral. The employee must be notified of the ability to choose cash instead of the deferral and, after receiving notice, must have a reasonable period to make the election before the date on which the cash would be available.

The 2004 General Information Letter approves use of scheduled increases to the percentage if they are disclosed in the notice to the participants.

Rev. Rule. 2000-8, issued January 27, 2000, extended its earlier ruling to include current employees who have elected to defer less than three percent of their compensation.

3. Pension Protection Act 2008 Safe Harbor.

a. General

The Pension Protection Act of 2006 provides for a nondiscrimination safe harbor effective in 2008.

b. To qualify for nondiscrimination safe harbor:

(i) Eligible employees default contributions would start at a minimum of 3% of pay and automatically increase by 1% annually to reach at least 6% (but no more and 10%) of pay. Employer would have to furnish advance notice of employees right to opt out, (not clear how this would work for new hires). Employer not required to apply the auto enrollment feature to current employees who have already made elections whether (or not) to participate.

(ii) Employer would have to make matching contributions for all eligible NHCEs equal to 100% of the first 1% of pay contributed by the participant, plus 50% of the next 5% of pay. This yields a maximum match of 31/2% of pay, which would have to be fully vested after two years of service. (Alternatively, the employer could make nonelective contributions for all eligible NHCEs equal to at least 3% of pay, again subject to a two year vesting schedule).

c. Other Automatic Enrollment Rules:

(i) An employee who is automatically enrolled may be given a 90 day window to elect out of the plan and withdraw the contributions made on his or her behalf and the earnings related to those amounts. The distribution is taxed in the year of receipt and is not subject to the pre age 59Â½ 10 percent penalty tax. This also applies to Section 403(b) plans and eligible Section 457(b) plans that have automatic enrollment.

(ii) If an automatic enrollment plan performs nondiscrimination testing rather than relying on a safe harbor, refunds to correct violations may be made within six months after the end of the year without penalty to the employer. The normal rule is that the employer may pay a 10 percent excise tax on refunds made later than two and a half months after year end.

(iii) Two related changes apply to refunds from both regular 401(k) and automatic enrollment 401(k) plans. First, attributable income need be added only through the end of the preceding plan year, so long as the refund is made within the two and a half or six month window. Second, all refunds, regardless of when they are made, will now be taxed in the year of distribution. Previously, refunds made within two and a half months after year end were included in taxable income for the prior year.

(iv) Default investments. Effective in 2007, fiduciary protections would be expanded to cover default investments, as long as participants receive advance notice and assets are invested in accordance with Department of Labor regulations.

NOTE ! It should be noted that the Act does not require 401(k) plans to include automatic enrollment, and plans with automatic enrollment are not required to follow the safe harbor design; an automatic enrollment plan can still be tested annually.

4. State and Federal Wage and Hour Laws

(i) Prior to the Pension Protection Act, some states have laws which restrict or even prohibit an employer from deducting amounts from an employee's payroll for example, Oregon (the IRS ruling does not address this issue).

Most states require at least a signed written consent from the employee and some require that the spouse must agree in writing to the withholding as well. Currently, the law is unclear on whether these state laws apply to 401(k) plans.

If the negative election would reduce the employee's income below the federal or state minimum wage, similar issues may arise. For example, under the Federal Wage and Hour Laws, an employer may reduce an employee's income, even below the minimum wage, if the deductions are required by law or are made pursuant to the employee's request and made for the employee's exclusive benefit.

(ii) Pension Protection Act Preemption. The PPA amends ERISA to preempt any state laws, such as state wage deduction or garnishment laws, that could have interfered with automatic enrollment arrangements.

To qualify for this protection from state law:

The automatic contribution must be a uniform percentage of compensation for all eligible employees;

Automatic contributions must be invested in accordance with Department of Labor (DOL) regulations covering the new rule for default investment arrangements); and

Written Notice requirements must be satisfied.

5. Investment of Automatic Deferrals

How will the automatic deferrals be invested? Since the election by the employee is negative, the employee will not have given any direction on how to invest his deferrals.

If the plan provides for participant-directed investments and the employee has not given any instructions as to how the automatic deferrals are to be invested, the plan fiduciary may be responsible (and potentially liable) for investing the deferrals. If the plan provides for a "default" investment fund until the participant gives investment instructions, the plan fiduciary may be responsible (and potentially liable) for the selection and monitoring of the default fund.

The Pension Protection Act provides for the following safe harbor.

In order to avoid potential fiduciary liability for the investment decision, the PPA provides that a safe harbor will be developed by the Department of Labor ("DOL"), which, if complied with, will relieve the plan fiduciary from any liability in the selection of the default fund.

The DOL has issued proposed regulations which provide that if the default fund is a "Qualified Default Investment Alternative" ("QDIA") and a notice requirement is met then the plan fiduciary will not be liable for any investment losses in the QDIA.

QDIA -- A Qualified Default Investment Alternative must satisfy the following:

A QDIA may not impose financial penalties or otherwise restrict the ability of a participant or beneficiary to transfer the investment from the qualified default investment alternative to any other investment alternative available under the plan.

A QDIA must be either managed by an investment manager, or an investment company registered under the Investment Company Act of 1940.

A QDIA must be diversified so as to minimize the risk of large losses.

A QDIA may not invest participant contributions directly in employer securities.

A QDIA may be:

Life-cycle or targeted retirement date fund based upon the participant's age;

Balanced fund with a target level of risk appropriate for participants of the plan as a whole;

Professionally managed account.

NOTICE

A notice must be furnished to participant and beneficiaries 30 days in advance of the first investment, and a least 30 days in advance of each subsequent plan year, and must include:
a description of the circumstances under which assets will be invested in a QDIA;

a description of the investment objectives of the QDIA; and

an explanation of the right of participants and beneficiaries to direct investment of the assets out of the QDIA.

3. Effective 2010

a. Combined Defined Benefit/401(k) Plans for Small Employers - Effective 2010.

Companies with up to 500 employees may establish combined defined benefit and automatic enrollment 401(k) plan beginning in 2010. These plans will have a single plan document and trust fund, and will be required to file only one Form 5500 annual report. Otherwise, they will operate as separate plans, independently subject to all ERISA and Internal Revenue Code qualification rules. These plans will be subject to strict rules governing minimum benefit and contributions levels, vesting, and uniformity of benefits, rights and features.

b. Time to Amend Plans.

Plan sponsors will have until the last day of the plan year beginning on or after January 1, 2009 (2009) to adopt plan amendments.

C. Defined Benefit Pension Plans

1. Effective 2006 and 2007

a. PBGC premiums.

b. Increased plan deduction limits.

c. Cash balance plan provisions.

2. Effective 2008

a. Defined benefit plan funding.

b. Benefit limits

c. Required periodic statements - lump sum distribution assumed interest rates.

D. Miscellaneous

1. PBGC Missing Participants Program for Terminated Defined Contribution Plans. The Pension Benefit Guaranty Corporation's missing participant program for defined benefit plans in expanded to cover terminated defined contributions plans. Effective after PBGC issues final regulations.

2. 401(k) Hardship Distributions Expanded. A 401(k) plan may provide for hardship distributions upon a hardship of a participant's designated beneficiary even if not a spouse or dependent; e.g. a grandchild, parent or domestic partner.

3. Safest Available Annuity. The Act requires the Department of Labor (DOL) to issue final regulations within one year of the date of enactment clarifying that the selection of an annuity contract as an optional form of distribution from a defined contribution plan (such as money purchase pension plans) is not subject to the safest available annuity standard, but would be subject to other applicable fiduciary standards.

II. IRS REVISED 401(k) POST TERMINATION PAY RULE

Included in the final 415 regulations was a change in the treatment of post termination pay. The final 415 regulations, like the proposed regulations, generally provide that amounts received following termination of employment are not considered compensation. The final regulations modify one exception made in the proposed regulations. The time frame for the exception for payments under bona fide sick, vacation or other leave, etc. that would have been available for use if employment had not been terminated has been expanded to the later of 2Â½ months after the termination of employment or the end of the limitation year that includes the date of termination of employment (the proposed rule was limited to 2Â½ months).

III. PAYMENT OF PLAN EXPENSES FROM TERMINATED PARTICIPANTS ACCOUNTS - SIGNIFICANT DETRIMENT?

Rev. Rul. 2004-10, Payment of Plan Expenses from Terminated Participants Accounts - significant detriment?

On May 19, 2003, the DOL issued Field Assistance Bulletin 2003-3 in which it provided guidance permitting a defined contribution plan to allocate certain expenses, such as distribution and QDRO expenses, to the participant who is receiving the distribution or obtaining the divorce, rather than allocating the expense among all of the participants. The guidance also permits a plan to allocate to former-employee participants their share of the plans administration expenses even though the employer is paying for administration expenses of the current-employee participants.

Initial statements by IRS officials indicated an IRS reluctance to approve the allocation of expenses to former-employee participants because of the possibility of compromising the consent rules. The IRS consent rules prohibit a plan from making an immediate distribution to a terminated participant without his/her consent if his/her account balance exceeds $5,000. A participant with an account balance that exceeds $5,000 can leave his/her benefit in the plan by not consenting to the distribution. The IRS regulations prohibit the plan from imposing a significant detriment on the participant because he/she refuses to provide consent for the distribution.

Revenue Ruling 2004-10 provides that a plan will not be imposing a significant detriment if it allocates to former employees accounts a reasonable, pro rata share of the plan's administrative expenses. The employer may pay for the administration expenses of the active employees but allocate to the former-employee participants accounts their pro-rata share of the plan expenses. The IRS concluded the allocation of the expenses to the former employees accounts was not a significant detriment since the former employees would have to pay IRA expenses if they rolled over the amounts to an IRA.

The ruling specifically approves of a pro rata allocation of plan expenses to former employees accounts and does not address a per capita method of allocating expenses. If a plan chooses to use a per capita method of allocating expenses, the plan has the burden of demonstrating to the IRS that the method is both reasonable and nondiscriminatory.

The plan's method of allocating expenses is a right or feature that must be available on a nondiscriminatory basis. However, the nondiscrimination rules test former employees separately from current employees. Therefore, if a plan allocates the plan expenses uniformly to all former-employee participants, the plan will comply with the nondiscrimination requirements.

IV. NEW FEDERAL BANKRUPTCY LAW.

The new Federal Bankruptcy Law was signed by the President on April 20, 2005. It provides protections for benefits under qualified plans and IRA's.

Expanded protection to include employer ERISA and also includes qualified retirement plans that are not subject to ERISA (i.e., governmental and church plans), 401(b) annuities and IRA's.

Plan Loans. The bill exempts plan loan repayments via payroll deduction from the automatic stay provisions. The bill provides that debtors could not discharge their loans owed to pension, profit sharing, stock bonus, or other retirement plans.

V EXPANDED ROTH IRA CONVERSIONS

On May 17, 2006, the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) was enacted. One of the changes in the law changes the rules for converting regular IRAs into Roth IRAs.

At present, a taxpayer cannot convert a regular IRA into a Roth IRA if the taxpayer's adjusted gross income exceeds $100,000. This prevents those individuals most interested in converting their IRAs from doing so. If an individual does convert an IRA, the entire taxable portion of the converted IRA is included as taxable income in the year of conversion. These rules will remain in effect through December 31, 2009.

Beginning January 1, 2010, an individual can convert a regular IRA to a Roth IRA regardless of the individual's AGI. All taxpayers will be able to do Roth conversions.

If a taxpayer converts a regular IRA to a Roth IRA in 2010, then the taxpayer will include half of the conversion amount in income in 2011 and half in 2012, unless the individual elects to include the entire amount in 2010 income.

Roth IRA conversions can be a planning tool. Conversion allows a taxpayer to avoid taxes on future earnings in the Roth account and to avoid 70Ã�Â½ lifetime required minimum distributions. But Revenue Raiser accelerates taxable income.
Ray Benner and Benner & Associates, P.C website is
http://www.bennerandassoc.com

Randy Durig and Durig Capital LLC Registered Investment Advisor - Accredited Investment Advisor home page is http://www.durig.com

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