Pension Protection Act of 2006

On August 17, 2006, President Bush signed into law the Pension Protection Act of 2006 (PPA) which includes major reforms to defined benefit plans and also contains several significant provisions affecting defined contribution plans.  Below is a brief summary of the important provisions included in the PPA which affect defined contribution plans, including 401(k) Plans.  The PPA included several provisions regarding Automatic Enrollment in plans.  See the separate article in this newsletter regarding the new Automatic Enrollment rules.  In general, the plan documents will not have to be amended until the end of the 2009 plan year.  However, plans must operate in accordance with the PPA changes until that time.

EGTRRA Provisions
Provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) which were scheduled to expire after 2010 were made permanent.  These include higher maximum annual salary deferral limits, catch-up contributions for participants which are age 50 or older, Roth 401(k) contributions, higher maximum compensation limits and increased portability between different types of retirement plans.

Saver’s Credit
This non-refundable tax credit for lower income workers for contributions to retirement plans was scheduled to expire after 2006.  The credit is for 10 to 50% of an individual’s contribution up to $2,000 each year.  The PPA makes this credit permanent and indexes the income limits for inflation.

Vesting Schedules
Effective for contributions made for plan years beginning in 2007, all employer contributions (including profit sharing and matching contributions) must be vested according to a three year cliff schedule or a six year graded schedule.  A three year cliff means that the participant is zero percent vested after years one and two and then 100% vested after year three.  A six year graded schedule means the participant is zero percent vested after year one and then 20% each year until the participant is 100% vested after year six.  The plan document does not currently have to be amended to reflect the new vesting schedule, but the plan must be operated in accordance with the new vesting schedule and plan participants should be notified of the new schedule.

Benefit Statements
Effective in 2007, PPA requires plans which permit participants to select their own investments to provide statements to the participants on a quarterly basis.  Plans that are not directed by the participants must provide statements on an annual basis.  The benefit statement must provide the total account balance and vested percentage for each participant.  In addition, statements for participant directed accounts must include language regarding the importance of diversification and the availability of additional information on the DOL website.

Rollover by Non-Spouse Beneficiaries
Beginning in 2007, non-spouse beneficiaries who inherit a participant’s balance in a qualified retirement plan can rollover these amounts into their own “inherited” IRA.  Previously, only spouses could rollover these amounts into an IRA.  However, a non-spouse beneficiary must immediately begin taking annual distributions from an inherited IRA based on the beneficiary’s life expectancy, while a spouse may choose to defer any distributions until they reach age 70 ½.

Hardship Withdrawals
Effective after the date the Department of the Treasury issues regulations, hardship withdrawals may now be taken for a financial hardship of any beneficiary of a plan participant.  Previously a hardship could only be taken for the participant’s spouse or dependents.

Direct Rollovers to Roth IRAs
Starting in 2008, participants with Adjusted Gross Income not exceeding $100,000 and meeting certain other conditions will be able to rollover amounts from a qualified retirement plan directly into a Roth IRA.  However, the participant will still be liable for the applicable taxes at the time of the rollover.

Investment Advice Exemption
Effective in 2007, this provision creates a prohibited transaction exemption that will enable investment advice to be provided by a “fiduciary advisor” (who would otherwise be precluded from doing so as a “party-in-interest” for a plan).  The investment advice is qualified for this exemption if it is based on one of the following two models: (1) advice provided through a computer model that has been certified by an independent third party, or (2)  the advisor’s compensation does not vary depending upon the investments that are recommended. This exemption will enable financial advisors and investment managers to provide advice to 401(k) plan participants if they meet the qualifications.

Missing Participants in a Terminated Plan
Effective after the Pension Benefit Guaranty Corporation (PBGC) issues regulations, terminating defined contribution plans may transfer the accounts of missing participants to the PBGC.  The amounts transferred will be accounted for and distributed in accordance with the PBGC missing participant program.

DB(k) Plan
Beginning in 2010, an employer with less than 500 employees may adopt a combination defined benefit and 401(k) plan.  The defined benefit component and the 401(k) component must conform to the respective rules under ERISA and the Internal Revenue Code for each component.  The plan must meet specific rules to be allowed to operate as a single plan with one plan document and one annual Form 5500 required.

Simplified 5500-EZ Requirements
Effective for plan years beginning on or after January 1, 2007, the PPA eliminates reporting requirements on IRS Form 5500 for one-participant retirement plans with assets of less than $250,000.

Distributions to Certain Military Personnel
Qualified reservists called to active duty may withdraw amounts from a 401(k) plan and the 10% early distribution penalty for withdrawals before the age of 59½ will not apply.  This provision applies only if the reservist is called up between September 11, 2001 and December 31, 2007 for more than 179 days.  The withdrawal would be subject to income tax in the year of withdrawal.  However, if the withdrawn amounts are re-contributed to the plan within a two year period after the participant’s active service ends, the participant can request a refund of the taxes paid.

This article is provided for general and educational purposes only, and is not intended to provide legal, tax or investment advice.

Contact Administrative Retirement Services, Inc. if you have questions about any of the above provisions.

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