PENSION PROTECTION ACT OF 2006

On August 17, 2006, President Bush signed the Pension Protection Act of 2006 into law. While this legislation focuses primarily on pension funding rules, it does include provisions that affect IRAs, 403(b) plans, 457 plans, and 529 college savings plans.

Our Take: This legislation is sweeping, and addresses many crucial issues like our inability to save as a nation, the importance of how pension money affects our retirement income, and much, much more. Throughout the year, The Olson Group representatives will be discussing this act with our customers in an effort to increase participation and awareness in their retirement programs. This legislation not only encourages participation, but increases flexibility in retirement plans as well. The following covers the major issues of the Pension Protection Act of 2006.

Automatic Enrollment Enhancements

The Act includes a number of provisions designed to encourage automatic enrollment programs. These provisions are effective for plan years beginning after December 31, 2007.

Automatic Enrollment Safe Harbor

Currently, 403(b) plans that provide for certain non-elective or matching contributions and meet notification requirements are deemed to satisfy the ACP test. Effective for plan years beginning after December 31, 2007, 403(b) plans that provide for automatic contributions and meet certain other requirements will also be deemed to pass the ACP test.

• A 403(b) plan must provide for certain automatic deferrals for all employees eligible to participate in the plan.
• Automatic deferrals may not exceed 10% of an employee’s compensation but must be at least 3% of compensation until the end of the first full plan year beginning after the safe harbor applies to the employee.
• The percentages increase to 4% during the second year; 5% during the third year; and 6% during the fourth year and thereafter.
• These requirements do not apply to employees who are hired before the plan adopts the safe harbor arrangement and who have an affirmative election in place either to make contributions or not to make contributions.
• Each employee must have an opportunity to change (or cancel completely) any automatic contribution.

In addition, the employer must make a minimum contribution on behalf of each non-highly compensated participant in the plan. The contribution may be either:

• A non-elective contribution equal to 3% of the employee’s compensation.
• A matching contribution equal to 100% of the employee’s contributions which does not exceed 1% of compensation and 50% of the employee’s contributions that exceed 1% but do not exceed 6% of compensation.
• Matching contributions cannot be made on deferrals that exceed 6% of a participant’s compensation.

Before the beginning of each plan year, a safe harbor plan must also provide each employee who is eligible to participate in the arrangement with a written notice that explains the employee’s right under the arrangement not to make elective contributions (or to elect contributions in a different amount).

403(b) and 457 PLANS

Accelerated Vesting Requirements

Before EGTRRA was enacted in 2001, all contributions to a 403(b) plan subject to ERISA were required to vest under either a 5-year cliff vesting schedule or a 7-year graded schedule. EGTRRA changed the law to require that matching contributions vest under either a 3-year cliff or a 6-year graded schedule.

The Act subjects all employer contributions to ERISA-covered 403(b) plans to the same vesting requirements as now apply to matching contributions.

• Employer contributions must vest under either a 3-year cliff vesting schedule or a 6-year schedule providing for 20% incremental vesting after 2 years of service through 6 years of service.
• All years of service, including those before the effective date of the new requirements, must be taken into account.
• The vesting requirements are effective for contributions for plan years beginning after December 31, 2006, although the requirements do not apply to a participant until the participant has one hour of service after the effective date.

ERISA Section 404(c) Protection

The Act expands the scope of fiduciary protection under ERISA section 404(c) for 403(b) arrangements (and IRA arrangements) subject to ERISA. It is applicable to all plans that permit participants to direct their investments.

Effective upon enactment, the Act amends ERISA section 404(c) to provide that participants who fail to make an affirmative investment election will be treated as exercising control over the assets in their accounts if certain requirements are met.

• The plan must provide that automatic contributions will be invested in accordance with guidelines issued by the Department of Labor (DOL). The DOL is directed to issue regulations within 6 months providing guideline on default investments for participants who fail to make an affirmative investment election. The default investments will be required to include a mix of asset classes.
• The plan must give notice to employees before the beginning of each plan year explaining their rights to make investment elections under the plan and how contributions will be invested in the absence of affirmative investment elections.

Explicit ERISA Preemption of State Wage Laws

Several states have taken the position that their wage and payroll laws prohibit automatic contributions to an employer-sponsored retirement plan in the absence of a salary deferral agreement. The Act explicitly provides that these state laws are preempted for 403(b) arrangements subject to ERISA if the automatic contribution arrangement meets certain requirements.

• The contributions must be invested in accordance with the regulations to be issued by the DOL under ERISA section 404(c); and
• The plan must give notice to participants before the beginning of each plan year explaining that participants have a right not to make contributions (or to change the amount of their contributions) and how the contributions will be invested in the absence of an affirmative investment election.

This new rule is not applicable to 403(b) arrangements or other plans that are not subject to ERISA.

Withdrawal of Contributions During First 90 Days

Under the Act, 403(b) and 457(b) plans may allow participants to withdraw automatic contributions within a 90-day window period without an early withdrawal or other penalty under certain circumstances. To permit early withdrawals, the following requirements must be met:

• The plan must be amended to permit an early withdrawal.
• The plan must implement the new ERISA section 404(c) provisions described above.
• The plan must provide a notice to each eligible employee before the beginning of each plan year explaining the employee’s right not to make automatic contributions (or to make such contributions in a different amount) and how contributions under the plan will be invested in the absence of an affirmative investment election.
• The withdrawal must be made at the election of the employee within 90 days of the first automatic contribution made for the employee and must include all of the employee’s automatic contributions. The amount withdrawn is included in income in the year of withdrawal, and, for 403(b) plans, is not taken into account for purposes of the ACP test.

Expansion of Corrective Distribution Period

For 403(b) plans with automatic deferrals, the new legislation also extends the period during which excess aggregate contributions resulting from ACP test failures can be distributed before incurring the 10% excise tax under Code section 4979. Currently, the period is 2-1/2 months from the end of the plan year. The Act extends that to 1 year and requires the distribution of income on excess amounts only through the end of the year in which the amounts were contributed.

Distribution Changes

There are several provisions of the Act that make changes relating to distributions from 403(b) and 457 plans.

Hardship Distributions

The Act provides that the Treasury Department must issue regulations within 180 days of the date of enactment providing that hardship or unforeseeable emergency distributions from a section 403(b) or 457 plan apply not only to certain hardships or unforeseeable emergencies of the participant’s spouse and the participant’s dependents, but also of the participant’s beneficiary under the plan.

Rollovers to Non-spouse Beneficiaries

Under current law, upon a participant’s death, a spousal beneficiary under a 403(b) or governmental 457(b) plan is permitted to rollover the benefit to the spouse’s IRA or other qualified plan. Nonspouse beneficiaries have not been permitted to rollover or otherwise move funds into their IRAs or other plans. Effective for Distributions after December 31, 2006, the Act permits nonspouse beneficiaries to make a direct transfer to an IRA from a 403(b) plan or 457(b) plan.

Rollovers of After-Tax Contributions to 403(b) Annuities

Currently, employee after-tax contributions can be rolled over from a qualified plan to another qualified plan, and employee after-tax contributions can be rolled over from a 403(b) plan to another 403(b) plan, provided the rollover is a direct rollover and the recipient plan or annuity accounts separately for the amounts rolled over. Current law does not permit after-tax funds to be moved from qualified plans to 403(b) plans, or vice-versa.

Beginning after December 31, 2006, after-tax contributions can be rolled over from a qualified plan to a 403(b) plan, as well as to a qualified plan. The new law does not appear to permit after-tax funds held in a 403(b) plan to be rolled over to a qualified plan.

Qualified Plan Conversions to Roth IRAs

Under current law, if a participant in a qualified plan, 403(b) plan, or 457 plan wants to convert his or her account to a Roth IRA, the participant must first roll the funds into a traditional IRA, and then convert the traditional IRA into a Roth IRA. Effective for distributions after 2007, the Act allows a rollover directly into a Roth IRA. Such rollovers are subject to current rules for conversions from traditional IRAs to Roth IRAs:

• The taxpayer must include the distribution in taxable income (except for distributions of after-tax funds);
• The conversion is not subject to the 10% early withdrawal tax; and
• For 2008 and 2009, only taxpayers with gross income less than $100,000 are eligible for conversions. (Under the Tax Increase Prevention and Reconciliation Act of 2005, the $100,000 income limitation on conversions is eliminated for conversions after 2009.)

Distributions from Governmental Plans for Health and Long-Term Care Insurance

The Act provides that annual distributions of up to $3,000 from a governmental 403(b) plan or 457 plan to pay for qualified health insurance premiums for eligible retired public safety officers are excludable from income if the amounts are paid directly to an insurer.

EGTRRA Permanence

The Act makes permanent the changes made by EGTRRA relating to 403(b) and 457 plans, including increased contribution limits, catch-up contributions for participants age 50 and over and expanded rollover options. The saver’s credit also continues to be available with respect to elective deferrals to a section 403(b) annuity and a governmental 457 plan.

ERISA §404(c) Changes

For 403(b) plans that are subject to ERISA, section 404(c) generally provides that plan fiduciaries are not subject to liability for individual participant investment choices in participant-directed plans, provided the participant is given adequate information regarding the investments and other procedures are followed.

Default Investments

The Act directs the DOL to issue regulations within 6 months of enactment providing standards for default investments for participants who fail to make an investment election. Plan fiduciaries who follow these standards are relieved of fiduciary liability in connection with these investment allocations.

Investment Mapping

The Act provides that when a plan changes investment choices and automatically maps participant choices to “reasonably similar” investments, ERISA section 404(c) relief will continue to apply with respect to the mapped investments if advance notice to participants is provided and other requirements are satisfied. This change is generally effective for plan years beginning after 2007, with a delayed effective date for collectively bargained plans.

Blackout Period

The Act specifies that section 404(c) relief does not apply with respect to a “blackout period” during which participants cannot change their investment elections unless the blackout period is implemented in accordance with standards to be issued by the DOL within one year following enactment. This change is generally effective for plan years beginning after 2007.

IRAs

Nonspouse Beneficiary Rollovers

Under current law, upon a participant’s death, a spousal beneficiary under a qualified plan is permitted to rollover the benefit to the spouse’s IRA or other qualified plan. Effective for distributions after December 31, 2006, the Act permits nonspouse beneficiaries to make a direct transfer to an IRA from a qualified retirement plan, a 457 plan, or a 403(b) plan.

• Unlike spouses, nonspouse beneficiaries are not permitted to move the funds by a rollover, but must utilize a trust-to-trust transfer.
• Nonspouse beneficiaries may not move funds to their retirement funds other than IRAs.
• Amounts transferred to an IRA will be treated as amounts held in an inherited IRA.
• Beneficiary will be subject to the minimum required distribution rules as apply to nonspouse beneficiary of an IRA.

Tax Exemption for Distributions Donated to Charity

The Act provides an exemption from taxation for certain distributions in 2006 and 2007 from a traditional IRA or Roth IRA (but not a Simple IRA or SEP) that are donated to charitable organizations. This exemption is available only if the taxpayer is at least age 70-1/2 at the time of distribution. The exemption is limited to $100,000 per taxpayer per year, and it only applies if the entire contribution would be deductible without taking into account the percentage limitations based on adjusted gross income.

Indexing of IRA Limits

Under current law, taxpayers with income above certain limits are permitted only reduced deductible traditional IRA and Roth IRA contributions, and are not permitted to make such contributions at all above certain income levels. The Act provides that the existing limits are indexed for inflation for 2007 and future years, with increases based on the nearest multiple of $1,000.

Direct Deposit of Tax Refunds

The IRS is directed to develop a form that will permit tax refunds to be deposited directly to a taxpayer’s IRA (or to a spouse’s IRA in the case of a joint return). The form would apply for the 2007 tax year and thereafter.

Limited IRA Make-Up Contributions for Bankruptcy/Criminal Acts

The Act permits make-up IRA contributions of up to $3,000 per year for 2007-2009 for individuals meeting the following criteria:

• The individual participated in a 401(k) plan with an employer match in employer stock on at least 50% of employee contributions;
• In an earlier tax year, the employer was a debtor in a bankruptcy case and the employer or another person was subject to indictment or conviction resulting from business transactions relating to the bankruptcy; and
• The individual participated in the 401(k) plan on the date six months before the bankruptcy case was filed.

A taxpayer cannot take advantage of both these make-up contributions and catch-up contributions for individuals age 50 and older.

EGTRRA Permanence

The act makes permanent the IRA-related changes made by EGTRRA, including the following:

• Increased IRA contribution limits, including catch-up contributions;
• Deemed IRAs under employer-sponsored retirement plans; and
• Increased rollover opportunities, including rollover of after-tax contributions.

Saver’s Credit

EGTRRA added a temporary nonrefundable tax credit for IRA and other qualified plan contributions. The credit applies to up to 50% of the first $2,000 of contributions, and the credit percentage phases out depending on taxpayer income levels. The credit was set to expire at the end of 2006. The act makes the saver’s credit permanent.

• Effective January 1, 2007, the Act also permits a taxpayer to elect that a saver’s tax credit refund be directly deposited by the Federal government into a qualified retirement plan or IRA identified by the taxpayer.
• In addition, the Act provides that the income limits for the saver’s credit will be indexed for inflation.

529 College Savings Plans

The tax-free withdrawals (federal tax only) for qualified education expenses introduced in EGTRRA will not expire in 2010.

ERISA Investment Changes

The Act includes various changes to ERISA that are intended to facilitate the provision of investment advise to participants and expand the ability of plans to utilize certain investments within the limitations of the prohibited transaction rules. These changes apply to 403(b) plans subject to ERISA.

Investment Advice

A new statutory exemption, ERISA section 408(b)(14), provides relief for the provision of investment advice to participants in participant-directed plans subject to ERISA. The exemption essentially provides that an investment advice arrangement will not give rise to a prohibited transaction if it is:

1. Based on a computer model certified by an independent expert; or


2. An arrangement in which the advisor’s fees do not vary depending on the investment selected.

From the plan sponsor and plan fiduciary perspective, the provision is also significant in that it provides specific relief for the sponsor and other fiduciaries (other than the advisor) from liability for any individual advice provided to participants. The change will be effective for advice provided after 2006.

Other Prohibited Transaction Rule Changes

The Act modifies the ERISA “plan asset” rules and prohibited transaction provisions in ways that will generally allow:

• Non-publicly traded investment funds, including hedge funds, to accept more ERISA plan funds;
• Non-fiduciary service providers to engage in certain transactions with plans to which they provide services, superseding some existing class exemptions issued by the DOL;
• Plan fiduciaries to effect large block trades on behalf of multiple plans;
• Purchases and sales of securities through certain electronic trading networks and alternative trading systems;
• Certain transactions on foreign exchanges; and
• “Cross-trading” by an investment manager in a wider variety of circumstances than currently permitted under an existing DOL class exemption.

REPORTING

Quarterly Benefit Statements

The Act requires administrators of 403(b) plans subject to ERISA to provide a benefits statement to each participant at least quarterly if the participant has a right to direct the investment of assets in his or her account. Other participants must receive a benefits statement at least annually. The benefits statement must include the following information:

• The total value of benefits accrued;
• The value of each investment to which assets in the participant’s account are allocated (including the value of investments in employer securities); and
• The participant’s vested accrued benefit or the earliest date on which the accrued benefit will become vested.

Proposed Form 5500 Changes

In July 2006, the Department of Labor, together with the IRS and PBGC, proposed significant changes to the Form 5500 and related schedules that affect defined contribution plans. The highlights of these changes include:

• A new short-form 5500 filing would be available for small plans that cover less than 100 participants and are invested exclusively in easy-to-value investments, such as mutual funds;
• All service providers receiving fees in excess of $5,000 would be required to be listed, rather than only the 40 receiving the most compensation; and
• Service providers receiving compensation from third parties in excess of $1,000 in connection with plan services would be required to so indicate, including listing the payor of the compensation and the amount of the compensation – most significantly, this would appear to require information to be disclosed with respect to service providers who receive 12b-1 and other fees with respect to plan investments.

Under current DOL rules, many 403(b) plans are exempt from Form 5500 reporting, including governmental plans and nongovernmental plans that offer only salary reduction contributions and have limited employer involvement. All other 403(b) plans currently have only limited Form 5500 reporting requirements. In a significant change, the limited reporting for these plans would be eliminated, and these plans would be required to report on the same basis as 401(k) plans.

EPCRS ENHANCEMENTS

The Act clarifies that the IRS has the authority to establish and implement its Employee Plans Compliance Resolution System (EPCRS), including waving income, excise, or other taxes. The Treasury Department is directed to continue to update and improve EPCRS, including (1) taking into account the special concerns of small employers; (2) extending the self-correction period for significant compliance failures; (3) expanding the ability to self-correct insignificant errors during audit; and (4) assuring that taxes, penalties, and sanctions under the program are not excessive.

VOLUNTARY EARLY RETIREMENT AND RETENTION PLANS EXEMPT FROM SECTION 457 LIMITS

The Act provides that certain voluntary early retirement incentive plans and retention plans maintained by local educational agencies or tax-exempt education associations that principally represent employees of local education agencies are not subject to the limits under Code section 457.

EXPANSION OF PARTICIPATION RULES UNDER SECTION 457

The Act provides that an individual is not precluded from participating in an eligible deferred compensation plan under Code section 457 by reason of having received a distribution of up to $3,500 under section 457(e)(9) as in effect before the Small Business Job Protection Act of 1996.

2006/2007 Form 5500 Due Dates for All Plan Anniversaries

• Do not carry your Social Security Card, passport, or birth certificate in your wallet.


• Request a randomly assigned driver’s license number rather than using your Social Security Number (SSN).

• Do not have personal checks pre-printed with your Social Security Number.


• Do not have personal checks sent to your home mailbox. Pick them up at the bank or a locked mailbox.


• Mail bills or other sensitive items at the post office rather than from your residence or neighborhood drop box.

• Cancel all unused credit cards since the account numbers are recorded in your credit report and could be used by thieves.


• Keep a list or photocopy of all credit cards, account numbers, expiration dates, and telephone numbers of customer service and fraud departments in the event your cards have been lost or stolen. Do the same with your bank accounts.


• Never give out your personal information over the phone unless your initiated the call and you have a trusted business relationship with the company.


• Always take credit card and ATM receipts with you.


• Request in writing that the issuer of each of your credit cards remove your name from their marketing and promotional list that they may sell to other companies.

• Choose PIN numbers and passwords that are not obvious and do not contain identifying information.
• Memorize all passwords. Don’t record them on anything in your wallet.
  
• Shield your hand when using your PIN at ATM machines or when making calling card phone calls.

• Always shred bills and other statements before throwing them away.
• Find out how the companies that you work with dispose of information.
• Carefully review your credit card and phone bills for unauthorized charges.