|
|
Newsletter
September
2006 Volume
23 - Number 3
|
|||||||
|
|
This
newsletter is addressed to our clients their attorneys, accountants and other
professional advisors. Citations may be included for those who want to refer directly
to the source material. IN THIS ISSUE:
THE PENSION PROTECTION ACT OF 2006 (PPA) – The provisions of
PPA have numerous effective dates, which range from September 11, 2001
through January 1, 2009. This newsletter focuses on the provisions of PPA
that have retroactive effective dates prior to the enactment of PPA on |
|||||||
|
|
10% Early Withdrawal Excise Tax Exemption for
Individuals Called to Active Duty The exemption is
available for “qualified reservist distributions” made after September 11,
2001. A “qualified reservist distribution” is a withdrawal from an IRA,
401(k) or 403(b) account that is made to a reservist called up to active duty
between September 11, 2001 and December 31, 2007, whose active service is for
at least 179 days and receives the distribution during this period of service.
PPA also allows the reservist to repay a “qualified reservist distribution”
to an IRA by the later of two years after the period of active service or two
years after August 17, 2006. Guidance and procedures are needed for claiming
a refund of the excise tax. Effective for
distributions made after August 17, 2006, an exemption from the 10% early
withdrawal excise tax is available for public safety employees who terminate
employment after age 50. An existing rule eliminates the excise tax for a
distribution to any individual who terminates employment after age 55. Qualified Charitable Distribution from IRA Owner
Age 70½ Taxpayers that
have attained age 70½ are allowed to make tax-free distributions from their
IRA directly to certain charitable organizations. Such a distribution is
limited to $100,000 and is not includable in the donor’s income. This
opportunity is available only during 2006 and 2007. Blackout Notice Requirement Does Not Apply to
Certain Owner-Only Plans Owner-only plans
cover no other employees, only the owner of the company and their spouse or
the partners in a business partnership and their spouses. A blackout notice
is required when a participant can direct the investment of their account
balance, but the participant will be subject to temporary restrictions
affecting investment changes, and timing of distributions or loan withdrawal.
The blackout notice indicates the restrictions on the participant’s account
and the blackout period during which the restrictions will be in affect. Owner-only
plans are exempt from many of the requirements applied to other plans such as
certain bonding, reporting, filing and disclosure requirements. PPA provides
that the blackout notice required by Sarbanes-Oxley also does not apply to
owner-only plans. 6% Exception to the Combined Plan Deduction Limit Prior to the
enactment of PPA, defined benefit and defined contribution (i.e. profit
sharing) plans were subject to a combined contribution limit of 25% of
participant compensation. As a result the employer could not contribute to a
defined contribution plan if the employer’s contribution to the defined
benefit plan exceeded the 25% of participant compensation limit. Effective
for years beginning in 2006 and after, only employer contributions in excess
of 6% of participant compensation are subject to the combined limit. Under
the new rule, an employer that sponsors both a defined benefit plan and
profit sharing plan can always make a contribution from 0% up to 6% to the
profit sharing plan and more if the contribution to the defined benefit plan
is below the 25% threshold. This makes it possible for the sponsor to operate
a safe-harbor 401(k) plan which requires a 3% employer contribution or 4%
match so that the highly compensated employees can defer the maximum ($15,000
for 2006 and $20,000 if age 50) without the 401(k) feature having to pass the
401(k) non-discrimination test. In 2008 the combined limit is eliminated for
defined benefit plans covered by the Pension Benefit Guarantee Corporation
(PBGC). Defined Benefit Plan Lump-Sum Distributions The rates
established by the Pension Funding Equity Act (PFEA) expired at the end of
2005. As a result the interest rate used to determine the maximum lump-sum
distribution to a participant reverted back to prior law. Retroactive to
January 1, 2006, PPA basically reinstated the PFEA rule and added a new
component. The interest rate used to calculate the maximum lump-sum is now
the greatest of the following 1) 5.5%, 2) the plan rate, or 3) the rate that
provides 105% of the benefit calculated with the 417(e)(3) rate. Guidance is
needed for lump sum distributions made during 2006 under prior law and before
PPA was enacted. It is expected that IRS will address the issue soon. Defined Benefit Plan 30-year Treasury Rates The temporary
interest rate established by the Pension Funding Equity Act of 2005 has been
extended to 2006 and 2007 for the purposes of funding and PBGC premiums. For
funding, this rate is used to project the growth of investments for the
purpose of determining the employer’s required contribution to meet the
minimum funding standard. PPA also provides for an overhaul of the minimum
funding rules in 2008. Defined Benefit 415(b) Limit Based on All Service Effective in
2006, PPA specifically allows defined benefit plans to use average
compensation over any years of service not just years while a participant in
the plan. This is an important clarification because not only was this rule
ambiguous, but IRS had proposed regulations that would only recognize years a
participant was in the defined benefit plan. Under the new rules the
limitation that a participant’s benefit may not exceed 100% of the
participant’s compensation for his high 3 years of compensation will be
determined during any years of service not just the years as a participant in
the plan. Defined Benefit Deduction Limit Increased For years
beginning in 2006 and 2007, the deduction limit for single-employer defined
benefit plans is equal to 150% of the plan’s current liability less the value
of the plan assets. This rule eliminates the old funding limitations which
were far more restrictive. Under prior law the deduction was limited to 100%
of current liability. Limit on PBGC Guarantee Applies to Benefit
Increases due to the Occurrence of an Unpredictable Contingent Event PBGC guarantees
benefits payable, within certain limits, under a defined benefit plan.
Currently, the guarantee for benefits increased by an amendment is phased in
over a 5 year period following the effective date of the amendment. PPA makes
it so that unpredictable contingent event benefits such as those created by a
plant shutdown will also be phased in over 5 years. The five year period
begins on the date of the unpredictable contingent event. This provision is
effective for events occurring after July 26, 2005. Cash Balance and Hybrid Plans Not Inherently Age
Discriminatory Cash balance and
other hybrid plans have been accused of being age discriminatory because the
ultimate value of an annual accrual for a younger employee is arguably
greater than the ultimate value of an annual accrual for an older employee.
This is due to the way interest is credited and the accumulation during the
years until retirement. PPA provides that cash balance and other hybrid plans
are not inherently age discriminatory as long as the annual accrual itself
does not discriminate based on age. No Wear Away for Cash Balance Plan Conversions Effective for
conversions of defined benefit plans to cash balance plans occurring after
June 29, 2005, the wear away of the benefits that accrued prior to the
conversion is prohibited. In some cases, when a
defined benefit plan formula is changed to a cash balance plan formula, the
benefit earned under the old formula may exceed the amount determined to be
your benefit under the cash balance plan formula. In this situation, you
might not earn any additional benefits until your benefit under the cash
balance plan formula exceeds the benefit you had earned under the old
formula. This is commonly referred to as “wear away.” Essentially under
the new rule, a participant’s benefit must equal the value of the
pre-conversion benefit plus the benefit earned after the conversion. In
addition, post-conversion accruals are required for all participants
including those with benefits accrued prior to the conversion. Hybrid (Cash balance) Plan Vesting and Interest
Rate Rules For plans established after June 29, 2005, these provisions are
effective retroactively to the plan starting date. For plans in existence on
June 29, 2005, these provisions are effective for plan years beginning in
2008. Participants must become 100% vested in their account balance after 3
years of service. Also, plans must provide an interest credit no greater than
a market rate. This interest limit appears to address the whipsaw affect.
Whipsaw refers to a certain variation regarding the calculation of a lump-sum
distribution from a cash balance plan. The calculation involves projecting
the cash balance forward to retirement age and then discounting back to
present value at distribution. The interest rate used to project to
retirement may be defined by the plan, but the discount rate is prescribed by
statute. If the plan's projection rate exceeds the statutory discount rate,
then the present value of the accrued benefit will exceed the participant's
account balance. Unless this higher figure is paid out, the IRS takes the
view that an impermissible forfeiture has occurred. |
|||||||
|
|
|
