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Pension Protection: the Pension Protection Act of 2006 makes extensive changes to existing law.

President Bush signed the Pension Protection Act of 2006 on Aug. 17, 2006, providing extensive changes to existing law and new rules affecting qualified retirement plans, plan sponsors and plan participants. The PPA makes comprehensive amendments to the Internal Revenue Code and to the Employee Retirement Income Security Act of 1974, as amended.


The following is a summary of the major provisions of the PPA that affect retirement plans. Note, too, that the PPA contains other important provisions that affect corporate-owned life insurance, health and welfare plans, charitable organizations and Sec. 529 plans. (For more information on the PPA, see pages 29 and 35.)


The Economic Growth and Tax Relief Reconciliation Act of 2001 made many favorable changes to the IRC, such as catch-up contributions for workers age 50 and over, increased contribution limits and expanded rollover options. The provisions of EGTRRA were temporary and were set to sunset after Dec. 31, 2010. The PPA makes EGTRRA provisions relating to retirement plans permanent, which means that plans will not need to go back to the pre-EGTRRA plan rules.


Automatic Enrollment

Effective for plan years beginning in 2008, the PPA permits employers to "automatically" enroll employees into their 401(k) plans without first obtaining a written election to contribute from the employees. Instead, an employee must opt out of contributing to the plan. While automatic enrollments were available before the PPA, this feature has been expanded and added to ERISA and comes with federal pre-emption of state law, thereby eliminating concerns over California labor law restrictions.

If the automatic enrollment feature of a plan is "qualified" it will be treated as satisfying the annual anti-discrimination testing (ADP/ACP tests), and will be exempt from the top-heavy requirements. To be a qualified automatic enrollment feature, the plan must provide for either an employer matching contribution or a profit sharing contribution. Unlike the existing Sec. 401(k) safe harbor, these contributions must be fully vested within two years, rather than immediately.

To satisfy the automatic enrollment safe harbor, elective contributions must fall within a range from a minimum contribution of 3 percent up to 10 percent of compensation depending on, and increasing with, the employee's length of participation. Matching contributions or profit sharing contributions must also satisfy certain percentages, and notice requirements apply as well.

A plan with an automatic enrollment arrangement that is not qualified will be allowed to make ADP/ACP refunds up to six months after the close of the plan year (rather than 2.5 months under prior law) without a 10 percent excise tax on the employer.

DB(k) Plans

Subject to certain conditions, beginning in 2010, an "eligible combined plan" can contain both a 401(k) component and a defined benefit component. These plans must provide a 4 percent of pay automatic enrollment feature and a fully vested 50 percent match on the first 4 percent of pay deferred under the 401(k) component. Each component will be subject to its respective rules under the IRC and ERISA. "Eligible combined plans" will be limited to employers with no more than 500 employees and will be subject to a single Form 5500 filing requirement. Nonelective contributions will be permitted.


Combined Deduction Limit Under IRC Sec. 404(a)(7)

For plan years beginning in 2006, the IRC Sec. 404(a)(7) deduction limitation--which limited deductions to 25 percent of eligible plan compensation when an employer sponsors both a defined contribution (DC) and defined benefit (DB) plan--will be determined without regard to DB plans that are covered by the Pension Benefit Guaranty Corporation.

This means that an employer can fully fund a DB plan plus contribute 25 percent of compensation to a DC plan. If the employer maintains a DB plan not governed by the PBGC, the 25 percent limit will only apply to the combined plans if employer contributions to the DC plan exceed 6 percent of eligible compensation. Sec. 401(k) contributions are disregarded for purposes of the 25 percent limitation, as they are under pre-PPA law.

Contributions to DB Plans

For DB plans, the PPA encourages sponsors to ensure proper funded status by increasing the deduction limit. Current law limits the deduction to 100 percent of the plan's current liabilities, but the new rules will allow deductions up to 150 percent of current liabilities. This will allow employers to accelerate funding in years they can afford to do so and may have the effect of increasing contributions in certain underfunded DB Plans.


Form 5500-EZ

Effective for plan years beginning in 2007, the threshold for filing IRS Form 5500-EZ (one-participant plans) is increased from $100,000 to $250,000. Also for 2007, there will be a new, streamlined Form 5500 for small plans. This simplified return will be available for any retirement plan that covers fewer than 25 participants on the first day of the plan year.

Companies that maintain an intranet website solely for the purpose of communicating with employees will have to display the Form 5500 information on that website.

Reporting and Disclosure Statements

Benefit statements will be required for all DC plans (e.g. 401(k) plans, profit sharing plans, etc.) at least quarterly for those who direct their own investments, and annually for those who do not. The statement must contain information regarding vesting and the value of each investment held. This rule takes effect for plan years beginning in 2007. Failure to comply will carry a penalty of up to $100 per day per participant. DB plans will be required to provide statements and individual benefit notices every three years or upon written request. Effective for plan years beginning after 2007, DB plans will have to furnish participants with an annual funding notice.


Investment Advice

Effective 2007, the PPA provides for a prohibited transaction exemption for certain investment advice to participants in individual account plans. The advice must be provided by a "fiduciary adviser," which is defined as a registered investment adviser (under the Investment Advisors Act of 1940) or a bank, insurance company or broker-dealer (under the Securities Act of 1934).

The advice must be made pursuant to an "eligible investment advice arrangement," which either provides that the fees received by the fiduciary adviser do not vary on the basis of which investment options are chosen, or uses a computer model under an investment advice program meeting certain conditions. There are several requirements mandating the full disclosure of the relationship with the fiduciary adviser.

If certain requirements are satisfied, the fiduciary relief under Sec. 404(c) of ERISA will apply to default investments in individual account plans. The Department of Labor will issue regulations on how to map investment options when there is a change in investment provider. These rules will be in effect for plan years beginning in 2008.

Cash Balance Pension Plans

The PPA provides that DB plans (including cash balance) are not inherently age discriminatory. However, a participant's accrued benefits under a DB plan must be fully vested after three years of service. Furthermore, an age discrimination test will be satisfied if a participant's accrued benefit is not less than the accrued benefit of any similarly situated younger employee. "Similarly situated" means that the participants are identical in every respect, such as period of service, compensation, position, date of hire and work history, except age.

Most importantly, for cash balance or hybrid plans, the accrued benefit may be expressed as an annuity payable at retirement age, the balance of a hypothetical account, or the current value of the cumulative percentage of the employee's final compensation. These rules are generally effective for plan years beginning after June 29, 2005, except for the vesting provisions, which take effect in 2008.


The PPA contains provisions that broaden the opportunity for participants to move their retirement savings to other retirement plans and receive plan payouts.

Non-spouse Rollovers. A non-spouse beneficiary will be permitted to roll over benefits from a plan to an IRA so that the IRA, rather than the plan, can satisfy the minimum distributions due the beneficiary. This is effective for distributions made after 2006.

Hardship Withdrawals. Participants will be entitled to hardship withdrawals for hardships experienced by their beneficiaries, if the hardship would qualify for distribution if experienced by a spouse or dependent. The PPA instructs the Treasury to issue rules that allow 401(k) plan withdrawals for such hardships and unforeseen financial emergencies.

Tax-free IRA Distributions for Charitable Giving. Up to $100,000 can be distributed tax-free from an IRA if it is made to a charitable organization, and the IRA owner is at least 70.5 years old. This will apply only to distributions in 2006 and 2007. This will not apply to distributions from SEP-IRAs or SIMPLE-IRAs.


To ensure solvency of all private pensions, the PPA establishes new funding requirements and limits benefit accruals for certain plans deemed "at risk." A plan will be at risk if the accrued benefits under the plan are less than 80 percent funded based on the prior year's assets. At-risk plans will trigger accelerated funding requirements and may, depending on the level of underfunding, cease benefit accruals under the plan (if the plan is 60 percent underfunded) or disallow benefit increases (if the plan is between 60 percent and 80 percent underfunded). These rules apply only to plans with more than 500 participants and will generally be effective for plan years beginning in 2008.


In general, amendments reflecting the changes made by the PPA are required by the end of the 2009 plan year. Governmental plans have an additional two years to amend.

It is important to talk to your retirement plan professionals to make sure that your retirement plan and those of your clients comply with the PPA.

Mark W. Clark, APA, QPA is a partner in Orange-based Benefit Associates, Inc., a fee-only pension and profit sharing plan consulting and administration firm. He is also an author and instructor for the California CPA Education Foundation. You can reach him at Meredith J. Sesser, Esq. is a Los Angeles-based attorney with Brucker & Morra, specializing in all tax and ERISA aspects of employee benefits. You can reach her at

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Author:Sesser, Meredith J.
Publication:California CPA
Date:Oct 1, 2006
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