On December 23, 2008, President George W. Bush signed the Worker, Retiree, and Employer Recovery Act of 2008 (the Act). The Act makes a number of technical corrections to the Pension Protection Act of 2006 (PPA) and amends the Employee Retirement Income Security Act of 1974 (ERISA), as well as the Internal Revenue Code (the Code). The Act also provides temporary loosening of pension funding and distribution requirements in response to the broad economic downturn and associated decline in the value of most retirement plan investments. As employers prepare plan amendments for PPA compliance during 2009, these changes need to be considered. The following is a summary of the key provisions of the Act.
Defined Contribution Plans – General Rules
Required Minimum Distributions
Tax-qualified retirement plans, including 401(k), 403(b) and 457 plans, as well as individual retirement accounts and annuities (IRAs), must make minimum distributions to individuals who reach age 70½. The Act waives this requirement for 2009. Thus, an individual who would otherwise receive a required minimum distribution in 2009 will not have to take a required minimum distribution until 2010. Distributions that are actually made in 2009 that would otherwise be required minimum distributions may be treated as eligible rollover distributions. However, the Act waives the direct rollover notice, written explanation and 20 percent income tax withholding requirements with respect to these distributions. Moreover, plans are not required to handle these distributions as direct rollovers. The Act does not waive required minimum distributions for 2008 nor does the Act waive the requirement for defined benefit plans. The Internal Revenue Service (IRS) recently published Notice 2009-9, which provides additional information concerning these rules.
Under the PPA, two conditions must be met in order to effectuate a rollover from a tax-qualified defined contribution plan to a Roth IRA: (1) the amount being rolled generally must be included in the participant’s gross income and is subject to tax at the time of distribution, and (2) the participant’s modified adjusted gross income must not exceed established limits for 2008 and 2009 (there is no income limit beginning in 2010). The Act clarifies that these two conditions do not apply with respect to direct rollovers from a Roth 401(k) account to a Roth IRA.
An “eligible” automatic contribution arrangement (EACA) may allow participants to make withdrawals within 90 days of the first automatic contribution. In the absence of participant direction, these contributions must be invested in a qualified default investment alternative (QDIA). The Act eliminates this QDIA requirement, presumably to allow the investment of these contributions in a stable value or cash-type fund during the 90-day withdrawal period. After the 90-day period, however, the contributions could be moved to a QDIA to comply with ERISA rules for participant-directed investments. The Act also provides that “permissible withdrawals” under EACAs are not taken into account for purposes of applying the Code Section 402(g) annual limit on elective deferrals.
Elimination of Gap Period Income Rule
The Act eliminates the requirement that gap period income be provided on 402(g) excess deferrals for plan years beginning after December 31, 2007. Thus, the distribution of 402(g) excess deferrals need only include income realized on the excess deferral through the end of the tax year for which the deferral was made and need not include income realized through the date the excess deferral is actually distributed.
Defined Benefit Pension Plans – General Rules
Lump Sum Payments
Under the PPA, a plan that has a funding percentage of less than 60 percent or a plan whose sponsor is in bankruptcy may not make lump-sum payments. The Act waives this prohibition for mandatory lump-sum payments of $5,000 or less. The Act also clarifies that hybrid plans (e.g., cash-balance plans) may cash out participants’ account balances that are $5,000 or less without applying the present value rules under ERISA and the Code.
Cash Balance Vesting
The Act clarifies that the special three-year vesting requirement for hybrid plans (e.g., cash-balance plans) applies only to those plan participants who are credited with at least an hour of service on or after the effective date for the new vesting requirement.
Preservation of Capital Rule Clarified
The PPA prohibits an account balance under a hybrid plan (e.g., cash-balance plan) from being reduced below the aggregate amount of contributions made to the account. The Act clarifies that the failure to comply with this rule will result in a violation of the age discrimination rules under ERISA and the Code.
Extension of PFEA Amendment Date
Under the Pension Funding Equity Act of 2004 (PFEA), defined benefit pension plans were required to use a temporary interest rate assumption for purposes of adjusting the 2004 and 2005 benefit limits under Code Section 415. (The PPA extended and modified these rules.) The Act extends the deadline for amending plans to include the PFEA interest rate assumption from the end of the 2008 plan year to the end of the 2009 plan year. Furthermore, the Act clarifies that the mortality table under Code Section 417(e)(3) is the table used to adjust benefit limits under Code Section 415(b).
Accrual Freeze Requirements
Single-employer pension plans with an Adjusted Funding Target Attainment Percentage (AFTAP) less than 60 percent cannot allow for continued benefit accruals. The AFTAP is calculated using assets and liabilities measured as of the first day of the applicable plan year. For plan years beginning between October 1, 2008, and September 30, 2009, the Act requires plans to use the prior year’s AFTAP (if higher) to determine whether current-year accruals are permitted.
Defined Benefit Pension PLANS – Funding RULES
Funding Target Transition Relief
Although the PPA ultimately calls for a pension plan to fund toward 100 percent of its funding target, the PPA provides transition funding target percentages over a three-year period (92 percent in 2008, 94 percent in 2009 and 96 percent in 2010). If a plan is not funded to the transition funding target percentage for a year, then the plan forever loses the transition relief and must be funded to 100 percent of the plan’s funding target. The Act eliminates this result by requiring that plans be funded to the applicable transition funding target percentage for each of the three transition relief years, regardless of whether the plan met the prior year’s target. Thus, for example, if a plan was funded at 90 percent in 2008, the funding shortfall for 2008 would be 2 percent and the plan would need to fund to 94 percent in 2009 rather than 100 percent as required under the PPA. These Act provisions do not apply to plans established after 2007 or that were subject to additional funding requirements for the 2007 plan year.
PPA defines an at-risk plan, generally, as a defined benefit pension plan that is (a) less than 80 percent funded using the plan’s actuarial assumptions for determining funded status and (b) less than 70 percent funded using actuarial assumptions prescribed under PPA for making at-risk valuations. PPA phases in the 80 percent test over four years (i.e., 65 percent for 2008, 70 percent for 2009, 75 percent for 2010, and 80 percent for 2011 and beyond). The Act provides that the 4-year phase-in rule also applies to the 70 percent test, which will keep certain plans from being deemed at-risk.
The Act permits plan sponsors that are using the averaging method to value the plan’s assets to include expected earnings on the assets through the valuation date. Under the averaging method, an averaging period of not more than 24 months must be used and the averaged value is limited to at least 90 percent and not more than 110 percent of current market value. The expected earnings assumption is to be determined by the plan’s actuary, but it cannot exceed the PPA third-segment rate. The Act retains the requirement that the asset value used is limited to at least 90 percent and not more than 110 percent of current market value.
Target Normal Cost (Plan Expenses)
The Act requires that plan sponsors add plan-related expenses expected for the year to the plan’s target normal cost. However, the Act does not clearly indicate whether investment-related expenses are included in the broader category of plan-related expenses. Further guidance concerning the definition of plan-related expenses is expected.
Other Significant Provisions Affecting Both DB And DC Plans
The Act amends the PPA to clarify that all tax-qualified retirement plans are required to permit non-spouse beneficiaries to roll over distributions and that the plan must provide the non-spouse beneficiary with notice of this right. The Act’s provisions are effective for plan years beginning after December 31, 2009.
Clarification of Combined Deduction Limit for Defined Benefit and Defined Contribution Plans
The Act clarifies that the combined deduction limit for employers maintaining both a defined contribution plan and a defined benefit plan applies only to the extent that contributions to the defined contribution plan exceed 6 percent of compensation. If contributions to the defined contribution plan are greater than 6 percent of compensation, only those contributions in excess of 6 percent of compensation count toward the combined deduction limit.