Calendar year 2007 is now in full swing -- and it has brought with it several changes to defined contribution retirement plans which were included in the Pension Protection Act of 2006 (PPA). In addition, the IRS issued new PPA guidance in late January. While most PPA changes will not require an immediate amendment, many changes became effective for plan years beginning on or after January 1, 2007, so plan sponsors need to be aware of them.
- Use of New Vesting Schedules.
The Pension Protection Act of 2006 implemented new vesting requirements for all employer contributions made to defined contribution plans. These vesting requirements must apply to all employer contributions made in plan years beginning on or after January 1, 2007. (Delayed effective dates apply to certain collectively bargained plans and leveraged ESOPs.)
The alternative vesting schedules are the same as those which formerly applied to employer matching contributions and to “top-heavy” plans; that is: a three-year “cliff” vesting schedule or a six-year “graduated” vesting schedule. Thus, the most restrictive vesting schedules a plan may use are as follows:
The new vesting schedules are required to apply to contributions made for plan years beginning in 2007 or later. Notice 2007-7 allows plans to maintain separate vesting schedules under the old rules for pre-2007 contributions. However, many if not most plans will choose to apply the new vesting schedules to both old and new contributions.
- Rollovers by Non-Spouse Beneficiaries.
For distributions made on or after January 1, 2007, a plan benefit payable to a non-spouse beneficiary may be paid in a direct trustee-to-trustee transfer to an IRA. (The IRA must be a separate IRA established for the purpose of receiving the distribution.) That transfer will be treated as a tax-free direct rollover by the beneficiary.
This new rule has given rise to some controversy due to guidance issued by the IRS in late January. Notice 2007-7 states that a plan is not required to make such a direct transfer, even if the beneficiary requests it. Further, any amount which constitutes a minimum required distribution to the beneficiary under Code Section 401(a)(9) is not eligible for rollover.
- Beneficiary Hardships.
The PPA directed the IRS to change the rules governing hardship distributions from 401(k), 403(b) and 457(b) plans to treat a participant's beneficiary the same as a participant's spouse or dependent. The change also applies to distributions from nonqualified plans resulting from an unforseeable emergency under Section 409A.
Under Notice 2007-7, a plan that permits hardship distributions under the "deemed" hardship standards in the Regulations may allow distributions for medical, tuition and funeral expenses attributable to a primary beneficiary of the participant. For this purpose, the primary beneficiary means the person who is named as the beneficiary of all or a portion of the participant's plan account.
- Default Investments.
The PPA provided fiduciary protection for “default” investments made available by a defined contribution plan. As yet, however, the Department of Labor has not issued final regulations governing what constitutes a qualified default investment alternative (QDIA). Proposed Department of Labor regulations have indicated that a QDIA may consist of one of three different types of investments:
- a target retirement date or life-cycle type fund;
- a balanced fund; or
- a managed account where an investment manager manages the participant’s account based upon the participant’s age and other factors.
Note: The Department of Labor has stated in proposed regulations that, in general, money market funds and stable value funds will not constitute a QDIA. However, it is possible the DOL may expand the list of QDIAs in final regulations. Participants must also receive notice of the QDIA.
Final regulations have yet to be issued by the DOL, and sponsors are not yet permitted to rely on the proposed regulations.. However, plan sponsors who wish to do so should be ready to designate a QDIA and to issue the appropriate notice when final regulations have been issued.
- Benefit Statement Requirements.
Plans which allow participants the right to direct investments must now provide participant statements at least once each calendar quarter. The statements must contain information about the participant's vested interest and the investments included in the participant's account. The statement must also contain a description of any restrictions on the participant's right to direct investments, and an explanation of the importance of diversification of investments.
Field Assistance Bulletin (FAB) 2007-03, issued by the Department of Labor (DOL), contains some preliminary guidance on participant statements. As to timing, the FAB states that until final regulations are issued, furnishing statements within 45 days after the reporting period will constitute good faith compliance. The FAB confirms that plans which do not allow participants to direct investments still need only supply participant statements once a year. For plans which allow participant direction of investments, the FAB includes a model statement explaining the importance of diversification.
- Diversification Right for Plans Holding Publicly-Traded Employer Securities.
Plans which invest in publicly-traded employer securities must now allow participants to diversify that investment. In general, participants must have the right to immediately diversify elective deferrals, and participants with three years of service must be able to diversify employer contributions (subject to transition rules). At least three diversified investment alternatives are required.
All plans holding employer securities, even those which already comply with the requirements, are required to provide participants a notice of the diversification rights and the importance of diversification. However, FAB 2006-03 (described above) states that, for plans which already comply with the diversification rules, the notice regarding the importance of diversification contained in the participant's quarterly statement is sufficient for this purpose.
- Extension of Notice and Consent Period for Plan Distributions.
The PPA provides that notices to participants of their rights in connection with a plan distribution may be provided as early as 180 days in advance of the distribution (rather than the former 90 day rule) and requires that the notice contain information about the consequences of failure to defer a distribution. The new rules are effective for the 2007 plan year. Notice 2007-7 states that participant notifications must be changed now to reflect the new rules, but that until regulations are issued a reasonable good faith effort to comply will be sufficient. Notice 2007-7 also contains guidance on how to communicate the consequences of a failure to defer distributions.