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February 2008 Developments:
1. President Signs Tax Technical Corrections Act
On December 29, 2007, the President signed the Tax Technical Corrections Act of 2007 (P.L. 110-172). The legislation is composed of technical corrections to nine prior tax acts going as far back as the IRS Restructuring and Reform Act of 1998. The Act contains a handful of provisions affecting pensions and benefits, including amendments relating to IRA distributions made for charitable purposes, application of the special elective deferral limit under Code Sec. 402(g)(7) to designated Roth contributions, and application of FICA taxes to designated Roth contributions. The effective dates for the technical corrections generally relate back to the effective date for the Act provision which a particular technical correction is amending.
2. IRS Proposed Rules Implement 401(k) Plan Diversification Requirements
The IRS has issued proposed regulations implementing the diversification requirements enacted under the Pension Protection Act of 2006 that require 401(k) plans holding publicly traded employer securities to provide plan participants and beneficiaries with the right to divest publicly traded employer securities held in their individual accounts. The proposed rules, which supplement guidance issued by the IRS in IRS Notice 2006-107, are designed to be effective for plan years beginning on or after January 1, 2008. However, plans may apply the proposed regulations for plan years before the final regulations go into effect.
401(k) plan diversification requirements. Generally effective for plan years beginning after 2006, 401(k) plans and other applicable defined contribution plans that hold publicly traded employer securities must, as a condition of qualification, provide plan participants and beneficiaries with the right to divest publicly traded employer securities held in their individual accounts. Employers are required to provide advance notice to participants, informing them of their diversification rights within 30 days of their eligibility to exercise those rights.
Diversification rules apply if any portion of individual account is invested in employer securities. There is no threshold level of elective deferrals, after-tax contributions, or rollover contributions that must be invested in employer securities in order for the diversification rules to apply. The proposed regulations state that the diversification requirements apply if any portion of the individual account under the plan attributable to such contributions is invested in employer securities.
3-year holding period for nonelective contributions. Plan participants, alternate payees, and beneficiaries of deceased participants are also entitled to diversify holdings attributable to employer contributions other than elective deferrals. Specifically, participants who have completed three years of service, alternate payees who have accounts under the plan with respect to a participant who has completed three years of service, and beneficiaries of deceased participants (without regard to whether the participant has completed 3 years of service) will be allowed to divest individual accounts of employer securities that are attributable to matching and nonelective contributions).
Completion of 3 years of service. The date on which a participant completes 3 years of service occurs immediately after the end of the third vesting computation period provided for under the plan that constitutes the completion of a third year of service under Code Sec. 411(a)(5). However, if a plan uses the elapsed time method of crediting service for vesting purposes, or the plan provides for immediate vesting (without using a vesting computation period or the elapsed time method of determining vesting) the participant will be considered to complete three years of service on the third anniversary of the participant's date of hire. The proposed rules would clarify that, with respect to a plan that uses the elapsed time method of crediting service for vesting purposes (or a plan that provides for immediate vesting without using a vesting computation period or the elapsed time method of determining vesting) a participant would complete 3 years or service on the day immediately preceding the third anniversary of the participant's date of hire.
Prohibited restrictions on divestment and reinvestment. A plan may limit the time for the divestment and reinvestment of employer securities to periodic and reasonable opportunities, occurring no less frequently than quarterly. However a plan may not impose restrictions or conditions with respect to the investment of employer securities that are not imposed on the investment of other plan assets (other than restrictions or conditions imposed under securities laws). Thus, a plan may not place restrictions on an individual's right to divest an investment in employer securities that is not imposed on an investment that is not in employer securities. Nor may a benefit be conditioned on an investment in employer securities.
Indirect restrictions and conditions prohibited. The IRS proposed regulations would further prohibit a plan from imposing a direct or indirect restriction on an individual's right to divest investments in employer securities. Similarly, a plan would not be allowed to directly or indirectly condition a benefit on investment in employer securities. Thus, under the proposed rules, a plan could not prevent a participant who divests his or her balance of an investment in employer
securities from reinvesting in employer securities for a specified period of time.
Permissible restrictions on investments in employer securities. The IRS notes that restrictions on investments in employer securities may be implemented, as long as the limits apply without regard to a prior exercise of divestment rights. Thus, for example, a plan may limit investments in employer securities to 10 percent of an individual's account balance.
Restrictions on trading frequency. The proposed regulations would allow a plan to impose reasonable restrictions on the timing and number of investment elections that an individual may make to invest in employer securities. However, the restrictions must be designed to limit short-term trading in employer securities. Pursuant to this rule, a plan could prohibit an employee from electing to invest in employer securities if the employee has elected to divest employer securities within a short period of time (e.g., 7 days). By contrast, the IRS cautions, the plan may not restrict an individual's right to divest securities.
Fees on alternative investment options. A plan is not prohibited from imposing fees on other investment options under the plan merely because fees are not imposed with respect to investments in employer securities. The proposed regulations would further provide that a plan may impose a reasonable fee for the divestment of employer securities, without being treated as restricting the participant's divestment rights.
Transition relief for grandfathered investments. Under the transition relief issued by the IRS in Notice 2006-107, plans could continue to impose certain restrictions on investment in employer securities through 2007 under plan terms in effect on December 18, 2006. Thus, until January 1, 2008, a plan could apply a divestment restriction or condition on investment in employer securities that did not apply to a stable value fund. In addition, a plan could continue to restrict participants from divesting employer securities on a more than periodic basis, while allowing participants to divest other investments on a more frequent basis, as long as the other investment was not a generally available investment (e.g., the other investment is restricted to a fixed class of participants).
The proposed regulations would apply the above rule to a fund that is ``similar'' to a stable value fund. Specifically, in the event a plan has several investment funds, including one or more funds invested in employer securities, a fund which is a stable value or similar fund, and other funds which are not invested in employer securities, the plan may permit transfers to be made in the stable value or similar fund more frequently than the funds invested in employer securities or other funds.
Under the initial relief, any restriction that continued to be imposed after 2007 would violate Code Sec. 401(a)(35)(D)(ii)(II). The IRS (in Notice 2008-7 extended the transition relief provided for grandfathered investments for the period prior to January 1, 2008 to a period after 2007, until the regulations issued under Code Sec. 401(a)(35) go into effect. The proposed regulations are intended to be effective on or after January 1, 2009.
Securities held by regulated investment company. Plans will not be treated as holding employer securities subject to the diversification requirements with respect to securities held by either an investment company registered under the Investment Company Act of 1940 or a similarly pooled investment vehicle that is regulated and subject to periodic examination by a State or Federal agency and with respect to which investment in the securities is made both in accordance with the stated investment objectives of the investment vehicle and independent of the employer and its affiliates. The exemption, however, only applies if the holdings of the investment company or similar investment vehicle are diversified so as to minimize the risk of large losses.
Pooled investment vehicles. The proposed regulations would require the pooled investment vehicle to be a common or collective trust fund or pooled investment fund maintained by a bank or trust company supervised by a state or federal agency, a pooled investment fund of an insurance company that is qualified to do business in the state, or an investment fund designated by the IRS.
Percentage limitation on aggregate value of employer securities. The proposed regulations retain the requirement that the investment in employer securities held under the pooled investment fund must be independent of the employer and any affiliate thereof. However, the proposed regulations would add a percentage limitation , pursuant to which an investment in employer securities in a fund would be considered to be independent of the employer only if the aggregate value of the employer securities held in the fund did not exceed 10 percent of the total value of all of the fund's investments.
3. DOL Proposed Rules Govern Assessment of Penalties for Failure to Provide Automatic Contribution Notice
The Employee Benefits Security Administration (EBSA) has issued proposed regulations that would provide for the assessment of civil penalties under ERISA Sec. 502(c)(4)) that are applied when a plan administrator fails to provide the notice required under ERISA Sec. 514(e)(3) to employees participating in automatic contribution arrangements. The proposed regulations stress that the penalty is a personal liability of the plan administrator that may not be transferred to the plan as a reasonable expense of plan administration. However, the proposed rules would also authorize the EBSA to waive or reduce the penalty assessment upon a showing by the plan administrator, in a written reasonable cause statement, of compliance or mitigating circumstances regarding the degree or willfulness of noncompliance.
Proposed regulations provide procedural framework. The proposed rules would govern the computation of the maximum penalty amount, identify circumstances under which a penalty may be assessed, establish procedural rules for service and filing, and provide plan administrators with a mechanism by which to contest a penalty assessment.
Degree of willful noncompliance affects amount of penalty. The amount of the penalty assessment would vary depending on the degree or willfulness of the compliance failure. However, the amount assessed for each violation could not exceed $1000 per day.
Reconsideration or waiver of penalty. The proposed regulations authorize the EBSA to waive or reduce the penalty assessment upon a showing by the plan administrator of mitigating circumstances regarding the degree or willfulness of the noncompliance. The plan administrator would have 30 days from the date of service of the notice of intent to assess a penalty to file a written statement of reasonable cause, explaining why the penalty should be reduced or waived.
The failure by a plan administrator to file a statement of reasonable cause within the prescribed period would be deemed a waiver of the right to appear and contest the facts alleged in the notice of intent. In addition, the failure to file the statement would be deemed an admission of facts alleged in the notice.
Liability for penalty. The proposed regulations would confirm that liability for the penalty is applied on a joint and several basis among the persons responsible as an administrator for the compliance failure. In addition, the penalty would be treated as a personal liability of the plan administrator, which the DOL stresses, could not be transferred to the plan as a reasonable expense of plan administration.
4. Proposed Cash Balance/Hybrid Plan Regs Issued by IRS
The IRS has issued proposed regulations governing hybrid defined benefit plans, such as cash balance plans, that incorporate and expand upon the transitional guidance provided under Notice 2007-6, which began to implement amendments enacted by Pension Protection Act of 2006 (PPA; P.L. 109-280).
Special vesting rules. Under the proposed regulations, a plan would not violate rules regarding a participant's accrued benefit derived from employer contributions merely because the plan determines the present value of benefits under a lump sum-based benefit formula as the amount of the hypothetical account maintained for the participant, or as the current value of the accumulated percentage of the participant's final average compensation under that formula.
Age discrimination safe harbor. The proposed regulations would provide a safe harbor from age discrimination claims in the event a participant's accumulated benefit expressed under any benefit formula would not be less than any similarly situated, younger participant's accumulated benefit expressed under the same formula. The safe harbor standard would be available only where a participant's accumulated benefit under the terms of the plan is expressed as an annuity payable at normal retirement age, the balance of a hypothetical account, or the current value of the accumulated percentage of the employee's final average compensation.
Conversions. Under the proposed regulations, a participant whose benefits are affected by a conversion amendment which occurred after June 29, 2005, must generally be provided with a benefit after the conversion that is at least equal to the sum of the benefits accrued through the date of the conversion and benefits earned after the conversion, with no permitted interaction between these two portions. This provision is intended to assure participants that no "wear-away" results from the conversion.
The proposed rules would also provide an alternative method under which the plan may provide for the establishment of an opening hypothetical account balance as part of the conversion, keeping separate track of the opening hypothetical account balance and the post-conversion hypothetical contributions.
Market rate of return. The proposed regulations reflect the rule that a statutory hybrid plan may not provide an interest crediting rate which is in excess of a market rate of return. The proposed regulations define an "interest crediting rate" as the rate by which a participant's benefit is increased under the ongoing terms of a plan to the extent the amount of the increase is not conditioned on current service, without regard to whether the amount is calculated by reference to a rate of interest, a rate of return, an index, or otherwise.
5. IRS Proposes Rules on Measurement of Plan Assets and Liabilities Under PPA
The IRS has released proposed regulations governing the measurement of plan assets and benefit liabilities for purposes of the new funding rules applied to single-employer defined benefit plans under Code Sec. 430, as enacted by the Pension Protection Act of 2006.
The proposed regulations are generally applicable to plan years beginning January 1, 2009. However, for plan years beginning in 2008, plans are permitted to rely on the proposed regulations for purposes of satisfying the requirements of Code Sec. 430.
Determining funding target and target normal cost. The proposed regulations provide rules for determining the funding target and the target normal cost for plans that are not in at-risk status. Under the rules, the funding target would be the present value of all benefits that have been accrued or earned under the plan as of the first day of the plan year. The target normal cost for the plan year is the present value of all benefits that accrue or are earned under the plan during the plan year. In making this determination, future benefits to be paid from the plan must be allocated among the prior plan year, the current plan year, and future years. The rules explain how to calculate the amount to be taken into account in the funding target under circumstances where the amount of a benefit that is expected to be paid: (a) is a function of the accrued benefit at the time the benefit is expected to be paid; (b) is not a function of the accrued benefit at the time the benefit is expected to be paid, but is a function of the participant's service at that time; or (c) is neither.
Valuation date and value of plan assets. Under the proposed regulations, a plan's valuation date, for plans other than small plans (defined for this purpose as plans with 100 or more participants within the employer's controlled group) is the first day of the plan year. The proposed regulations require assets to be valued either at their fair market value on the valuation date, or as an average of the fair market value on the valuation date and earlier determination dates (typically the two immediately preceding valuation dates, adjusted for asset and liability differences from the current valuation date).
Interest rates. The proposed regulations specify the interest rates to be used when determining present value and other calculations under Code Sec. 430. For the month that includes the valuation date, the rates are generally based on the 24-month moving averages of 3 separate segment rates, based on portions of the corporate bond yield curve. For existing plans, a transition rule applies for 2008 and 2009 under which these segment rates are blended with the long-term corporate bond rate that applies under pre-PPA law.
Plans in at-risk status. Significantly underfunded plans, referred to as "at-risk," are subject to special rules for determining funding targets. In calculating the funding target attainment percentage (FTAP) for such plans, the proposed regulations define the FTAP as the value of plan assets for the plan year after subtraction of the prefunding balance and the funding standard carryover balance, divided by the at-risk funding target of the plan for the plan year. In general, the proposed regulations would provide that the at-risk funding target and the at-risk target normal cost of the plan for the plan year are generally determined in the same manner as for plans not in at-risk status but using special actuarial assumptions, defined within the proposed rules.
6. Plan Participant's Benefits Were Not Illegally Cut Back in Transition to Cash Balance Plan
A plan participant's already accrued benefit in a defined benefit plan was not illegally cut back by the transition to a cash balance plan of the new employer, the U.S. Court of Appeals in Boston (CA-1) has held.
The participant sought to have his benefit calculated by including both the amount accrued under his previous pension, which included his early retirement benefit, plus an early retirement benefit subsidy granted by the transition benefit. However, the First Circuit ruled that this calculation method would amount to a double counting of the early retirement subsidy to which the participant was not entitled.
The plan participant further argued that the trial court should have compared the amount that the participant would have accrued under the former pension plan at normal retirement age with the same amount calculated at normal retirement age under the new plan. The Court of Appeals held that the plan participant submitted insufficient evidence showing that he would have received more money as of his normal retirement age under the previous plan than under the current plan. The participant should not have left the district court to make this comparison itself, the court explained, without the relevant argumentation and data.
Gillis v. SPX Corp. Individual Account Retirement Plan (CA-1)
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