Getting Ready for January 2007
Rev. 11/17/06, E-mail Alert 2006-22

This article is a recap of Pension Protection Act (PPA) provisions effective in plan years beginning on or after January 1, 2007, and a discussion of where they stand regarding guidance and implementation.

Divestiture of Employer Stock in non-ESOP plans; Notice requirement. (PPA §901; §507)
On or after the first day of the 2007 plan year, certain plans holding employer stock must permit participants to divest any employer securities purchased with their elective deferrals or other employee contributions and to reinvest the proceeds into other plan investments. Divestment of employer securities bought with employer contributions must be allowed at anytime after the participant has completed three years of service. The above requirements do not apply to Employee Stock Ownership Plans that do not hold elective deferrals, other employee contributions, employer matching or certain nonelective contributions. A three-year phase-in period applies to employer contributions in existing plans. The IRS is required to issue a model participant notice within six months after August 17, 2006.

Top-heavy vesting for all employer contributions. (PPA §904)
EGTRRA mandated the use of the top-heavy cliff or graded vesting schedules for matching contributions. PPA extends this requirement to all other employer contributions made to defined contribution plans. This accelerated vesting schedules must apply to employees who have worked at least one hour in 2007; however, a broader application is permitted. Plan sponsors should also consider the additional administrative complexity and cost when deciding whether to limit the application of the accelerated vesting requirements to just post 2006 assets or to apply the new schedule across-the-board for affected participants.

Rollovers for nonspouse beneficiaries. (PPA §829)
For distributions occurring after December 31, 2006, a nonspouse beneficiary of a qualified plan (such as a 401(k) plan) will be able to make a rollover to an inherited IRA. Previously, only surviving spouses could do rollovers. However, the nonspouse beneficiary must begin required distributions immediately using the so-called “minus one” method, while a spouse may continue to defer required distributions until December 31st of the calendar year in which the decedent would have attained age 70½. Alternatively, a spouse may do a rollover to their own plan account or IRA and wait until they attain age 70½, if later. The beneficiary of a participant who died in 2006 or later will be able to use these rules. However, IRS guidance is needed to determine whether this also applies to a beneficiary of a participant who died before 2006, assuming the beneficiary will continue to receive distributions after December 31, 2006.

Prohibited Transaction Exemption for Investment Advice. (PPA §601)
Retirement plan service providers who offer investments to the plan (“fiduciary advisors”) will be allowed to recommend their own funds without violating fiduciary rules. To qualify, the investment advice arrangement either has to make the advisor’s fees neutral with respect to the investments chosen or use an unbiased computer model, certified by an independent expert, to create a recommended portfolio to be considered by the Participant. The downside is that vendors will have to accept “fiduciary” status that in the past many tried to avoid. "Eligible investment advice arrangements" will be required to comply with a new annual independent compliance audit for years beginning in 2007.

Tax refund may be sent to an IRA. (PPA §830)
Starting with their 2006 tax returns, taxpayers may have all or part of their federal income-tax refunds deposited directly into an IRA. However, the statutory contribution limits still apply. Thus, a taxpayer may not deposit a $10,000 refund into their IRA. The IRS already has issued Form 8888 in draft form, and we await finalization of this form.

Rollover/402(f) Notice. (PPA §1102)
The rollover notice (the 402(f) notice) explains the rollover and taxation rules for distributions from a qualified plan. The timeframe for providing the notice has been increased from 30 to 90 day period in advance to a period of 30 to 180 days in advance of a distribution date. The IRS is expected to update its model notice to include information on the non-spouse beneficiary rules and direct rollovers from a qualified plan to a Roth IRA. We recommend remaining with the current 30 to 90 day timeframe until the IRS issues further guidance or a new 402(f) notice.

Rollover of after-tax amounts in annuity contracts. (PPA §822)
The Act permits rollovers of after-tax amounts in 403(b) plans, however, the plan must be able to separately account for the after-tax contribution amount for this provision to be allowed.

Qualified Default Investment Arrangement. (PPA §624)
The effective date will be 60 days after the final regulations are published in the Federal Register. Congress had instructed the DOL to issue guidance within six months after PPA's enactment date (which was on August 17, 2006). The DOL quickly issued proposed regulations and the comment period ended November 13, 2006 (See our separate article on this topic).

Updated participant statement requirements. (PPA §508)
Quarterly statement requirements become effective in 2007 for defined contribution plans. The DOL was instructed to issue model benefit statements within 12 months after August 17, 2006 (PPA's enactment date). Obviously, there is a gap between when the first couple of quarterly statements must be provided and when the DOL models may be available.

Statements may be provided in written or electronic form as long as they are accessible. Regulations would permit benefit statements to be made available on a continuous basis on a secure website. Such statements must be able to be understood by the average plan participant. The use of the DOL's model benefit statement is optional, however.

Defined contribution statement requirements.
A defined contribution plan must provide a quarterly statement to participants who may select their own investments. If the fiduciary directs investments, only an annual statement is required. The value of each investment determined as of the plan’s most recent valuation date, including employer securities must be disclosed on the statement.

New disclosure language requirements for quarterly statements.
The quarterly benefit statement provided to a participant or beneficiary who has the right to direct investments must also include:

1. an explanation of any limitations or restrictions on any right of the individual to direct an investment;
   
2. a plain English explanation of the importance — for the long-term retirement security of participants and beneficiaries — of a well-balanced and diversified investment portfolio, including a statement of the risk that holding more than 20 percent of a portfolio in the security of one entity (such as employer securities) may not be adequately diversified; and
   
3. a notice directing the participant or beneficiary to the Internet website of the Department of Labor for sources of information on individual investing and diversification.

The quarterly statement mandate applies to both daily valued and balance forward plans that permit participant direction. This means that balance forward plans, which usually issue one or two statements a year, have to issue quarterly statements. This will result in additional administrative complexity and expense.

Similarly, plans with both pooled and participant directed assets will also have to issue quarterly statements for at least the participant-directed portion of the plan.

Defined benefit statement requirements.
Active participants having a nonforfeitable accrued benefit in a defined benefit plan generally must be given a benefit statement at least once every three years or annually, upon written request. Under an exception for such plans, it appears that if an active participant is provided with an annual notice about the right to request a written statement, then no statement must actually be provided, unless the participant does formally request it.

Bill Griossman, QPA