President Bush's Pension Protection Act (PPA) of 2006 is the most significant and comprehensive retirement legislation that has been enacted in recent history. The PPA has a broad reach with new rules impacting defined benefit plans, defined contribution plans, IRAs and health and welfare plans. There are a number of effective due dates, but much of the legislation came into force in January of this year making it crucially important for those concerned to learn about the legislation.
The PPA adds a new diversification requirement for 401(k) plans that offer employer securities. The new rules state that for employee contributions participants and beneficiaries must be allowed to divest employer securities into other investment options. “This provision may not have much impact for those plans which already allow the employees own money to be invested in a wide range of investment options,” said Bowden. Other requirements state that for matching contributions and other employer contributions, plan participants and beneficiaries with at least three years of service must be allowed to diversify out of employer securities on a phased schedule. Bowden comments: “If you have a plan design that invests all or part of the companies contribution into employer securities this rule allows beneficiaries to elect to get out of those employer securities.” The minimum phased schedule is 33% of employer securities subject to diversification in 2007, 66% the year after and 100% the following year. Additionally if a plan participant has at least three years of service and is 55 or older, the participant’s entire account must be eligible for diversification. Concurrently, the plan must offer at least three other investment options with materially different risk and return characteristics.
Plan sponsors subject to this requirement need to make certain decisions and design choices, says Bowden. For example, do you want to phase in and follow the savings schedule or allow 100% diversification immediately? By allowing plan participants to diversify 100% of their assets immediately an organization could reduce the burden of administering the plan. It's worth discussing this point with your financial advisers, says Bowden, particularly if the plan has a lot of employer securities and your stock is not heavily traded. Another consideration is whether to make the diversification rules available to everybody or limit to individuals with three years of service which requires more administration. According to the new rules, the employer must provide a notice explaining the right to diversify at least 30 days before the participant’s right to diversify begins. Of course, being prepared for this notification is an advantage. A model notice has been issued by the IRS and is available on their website (IRS Notice 2006-107).
The PPA has a number of new provisions for offering investment advice to plan participants. A significant new statutory provision, ERISA 408(b)(14), has been added which allows individualized investment advice to participants if certain requirements are met. Many plans may already supply general investment advice, but under the old law some of the rules have limited plan sponsors with offering individual tailored investment advice because of concerns about fiduciary liabilities or prohibited transaction issues. The new provisions are an attempt to address concerns about participants ability to make appropriate investment decisions over the long term and diversify sufficiently. In effect, the PPA gives employers the ability to offer investment advice which they may not have been able to do in the past. Specifically, “fiduciary advisers” (certain investment advisers, banks, insurance companies and brokers) are permitted to give investment advice pursuant to “an eligible investment advice arrangement” (an arrangement that is either based on an unbiased certified computer model or designed so that its fees do not vary depending on the investment selected). Put simply, if certain requirements are met then provision of investment advice, engaging in investment transactions and the receipt of fees in connection with providing investment advice will be exempt from the prohibited transaction rule.
Certain conditions must be met in order to provide investment advice. In brief, the arrangement should be authorized by an independent auditable plan fiduciary who assumes responsibility in writing and is compensated at a reasonable rate on arms-length terms.
“Not only do we have a new exception to the prohibited transaction rule but also if you meet all of the requirements the plan sponsor will not be deemed to have breached any fiduciary duty solely by providing investment advice,” says Bowden. Adding that, under these conditions and with suitable consultation from legal, financial and investment advisers, plan sponsors should seriously consider an investment advice feature.
Congress, which has been concerned by the low level of retirement plan participation particularly among the lower paid population, has introduced new automatic enrolment rules. Automatic enrolment in retirement plans has been allowed for a number of years, but the PPA adds some new features that could make automatic enrolment more attractive. The primary change is a new ADP/ACP non discrimination testing safe harbour if the plan provides for automatic enrolment and meets certain other requirements.
There are a number of requirements to qualify for the new safe-harbour which Bowden listed and explained in her presentation. These include: automatic enrolment for all participants; automatic deferrals; minimum employer contributions; 100% vesting within two years; and employees with the opportunity to change or cancel automatic deferral.
The new rules allow beneficiaries other than the participants spouse to rollover payments (via direct transfer) to an IRA. Previously, only spouses were eligible to roll over payments. In addition, direct rollovers from a 410 (k) to a Roth IRA are permitted and hardship withdrawals are allowed for situations affecting the participants named beneficiary, even if the beneficiary is not a family member. With respect to these changes, Bowden suggests, reviewing plan provisions for non-spouse beneficiaries, educating staff around rollovers by non-spouse beneficiaries and deciding whether or not to expand hardship provisions.
The PPA also accelerates the vesting for non-matching employer contributions. Old rules applying to matching contributions now apply to all employer contributions meaning that sponsors are required to review their plans to ensure compliance with the vesting schedule.
The Economic Growth Tax Relief Reconciliation Act of 2001 (EGTREE) made a number of changes to 401(k)s, however a number of these provisions were scheduled to “sunset” after the end of 2010. Many of these EGTRAA provisions have become popular and important parts of 401(k) plans so the PPA has now made certain ones permanent, including: catch up contributions; increased 402(g) limit; increased compensation limit; increased 415 limit and a permanent Roth 401(k) feature.
Finally, under the PPA, if the 401(k) plan allows investment directions sponsors must provide quarterly statements with very specific information. There are also changes to the annual return form 5500.