By the Tax Management Staff
Washington, D.C.

The Pension Protection Act of 2006, P.L. 109-280, will have a far-reaching impact on the operations of private pension plans, in particular, by requiring pension plans to meet a 100% funding target in seven years. The Act makes extensive amendments to the benefit provisions of the tax Code and to the Employee Retirement Income Security Act of 1974 (ERISA). The Act was passed by the House of Representatives on July 28, and by the Senate on August 3, and was signed by the President on August 17.

INTRODUCTION

The Act, which took a long and sometimes bumpy road to passage by Congress, replaces the funding requirements for defined benefit pension plans, imposes new benefit limits on underfunded plans and changes the premiums that the sponsors of underfunded plans must pay to the Pension Benefit Guaranty Corporation (PBGC) to insure a minimum level of benefits to their participants. Also, the Act extends certain tax incentives for retirement savings, modifies tax provisions relating to spending for health care, establishes a safe harbor for employers to provide investment advice to help employees manage their §401(k) accounts and provides for automatic enrollment of employees in §401(k) plans.

The Act clarifies the legal standing of cash balance pension plans, many of which have been in regulatory limbo for years in the IRS's determination letter program.

Numerous but less well-known provisions in the Act make a variety of changes to the pension and benefit universe, such as modifications to the plan asset rules that determine when participant contributions become assets of a plan, and to the prohibited transaction rules, which prohibit a wide range of transactions between a plan and a party in interest unless an exemption applies. While many of these provisions may seem technical, they could have significant effects on the administration and structure of benefit plans and the manner in which fiduciaries operate.

DISCUSSION OF ACT PROVISIONS

Title I--Reform of Funding Rules for Single-Employer Defined Benefit Pension Plans

Minimum Funding Rules

Single-employer defined benefit pension plans are subject to minimum funding requirements under ERISA and the tax Code. The amount of contributions required to be made by the plan sponsor for a plan year under the funding rules generally is the amount needed to fund benefits earned during that year and that year's portion of other liabilities that are amortized over a period of years, such as benefits resulting from a grant of past service credit. The amount of required annual contributions is determined under one of a number of acceptable actuarial cost methods. Additional contributions are required under the deficit reduction contribution (DRC) rules for certain underfunded plans. No contribution is required under the funding rules for plans that meet the full funding limit.

Defined benefit plans are required under current law to maintain a special account, called a “funding standard account,” to which specified charges and credits are made for each plan year, including a charge for normal cost and credits for contributions to the plan.

Beginning with the 2008 plan year, the Act repeals the current-law funding rules, including the requirement that a funding standard account be maintained by single-employer plans. The Act includes an entirely new set of rules for determining minimum required contributions.¹

Funding Standard Carryover or Prefunding Balance. Under current law, employers have considerable flexibility to choose the assumptions and methods used to calculate minimum funding requirements. However, employers with plans that are less than 90% funded generally must make contributions to those plans on a more accelerated basis under the DRC rules, using specified interest and mortality assumptions.

The DRC is the sum of (1) the “unfunded old liability amount,” (2) the “unfunded new liability amount,” and (3) the expected increase in current liability due to benefits accruing during the plan year. The unfunded old liability amount is the amount needed to amortize certain unfunded liabilities under 1987 and 1994 transition rules. The unfunded new liability amount is the applicable percentage of the plan's unfunded new liability. Unfunded new liability generally means the unfunded current liability of the plan (i.e., the amount by which the plan's current liability exceeds the actuarial value of plan assets), but determined without regard to certain liabilities, such as the plan's unfunded old liability and unpredictable contingent event benefits.

If employers make contributions in excess of the minimum required, the excess is added to the plan's “credit balance,” under current law. The credit balance increases each year with earnings at the interest rate assumed by the plan. The accumulated credit balance can be applied toward the future years' minimum contribution requirements.

Under the Act, the minimum required contribution of a plan sponsor to a single-employer defined benefit plan for a plan year generally depends on a comparison of the value of the plan's assets with the plan's funding target and target normal cost. Credit balances can be used in certain circumstances to reduce otherwise required minimum contributions. In addition, contributions in excess of the minimum contributions required under the Act are credited to a prefunding balance that could be used in certain circumstances to reduce otherwise required contributions. To facilitate the use of such balances to reduce minimum required contributions, while avoiding the use of such balances for more than one purpose, the value of plan assets are reduced by the prefunding balance and/or the funding standard carryover balance.

A plan's credit balance under current law becomes the balance of the “carryover” account under the Act. Contributions in excess of the minimum required under the Act are added to a new “prefunding” balance. Both the carryover and prefunding balances are credited with the plan's actual rate of return each year.

Plan sponsors are prohibited from using credit balances if their plans are funded at less than 80%. In other words, plan sponsors can elect to use the carryover and prefunding balances to reduce the minimum required contribution only if the plan's funding target attainment percentage is at least 80%. For the 80% test, the funding target attainment percentage is determined by subtracting only the prefunding balance from the plan assets.

Interest Rate. The Act provides a permanent interest rate based on a modified “yield curve” for plan sponsors to measure current pension liabilities as they come due. Assets can be averaged over 24 months, but the result is limited to 105% of market value as of a plan's valuation date. As under the DRC rules, the Treasury will establish the standard mortality table. However, some employers can develop and use plan-specific mortality tables for minimum contribution calculations.

Amortization Periods. Plan sponsors must make sufficient contributions in order to meet a full funding target and ease funding shortfalls over seven years so that all plans are fully funded in seven years under the Act.

The liability for benefits earned under a plan in past years is the plan's “target liability.” The liability for benefit accruals in the current year is the plan's “normal cost.” The plan's minimum contribution requirement for a year is the normal cost plus the amounts required to amortize any funding shortfall over the 7-year period. Under the Act, for the first year, the funding shortfall is the target liability minus assets. In subsequent years, a new shortfall amortization will be established to reflect gains or losses during the preceding year. Generally, both the carryover and prefunding balances will be deducted from plan assets to calculate the funding shortfall.

At-Risk Plans. The Act creates an additional liability for “at-risk” plans. A plan is considered at risk under the Act if the plan's funding target attainment percentage is both less than 80% without regard to at-risk liabilities and less than 70% counting at-risk liabilities. The funded percentage is determined by subtracting both the carryover and prefunding balances from plan assets. The 80% test is phased in at 65% in 2008, 70% in 2009, 75% in 2010 and 80% in 2011 and thereafter. The plan determines the at-risk liabilities by assuming that workers eligible to retire in the next 10 years will retire as early as possible. The at-risk liability is phased in at 20% per year for each consecutive year the plan is at risk. If a plan is at risk for the current year and two out of the previous four years, a load of 4% of liability plus $700 per participant is added to the at-risk liability. Plans with 500 or fewer participants are not subject to the at-risk liability.

If a plan sponsor meets one of the above tests, it avoids the at-risk designation, but is required to make up its overall funding shortfall over seven years.

Waiver for Business Hardship

Under the Act, the Secretary of the Treasury may waive the minimum funding standards for no more than three of any 15 consecutive years (five of any 15 years for multiemployer plans) if an employer (or 10% or more of the employers contributing to a multiemployer plan) is unable to satisfy the funding requirements for a plan year without temporary substantial business hardship and satisfying the requirements would be adverse to the interests of the plan participants in the aggregate.²

Benefit Limits Under Single-Employer Plans

Under current law, employers in bankruptcy may not make a benefit increase effective until the employer reorganizes. Also, if a plan's new current liability funding percentage is less than 60%, an increase generally may not be effective until the employer has brought the plan's funding up to 60%.

The Act includes limits based on the plan's “adjusted funding target attainment percentage.” The funding target attainment percentage is the ratio of assets (minus carryover and prefunding balances, see above) to target liability (without regard to at-risk status, see above). The adjusted percentage is determined by adding the amount of annuity purchases for non-highly compensated employees in the last two years to both assets and liabilities.

If the adjusted funding target attainment percentage is below 60% for a plan year, the Act prohibits the plan from triggering shutdown benefits or accelerated payments--including lump sums--during the year, and freezes benefit accruals. If the percentage is below 80%, a plan can not have benefit increases. Between 60% and 80%, lump sum payments is limited to the lesser of the present value of the participant's PBGC guaranteed benefit and 50% of the lump sum the participant otherwise would receive. The balance of the benefit is payable in the form of an annuity.

The restrictions do not apply to plans that are 100% funded without reducing assets for credit balances. Collectively bargained plans will have to convert carryover and prefunding balances to assets if the conversion eliminates a restriction. Special rules apply to new plans and to plans of employers in bankruptcy.³

Delayed Effective Date for Funding and Benefit Limits for Certain Plans

The Act delays the effective date of the funding and benefit limit rules discussed above for rural electric, agricultural, and telephone multiple employer plans until 2017; eligible government contractors until the earlier of when the Cost Accounting Standards Board allows recovery of the new contribution rates or 2011; and until 2014 for plans of employers that took over sponsorship of a plan so that the PBGC did not have to terminate the plan. In addition, the Act modifies existing special rules for “a company that is engaged primarily in the interurban or interstate passenger bus service.”⁴

Restrictions on Nonqualified Deferred Compensation

Under current law, employers may set aside or reserve money to pay nonqualified deferred compensation as long as the plan is not considered funded. The Act prevents such a reserve for certain executives if the employer or a member of its controlled group is bankrupt, has an at-risk plan (generally less than 80% funded; see above) or a plan that has terminated without having sufficient assets to pay all benefits.

The Act denies an employer a deduction for “gross ups” intended to cover penalties incurred by prohibited funding of nonqualified arrangements.⁵

Title II--Funding Rules for Multiemployer Defined Benefit Plans and Related Provisions

Multiemployer plans are subject to the same general funding rules as single-employer plans except that longer amortization periods apply to multiemployer plans than to single-employer plans. The Act retains the funding standard account approach under current law for multiemployer plans but reduces longer amortization periods to 15 years and allows the plan to stop using the shortfall method. A multiemployer plan can get an automatic five-year amortization extension, and another five years with IRS approval. The amortization extension interest is the funding rate but the old rate is grandfathered for extensions under applications filed before June 30, 2005.⁶

The Act adds new funding rules for multiemployer plans that are in endangered, seriously endangered, or critical status, including some relief from excise taxes for an accumulated funding deficiency. Status generally is based on current funding percentages and projected accumulated funding deficiencies. A plan less than 80% funded is in endangered status, and if the plan has an accumulated funding deficiency for six succeeding plan years, the plan is in seriously endangered status. A plan less than 65% funded is in critical status. Endangered (and seriously endangered) plans must develop funding improvement plans that will increase the plan's funding percentage over 10 or 15 years. Critical plans must adopt a rehabilitation plan that sets goals for how the plan will get out of critical status within 10 years.⁷

The Act expands from three to five years the time multiemployer plans in reorganization must determine whether they will be insolvent.⁸

Employers withdrawing from multiemployer pension plans are subject to withdrawal liability. The Act repeals the limitation on the withdrawal liability of insolvent employers and updates the rules relating to limitations on withdrawal liability based on the company's net worth, effective for sales beginning in 2007. The Act also addresses withdrawal liability if work is contracted out (effective for work after August 17, 2006); makes the employer participation rules available for building and construction trade plans; amends the fresh start option rules for calculating withdrawal liability (effective for withdrawals after 2006); and changes the withdrawal liability payment rules if the plan alleges a transaction was undertaken to evade or avoid withdrawal liability.⁹

The Act extends the ERISA retaliation prohibition against participants for enforcing their ERISA rights to contributing employers of multiemployer plans.¹⁰

The Act provides an exception from the new multiemployer plan rules for benefit increases made pursuant to an agreement with the PBGC prior to June 30, 2005, as long as the increases are funded in accordance with the agreement.¹¹

Multiemployer plans that have an accumulated funding deficiency are subject to an excise tax. The Act exempts a small, fishery-related multiemployer plan from any excise taxes that accumulate prior to the earlier of the plan adopting a rehabilitation plan or 2009.¹²

The Act includes a sunset provision for the new funding rules for endangered/critical plans and the automatic five-year extension for multiemployer plans. These provisions sunset in 2014, except that any plan already in endangered or critical status can continue to follow its plan.¹³

Title III--Interest Rate Assumptions

30-Year Treasury Rates

Current law requires the use of a 30-year Treasury rate for certain calculations. For 2004 and 2005, a long-term corporate bond interest rate was substituted by the Pension Funding Equity Act of 2005, P.L. 108-218, §101, for the 30-year Treasury rate for plan funding and PBGC premiums. The Act extends the 2004 and 2005 temporary rates to 2006 and 2007.¹⁴

Interest Rate Assumption for Determination of Lump Sum Distributions

A plan's lump sum payment under current law to a participant or beneficiary must be no less than the present value of the annuity to which the participant or beneficiary would have been entitled. For this calculation, the plan must use specified interest and mortality assumptions. The interest rate is the rate on 30-year Treasury bonds.

The Act requires that the plan calculate lump sum values using a three-segment yield curve. The yield curve value is phased in over five years at 20% per year, and the remainder is based on the existing methodology. The phase in starts in 2008, and in 2012 the yield curve is fully phased-in. The yield curve is based on a monthly interest rate not the funding yield curve's 24-month average.¹⁵

Interest Rate Assumption for Applying Benefit Limitations to Lump Sum Distributions

The maximum benefit a participant may accrue and receive under current law is stated in terms of an annuity. The tax Code specifies a minimum interest rate that may be used for conversion to other forms of payment. The permanent rate is the same as the rate for minimum lump sums. However, the Pension Funding Equity Act of 2005, P.L. 108-218, §101, temporarily provided (through 2005) for a conversion at 5.5%.

The Act provided that the rate cannot be less than the greater of 5.5%, 105% of the minimum distribution interest rate, or the rate specified in the plan.¹⁶

Title IV--PBGC Guarantee and Related Provisions

PBGC Premiums

Single-employer plans that have unfunded vested benefits must pay the PBGC a variable rate premium (VRP) equal to $9 per $1,000 of unfunded vested benefits. No VRP is due if the plan is fully funded. For 2004 and 2005, the unfunded vested benefits were valued using 85% of a rate based on investment-grade corporate bonds. Act §301 extends that methodology in 2006 and 2007. The Deficit Reduction Act of 2005, P.L. 109-171, created a temporary (five year) termination premium. The Act requires the use of the yield curve's segment rates for the premium calculation, eliminates the full funding exception to the variable rate premium, and makes the termination premium permanent.¹⁷

Commercial Airlines

The Act includes relief for the airline industry in the form of a longer amortization period and a higher amortization interest rate. The Act also adds somewhat different rules which applies to airlines that freeze their plans and those that do not. In addition, the Act increases the termination premium paid to the PBGC by certain airlines.¹⁸

Limits on PBGC Guarantee of Shutdown and Other Benefits

If a plan is amended to increase benefits, the PBGC guarantee of the increased benefits is phased in over five years from the date of the plan amendment. A shutdown benefit generally is based on a provision already in the plan, so the shutdown does not trigger a phase-in period. The Act treats a shutdown or other contingent event as an amendment that triggers the phase-in of guaranteed benefits.¹⁹

Rules Relating to Bankruptcy of Employer

The PBGC guarantees and asset allocations are tied to the date a plan terminates. The Act provides that if a plan terminates after the employer goes into bankruptcy, the bankruptcy date is treated as the plan's termination date for purposes of: (1) determining the applicable maximum guarantee and the five-year phase in of the guarantee; and (2) determining who, and what benefit, is in asset allocation priority category three.²⁰

PBGC Premiums for Small Employers

Small plans do not pay a variable rate premium to the PBGC. The Act requires that an employer with 25 or fewer employees pay a special reduced variable rate premium for each participant equal to $5 times the number of participants in the plan.²¹

Interest on PBGC Premium Overpayments

Presently, the PBGC charges interest on underpayments but is not authorized to pay interest on overpayments. The Act authorizes the PBGC to pay interest on premium overpayments.²²

Substantial Owner Benefits in Terminated Plans

Under current law, 10% owners are designated as “substantial owners” and special rules apply to them with respect to guaranteed benefits in terminated plans. The Act simplifies the rules by substituting majority owner rules (50% or more owners) for substantial owner rules and applying the special guarantee limitation (now on majority owners). The Act also changes the allocation of assets rules relating to majority owners.²³

Acceleration of PBGC Computation of Benefits

The PBGC shares benefit recoveries from an employer with participants based on the proportional losses of the PBGC and the participants. Smaller terminations use an average recovery ratio (SPARR) to accelerate processing (i.e., rather than applying separate ratios for each plan, the PBGC annually calculates an average ratio based on the last five years). Before doing the allocation, the PBGC must split the recovery between return of due and unpaid contributions (DUEC) and recovery of employer liabilities. The Act changes the SPARR rules so that the most immediate two years are not counted in the five-year averaging period. In addition, the Act ceates a similar averaging ratio for DUEC.²⁴

Controlled Groups--Cessation or Change in Membership

When a plan spins off part of the plan, the allocation of assets and liabilities between the parties generally is done using the PBGC termination assumptions. The Act adds a special rule allowing the plan's interest rate to be used instead for certain corporate transactions involving fully funded plans and investment-grade employers.²⁵

Missing Participants

The Act expands the PBGC's missing participant program to cover terminating multiemployer plans, terminating defined benefit plans of small professional plans, and terminating defined contribution plans.²⁶

Director of PBGC

The Act makes the PBGC Executive Director's position a presidential appointment subject to Senate confirmation by both the Finance Committee and the Health, Education, Labor and Pensions Committee.²⁷

PBGC Annual Report

The Act requires the PBGC's annual report to include additional information on the PBGC's microsimulation forecasting model (Pension Insurance Modeling System), including the specific parameters used for the PBGC forecast and the impact on the PBGC deficit or surplus.²⁸

Title V--Disclosure

Defined Benefit Plan Funding Notice

The Act requires plan administrators to provide participants a summary of the annual report (SAR) 60 days after the annual report is filed. Plan administrators of certain underfunded single-employer defined benefit plans are required to send a funding notice to participants and beneficiaries at the same time as they send the SAR.

Currently, multiemployer defined benefit plans must provide a funding notice within two months after the annual report. The Act creates a new funding notice that is due 120 days after the beginning of the plan year for multiemployer and single-employer defined benefit plans, or with the filing of the annual report for plans with 100 or fewer participants.

The Act requires the plan administrator to send the notice to the PBGC, participants, beneficiaries, unions, and, in the case of multiemployer plans, employers contributing to the plan. The notice will include detailed information on plan funding. A multiemployer plan will provide additional information, including whether the plan is in endangered or critical status and information on how to get a copy of the funding improvement or rehabilitation plan. The Secretary of Labor is required to publish a model notice by August 17, 2007.

The Act also repeals ERISA §4011, which requires the plan administrator of a plan that is subject to the additional premium under ERISA §4006(a)(3)(E) to provide notice of the plan's funding status to participants and beneficiaries.²⁹

Multiemployer Pension Plan Information

The Act expands the ability of participants, beneficiaries, unions, and contributing employers to get plan actuarial and financial information from multiemployer plans. Each multiemployer plan administrator is required to furnish the plan information, upon written request, within 30 days. In addition, the plan sponsor or administrator of a multiemployer plan is required to provide a notice containing estimates of potential withdrawal liability to contributing employers generally within 180 days after a written request. Civil penalties of up to $1,000 per day can be imposed for each violation. The Act also requires that contributing employers of defined benefit plans or individual account plans subject to the minimum funding standards under Code §412 be entitled to notice of any plan amendment that would significantly reduce the rate of future benefit accruals.³⁰

Additional Annual Reporting for Defined Benefit Plans

The Act deletes the SAR for defined benefit plans. Single-employer and multiemployer defined benefit plans are required to provide additional information on the annual report filed each year. If liabilities to participants or beneficiaries under a plan at the end of the plan year consist of liabilities under two or more pension plans as of immediately before the plan year, the annual report is required to include the funded percentage of each pension plan and of the plan for which the report is filed as of the last day of the plan year. A multiemployer plan also is required to include information about contributing employers and participants for whom no employer was required to make a contribution. The DOL is required to publish a model notice by August 17, 2007. In addition, a multiemployer plan has to provide a summary of the required information to contributing employers and to employee organizations within 30 days of the annual report.³¹

Electronic Display of Annual Report Information

The Act requires the DOL to electronically display annual report information in electronic form within 90 days after receiving it. The Act also requires employers with intranets to display the information on the intranet.³²

ERISA §4010 Filings with the PBGC

Currently, employers with plans with aggregate underfunding of $50 million or more must provide financial and actuarial information to the PBGC annually. The information is confidential and the PBGC may not make it public. The Act eliminates the $50 million filing requirement and substitutes a requirement that all plans with a funding target attainment percentage less than 80% file plan actuarial and employer financial information. In addition to the current requirement that such plans provide actuarial and financial information to the PBGC, the Act specifies that the employer must provide additional funding information, including the plan's funding target determined as if the plan had been in at-risk status for at least five plan years. Also, while current law permits a Congressional committee to request the information, the Act requires that the PBGC annually submit to the labor and tax committees of the House and Senate a summary report of the information submitted to the PBGC.³³

Disclosure of Termination Information to Plan Participants

The Act requires the plan administrator or plan sponsor in a distress termination or in an involuntary termination instituted by the PBGC to provide participants with information that the employer gives to the PBGC, with certain confidentiality limitations, within 15 days of filing it with the PBGC. The Act also requires the PBGC to make the administrative record of the involuntary termination decision available.³⁴

Notice of Freedom to Divest Employer Securities

The Act requires that the plan administrator provide a written notice of the right to divest within 30 days before the first date on which an individual is eligible to divest employer securities. The Act allows for a civil penalty of up to $100 per day for each participant or beneficiary to be imposed against a noncompliant plan administrator. The Act also requires the Treasury Secretary to issue a model notice within 180 days of August 17, 2006.³⁵

Periodic Pension Benefit Statements

The Act sets out specific requirements for single and multiemployer plans to provide to participants periodic benefit statements, which currently are not required on a regular basis. Defined benefit plans are required to provide individual benefit notices every three years or upon written request. In the alternative, the defined benefit statement requirement can be met by notifying participants annually how to obtain the information. Defined contribution plans must provide individual benefit notices annually; however, where there is individual investment direction, the plan is required to provide the notice quarterly. The Act allows for a civil penalty of up to $100 per day for each participant or beneficiary to be imposed against a noncompliant plan administrator. In addition, the DOL is required to develop model benefit statements by August 17, 2007.³⁶

Notice to Participants or Beneficiaries of Blackout Periods

The Act removes the blackout notice requirement imposed by §306 of the Sarbanes-Oxley Act of 2002 (SOXA) for self-directed plans that are one-person or partner-only (or partners and their spouses) plans.³⁷

Title VI--Investment Advice, Prohibited Transactions, and Fiduciary Rules

Investment Advice

Under current law, a fiduciary must act in a prudent manner and solely in the interest of participants and beneficiaries. Parties-in-interest cannot deal with the plan except pursuant to a statutory, class, or individual exemption. A party-in-interest may provide investment advice using an objective computer model of investment alternatives subject to certain limitations as discussed in the DOL's Sun America opinion. The Act creates a prohibited transaction exemption for investment advice tailored to a recipient and provided by a qualified fiduciary adviser -- an adviser who is fully regulated by applicable banking, insurance, and securities laws -- through an “eligible investment advice arrangement.” Investment advice provided to a participant or beneficiary of an employer-sponsored retirement plan through a computer model that is certified by an independent eligible investment expert qualifies, as long as the only investment advice provided under the program is the advice generated by the computer model and the transaction occurs solely at the direction of the participant or beneficiary. Also, advice provided to employer-sponsored plans and IRAs by a qualified fiduciary adviser who charges a flat rate fee (without regard to the investments selected) is permitted.

The prohibited transaction exemption provides that: (1) the arrangement must be expressly authorized by a plan fiduciary that is not the person offering the investment advice program, a person providing investment options, or an affiliate of either; (2) an independent auditor must determine that the arrangement complies with the exemption provisions in a written report compiled after an annual audit; and (3) the fiduciary adviser must provide a disclosure to the participant or beneficiary. The disclosure has to be written in a clear and conspicuous manner and provide information including: (1) any fees and other compensation (for which the DOL is required to issue a model form); (2) any potential conflicts; (3) past performance of the plan's investment options; (4) available services; (5) a statement that the adviser is acting as a fiduciary of the plan; (6) a statement that the recipient of the advice may arrange for advice from an unaffiliated advisor; and (7) how participant information will be used. The disclosure also has to be made before advice is first given, at least annually thereafter, whenever the worker requests the information, and whenever there is a material change to the adviser's fees or affiliations. The fiduciary adviser is required to maintain evidence of compliance with the exemption for six years after providing the advice.

The Act also directs the Secretary of Labor to determine, in consultation with Treasury and by the end of 2007, whether a computer model is available that takes into account the personal and subjective criteria about the account beneficiary, that is appropriate for the broader range of investment options common to IRAs (and Archer MSAs, health savings accounts, and Coverdell education savings accounts), and that allows the account beneficiary sufficient flexibility in obtaining advice to evaluate and select investment options.

Under the Act, a certified computer model is an option for providing investment advice related to IRAs only if the DOL determines an appropriate computer model is available; any person can ask the DOL to make such a determination. If the DOL determines that an appropriate model is not available, the DOL must issue a class exemption that protects IRA account holders from biased advice without requiring fee-leveling or a computer model. In addition, the exemption sunsets on the later of two years after an appropriate IRA computer model becomes available, or three years after issuance of the class exemption. The amendments provided by the Act do not alter existing individual or class exemptions.³⁸

Prohibited Transactions Related to Financial Investments

The Act provides statutory prohibited transaction exemptions for certain transactions involving block trading (in blocks of at least 10,000 shares with a market value of at least $200,000), regulated electronic communication networks, service providers who are not fiduciaries with respect to the assets involved, foreign exchange transactions, and cross trading (for plans with over $100 million in assets). The Act also provides relief from certain bonding requirements for broker-dealers subject to other bonding requirements and removes foreign and governmental plans from the numerator for purposes of determining whether more than 25% of a fund is from pension plan assets.³⁹

Correction Period for Securities and Commodities Transactions

The Act amends the correction period for prohibited transactions involving certain securities and commodities to 14 days after the party discovers or should have discovered that the transaction was prohibited. The Act also provides for abatement of an assessed prohibited transaction excise tax if there is a correction.⁴⁰

Blackout Periods

A plan fiduciary is protected from some liability in self-directed plans. The Act eliminates the fiduciary's protection during blackout periods when a participant cannot self direct unless certain specified requirements regarding reasonable blackout periods are satisfied.⁴¹

Bond Amount

The Act increases the fiduciary bond requirement from at least $500,000 to $1 million for plans that hold employer securities.⁴²

Penalties for Coercive Interference

The Act increases the penalties for coercive interference with the exercise of ERISA rights from a $10,000 fine and one year in prison to a $100,000 fine and 10 years in prison.⁴³

Participant Failures to Exercise Investment Elections

The Act extends fiduciary protections similar to those available in cases in which participants self direct their accounts to situations in which the participant does not make an investment choice and the plan sponsor makes a default investment consistent with DOL final regulations (to be issued within six months after August 17, 2006).⁴⁴

Annuity Contracts As Optional Forms of Benefit

The Act requires the DOL to issue regulations making clear that the “safest annuity available” standard under DOL Interpretive Bulletin 95-1 does not apply to annuities paid as an optional distribution from an individual account plan to a participant or beneficiary.⁴⁵

Title VII--Benefit Accrual Standards

In response to litigation addressing the application of the age discrimination rules of the Code, ERISA, and the Age Discrimination in Employment Act (ADEA) to hybrid defined benefit plans and to the conversion of traditional final-pay plans into hybrid plans, the Act provides rules for testing defined benefit plans, including hybrid plans, for age discrimination under the Code, ERISA, and ADEA. The Act requires a hybrid plan to meet certain conditions for vesting and for investment credits and prohibits the “wearaway” of benefits the participant has earned in a conversion to a hybrid plan. The amendments are prospective only, with no inference for the past. Applicable defined benefit plans (basically hybrid plans), defined below, are permitted to treat the hypothetical account balance as the lump sum value for distributions after August 17, 2006.⁴⁶

The Act amends the accrued benefit requirements to provide that a plan is not treated as violating the prohibition against ceasing or reducing the rate of an employee's benefit accrual solely because the employee attains a particular age (i.e., the continued accrual requirement) as long as a participant's accrued benefit as of any date under the terms of the plan, disregarding the subsidized portion of an early retirement benefit or retirement-type subsidy, equals or exceeds that of a similarly situated younger individual who is or could be a participant. The Act also provides that a plan is not treated as violating the continued accrual requirements solely because the plan: (1) provides offsets against plan benefits that are allowable to applying Code §401(a); (2) provides a disparity in contributions or benefits with respect to which the Code §401(a) requirements are met; or (3) provides for indexing of accrued benefits.

The Act defines an “applicable defined benefit plan” as a defined benefit plan under which all or part of the accrued benefit is calculated as the balance of a hypothetical account maintained for the participant or as an accumulated percentage of the participant's final average compensation. Treasury regulations will have to include in the term's definition any defined benefit plan, or any portion of such a plan, which has an effect similar to an applicable defined benefit plan. An applicable defined benefit plan is treated as violating the continued accrual requirements unless the plan terms provide that any interest credit for any plan year must be at a rate that is at or below market rate (the calculation of which may be determined by regulation); the plan terms also have to include specified language related to plan termination. A plan is not precluded from providing for a reasonable minimum guaranteed rate of return or a rate of return that is equal to the greater of a fixed or variable rate, however.

If an “applicable plan amendment”--an amendment to a defined benefit plan has the effect of converting the plan to an applicable defined benefit plan--is adopted after June 29, 2005, the plan is treated as failing to meet the continued accrual requirements unless, for each individual who was a participant in the plan immediately before the adoption of the amendment, the post-amendment accrual benefit under the plan terms is not less than the sum of his or her accrued benefit for years of service before and after the plan amendment's effective date; special rules apply for early retirement subsidies. If the coordination of the benefits of two or more defined benefit plans established or maintained by an employer has the effect of adopting an applicable plan amendment, the plan sponsor is treated as having adopted such a plan amendment as of the date coordination begins.

Under the Act, an applicable defined benefit plan is treated as meeting the vesting period requirements of Code §411(a)(2)/ERISA §203(a)(2) only if an employee who has completed at least three years of service has a nonforfeitable right to 100% of the employee's accrued benefit derived from employer contributions.

Regulations Relating to Mergers and Acquisitions. The Act requires the Treasury Secretary to issue regulations, by August 17, 2007, to deal with situations in which the conversion to a cash balance plan is made with respect to employees who become employees through a merger, acquisition, or similar transaction.⁴⁷

Title VIII--Pension Related Revenue Provisions

Deduction Limitations

Generally, plans can deduct contributions up to 100% of the plan's current liability. Contributions in excess of the limit are subject to a 10% excise tax. Because the plan's liability on termination generally is higher than its current liability, there is an exception that allows a deductible contribution equal to 100% of the plan's termination liability, but only in the year of termination. The Act increases the deductible limit for single-employer plans to the year's normal cost (generally the cost of benefits accrued in the year) plus the amount necessary to fully fund the funding target. In addition, employers can contribute and deduct a cushion, which is 50% of the funding target plus additional amounts reflecting projections of the participants' compensation and the statutory compensation limits.⁴⁸

The Act increases the deduction limit for multiemployer plans to 140% of the plan's current liability.⁴⁹

Employers that sponsor both defined benefit plans and defined contribution plans face a combined limit on deductible contributions. The Act provides that contributions to a PBGC-covered defined benefit plan are deductible without affecting the combined limit. For other plans, only contributions in excess of 6% of compensation count towards the combined limit.⁵⁰

EGTRRA Provisions Made Permanent

The Act makes the pension and individual arrangement provisions made under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), P.L. 107-16, permanent by eliminating the 2010 sunset in EGTRRA §901.⁵¹

The Act makes the EGTRRA provisions relating to the Code §25B Saver's Credit permanent by eliminating the sunset after 2006.⁵²

Portability, Distributions and Contributions

Although the Code restricts the purchase of pension benefits for service with another employer, special rules allow qualified retirement plans of state and local governments to allow participants to make after-tax contributions to purchase service credit under the plan for certain periods for which no credit had been given. The purchase of additional credits for years in which service credit has been given is not allowed. The rules also allow trustee-to-trustee transfers from §403(b) or §457 plans to purchase service credit without tax consequences. The Act allows the purchase of additional service credits even for years when service credit was given and provides more flexibility on prior educational service (elementary or secondary education) that is treated as permissive service for purposes of buying credit. The Act also provides more flexibility on trustee-to-trustee transfers so that the participant is not liable for income tax if the transferee plan improperly allows service purchase and allows the transfer between plans of unrelated employers.⁵³

The Act allows rollovers of after-tax amounts in §403(b) annuities to a qualified plan.⁵⁴

The Act clarifies the minimum distribution rules for governmental plans by requiring the Secretary of Treasury to issue regulations providing relief from the minimum distribution rules for governmental plans as long as the plan complies with a reasonable good faith interpretation of the statute. It is intended that the regulations apply retroactively.⁵⁵

The Act allows direct rollovers from eligible retirement plans to Roth IRAs.⁵⁶

Certain individuals who received a prior distribution from a plan may not participate in an eligible deferred compensation plan under §457. The Act eliminates the prohibition on an individual participating in an eligible deferred compensation plan merely because of a distribution from the plan before the Small Business Job Protection Act of 1996, P.L. 104-188, was effective.⁵⁷

The Act modifies the hardship regulations by requiring the Secretary of Treasury to issue regulations within 180 days after August 17, 2006, to expand “hardship” to include hardship of a beneficiary under the plan (even if it is not a spouse or dependent).⁵⁸

The Act creates a new exception from the 10% premature distribution tax for distributions before age 591/2 to a reservist (called up between September 11, 2001, and before December 31, 2007, for more than 179 days), and allows the money to be repaid within two years after the end of active service.⁵⁹

The Act allows public safety officers to avoid the early 10% distribution penalty for distributions based on separation from service if the officer is at least 50 (rather than 55).⁶⁰

The Act allows nonspouse beneficiaries to roll over to an IRA or other plan structured for that purpose amounts inherited as a designated beneficiary. The inherited amounts are subject to the annual minimum distribution rules requiring distributions over the person's life expectancy (recalculated annually).⁶¹

The Act requires the IRS to make available a form for a taxpayer to file with the IRS directing the IRS to send a refund directly to the taxpayer's IRA.⁶²

The Act allows individuals who worked for a bankrupt employer whose officers were indicted and whose employer had a least a 50% match in the form of employer stock in its §401(k) plan to make an additional IRA catch-up contribution (three times the otherwise applicable catch-up amount). The contributions can be made for 2007, 2008, and 2009.⁶³

The IRS has issued guidance that would only allow compensation earned while an individual is a participant in the plan to be counted towards the defined benefit plan benefit limits. The Act provides that the relevant test is compensation while working for the employer, not only when a participant.⁶⁴

The Act provides for indexing the adjusted gross income levels for the saver's credit and IRAs for taxable years after 2006.⁶⁵

Health and Medical Benefits

The Code allows excess plan assets to be transferred from an ongoing defined benefit plan to a §401(h) health account (within the defined benefit plan) to be used for retiree health costs for retirees covered by the plan. The Act allows a pension plan with assets in excess of 120% of the plan's current liability (or funding target) to transfer two or more years of estimated retiree medical costs to a health account under the plan. The maximum amount that can be transferred is the lesser of 10 years of estimated retiree medical costs or assets in excess of 120% of current liability. For all years for which a transfer has been made, the employer must make contributions sufficient to maintain the plan's 120% funding level (or transfer assets back from the health to the pension account). There also is a cost maintenance requirement that applies throughout the transfer period and four years thereafter. For employers meeting certain criteria, the cost maintenance requirement for multiyear transfers made pursuant to a collective bargaining agreement may be modified through the collective bargaining agreement.⁶⁶

The Act expands the right to transfer excess assets to a health plan to multiemployer pension plans.⁶⁷

The Act allows a plan maintained by a bona fide association to accumulate reserves of up to 35% of annual costs for medical benefits (other than post-retirement medical benefits).⁶⁸

Tax-free transfers are not available between annuity contracts without long-term care (LTC) riders and life insurance contracts with LTC riders. The Act permits LTC riders on annuity contracts and provide special tax treatment for the LTC component of a life insurance or annuity contract including allowing the cash value of such contracts to pay the LTC benefit, making LTC payments to a reduction in basis, allowing tax-free transfers between annuity contracts even if one has a LTC rider (with similar rules for life insurance contracts), and providing special rules that would treat the LTC rider as a separate contract for certain purposes. The Act also adds new reporting requirements.⁶⁹

Pretax contributions for health insurance only are permitted out of wages. The Act allows public safety officers to elect to annually defer up to $3,000 of retirement income to pay for health or long-term care benefits on a pretax basis.⁷⁰

Presently, there is a moratorium on the IRS disqualifying a state or local government plan because of a violation of the nondiscrimination rules. The Act extends the moratorium to other government plans such as federal plans.⁷¹

Miscellaneous Provisions

Payments of life insurance after the covered party's death generally are not taxable to the recipient. The Act requires businesses to treat proceeds from corporate-owned life insurance (COLI) as income unless the insured was an employee within 12 months of death, or was a director or highly compensated employee or individual at the time the contract was issued, or the proceeds paid to the insured's beneficiary are used to buy back any equity interest owned by the insured at the time of death. The COLI provision also includes notice and consent requirements and add new reporting requirements.⁷²

The Act provides that a church plan that self-annuitizes distributions does not fail the minimum distribution requirements as long as the plan satisfies the rules applicable to §403(b) plans.⁷³

The Act extends the exemption for qualified retirement plans from unrelated business income tax for leveraged investment in real estate to church annuity plans.⁷⁴

The Code limits the maximum benefit that participants can receive from defined benefit plans to highest-three year average compensation. The Act eliminates this limit for nonhighly compensated employees covered by church plans.⁷⁵

The Act provides that for purposes of allocating employer securities from a suspense account in a gratuitous transfer of employer securities, the applicable limit that can be allocated to a participant is based on the fair market value of the securities when allocated to participants.⁷⁶

TITLE IX--Increase in Pension Plan Diversification and Participation and Other Pension Provisions

Diversification Requirements for Certain Defined Contribution Plans

The Act requires a defined contribution plan that holds any publicly-traded employer securities to allow a participant (or any beneficiary entitled to exercise a participant's rights) to divest that portion of the account attributable to employee contributions and elective deferrals invested in employer securities and to reinvest an equivalent amount in other investment options. With respect to the portion of the plan account attributable to employer contributions other than elective deferrals which is invested in employer securities, the Act requires a defined contribution plan to allow each participant who has completed at least three years of service (or is a beneficiary of a such participant or of a deceased participant) to divest any employer securities and to reinvest an equivalent amount in other investment options. If the employer contribution portion of the account consists of employer securities acquired in a plan year beginning before January 1, 2007, the diversification requirement is phased in over three years (applied separately with respect to each class of securities), but this phase-in does not apply to a participant who has attained age 55 and completed at least three years of service before the first plan year beginning after December 31, 2005.⁷⁷

Regarding the reinvestment options for the divested employer securities, the Act requires the plan to offer not less than three investment options, other than employer securities, each of which is diversified and has materially different risk and return characteristics. Under the Act, a plan will not be treated as failing to meet this requirement merely because the plan limits the time for divestment and reinvestment to periodic, reasonable opportunities occurring no less frequently than quarterly. However, under the Act, except as provided in regulations and except for any restrictions or conditions imposed under securities laws, a plan will not meet this requirement if it imposes restrictions or conditions regarding the investment of employer securities that are not imposed on the investment of other plan assets.

Under the Act, the above provisions does not apply to an ESOP if (1) there are no contributions to the plan (or earnings thereunder) held within the plan and subject to Code §401(k) or (m), and (2) the plan is a separate plan for purposes of Code §414(l) with respect to any other defined benefit plan or defined contribution plan maintained by the same employer or employers. Also, the Act excludes “one-participant retirement plans,” as defined under the Act, from application of the above provisions.

Increasing Participation Through Automatic Contribution Arrangements

The Act allows a “qualified automatic contribution arrangement” to meet the actual deferral percentage requirements of Code §401(k)(3)(A)(ii) and the matching contribution percentage requirements of Code §401(m)(2). The Act also excludes such an arrangement from the definition of a top-heavy plan and amends §514 of ERISA to supersede any law of a state which directly or indirectly prohibits or restricts the inclusion in any plan of an automatic contribution arrangement.

Under the Act, each employee eligible to participate in the arrangement is treated as having elected to have the employer make elective contributions in an amount equal to a qualified percentage of compensation. Under the Act, the qualified percentage is any percentage determined under the arrangement if such percentage is applied uniformly, does not exceed 10%, and is at least: (1) 3% during the period ending on the last day of the first plan year which begins after the date on which the first elective contribution is made with respect to such employee; (2) 4% during the first plan year following that plan year; (3) 5% during the second plan year following that plan year; and (4) 6% during any subsequent plan year. The Act provides that the election treated as having been made ceases to apply with respect to any employee who makes an affirmative election to not have such contributions made or to make elective contributions at a level specified in that affirmative election. Under the Act, the automatic enrollment provision may be applied without taking into account any employee who was eligible to participate in the arrangement (or a predecessor arrangement) immediately before the date on which the arrangement became a qualified automatic contribution arrangement and had an election in effect on such date (either to participate in the arrangement or to not participate in the arrangement).

According to the Act, under the above provision, employers are required to: (1) make matching contributions on behalf of each employee who is not a highly compensated employee in an amount equal to the sum of 100% percent of the elective contributions of the employee to the extent that such contributions do not exceed one percent of compensation plus 50% of so much of such compensation as exceeds one percent but does not exceed six percent of compensation; or, without regard to whether the employee makes an elective contribution or employee contribution, make a contribution to a defined contribution plan on behalf of each employee who is not a highly compensated employee and who is eligible to participate in the arrangement in an amount equal to at least three percent of the employee's compensation. The Act provides that an arrangement is not treated as meeting the above requirements unless, with respect to employer contributions (including matching contributions) taken into account for this purpose, any employee who has completed at least two years of service has a nonforfeitable right to 100% of the employee's accrued benefit derived from such employer contributions and the distribution requirements of §401(k)(2)(B) are met with respect to all such employer contributions.

Under the Act, to be considered a qualified automatic contribution arrangement, within a reasonable period before each plan year, each employee eligible to participate in the arrangement for that year must receive an accurate and comprehensive written notice of the employee's rights and obligations under the arrangement written in a manner calculated to be understood by the average employee to whom the arrangement applies. The Act provides specific timing and content requirements.

The Act provides the following tax treatment of withdrawals of elective contributions (and related earnings) to an “eligible automatic contribution arrangement” made within 90 days of the date of the first elective contribution: (1) the amount of any such withdrawal is includible in the employee's gross income for the employee's taxable year in which the distribution is made; (2) no tax is imposed under §72(t) with respect to the distribution; (3) the arrangement is not treated as violating any restriction on distributions under the Code solely by reason of allowing the withdrawal; and (4) employer matching contributions are forfeited or subject to such other treatment as the IRS may prescribe.

For these purposes, the Act defines an eligible automatic contribution arrangement as an arrangement under an applicable employer plan: (1) under which a participant may elect to have the employer make payments as contributions under the plan on behalf of the participant, or to the participant directly in cash; (2) under which the participant is treated as having elected to have the employer make such contributions in an amount equal to a uniform percentage of compensation provided under the plan until the participant specifically elects not to have such contributions made (or specifically elects to have such contributions made at a different percentage); (3) under which, in the absence of an investment election by the participant, contributions described in (2) are invested in accordance with regulations prescribed by the Secretary of Labor under ERISA §404(c)(5); and (4) which meets certain notice requirements.

Under the Act, an applicable employer plan is: (1) an employees' trust under Code §401(a) which is exempt from tax under Code §501(a); (2) a plan under which amounts are contributed by an individual's employer for an annuity contract described in Code §403(b); and (3) an eligible deferred compensation plan described in Code §457(b) which is maintained by an eligible governmental employer described in Code §457(e)(1)(A).⁷⁸

Eligible Combined Defined Benefit Plans and Qualified Cash or Deferred Arrangements

The Act allows a small employer (i.e., an employer with an average of at least two but not more than 500 employees) to establish a combined defined benefit-§401(k) plan governed by one document and having specific accounting for the defined benefit and defined contribution portions of the trust. Generally, under the Act, the defined benefit rules apply to the defined benefit portion of the plan, and the defined contribution rules apply to the defined contribution portion of the plan. The Act requires the defined benefit component to satisfy minimum accrual requirements, and if the defined benefit component is a cash balance plan, the accrual must be in the form of minimum pay credits. Under the Act, the §401(k) component is required to have automatic enrollment (including opt-out, notice and election rights) and meet minimum matching contribution requirements. The Act requires all contributions and benefits under and all rights and features under each plan to be provided uniformly to all participants. Under the Act, a defined benefit plan and applicable defined contribution plan forming part of an eligible combined plan for any plan year is treated as meeting the top-heavy requirements of Code §416 for the plan year, Code §414(k) does not apply, and the plan is treated as a single plan for purposes of the reporting requirements of Code §§6058 and 6059.⁷⁹

Faster Vesting of Employer Nonelective Contributions

Under current law, there is accelerated vesting in defined contribution plans but only for matching employer contributions. They must be 100% vested after three years (three-year cliff vesting) or vest at a rate of 20% a year starting with year two (two-to-six-year phased vesting). Employee contributions are always 100% vested.

The Act applies accelerated three-year cliff vesting or two-to-six-year phased vesting to all employer contributions in a defined contribution plan (nonelective employer contributions as well as matching contributions).⁸⁰

Distributions During Working Retirement

Under current law, defined benefit plans are prohibited from allowing in-service distributions before normal retirement age. The Act allows in-service distributions once the participant is age 62.⁸¹

Pension Plans of Indian Tribal Governments

Under the Act, a governmental plan includes a plan which is established and maintained by an Indian tribal government, a subdivision of an Indian tribal government, or an agency or instrumentality of either, and all of the participants of which are employees of such entity substantially all of whose services as such an employee are in the performance of essential governmental functions but not in the performance of commercial activities (whether or not an essential government function). The Act further clarifies that tribal governments are subject to the same pension plan rules and regulations applied to state and other local governments and their police and firefighters.⁸²

TITLE X--Provisions Relating to Spousal Pension Protection

Domestic Relations Orders

The Act requires the Secretary of Labor to issue regulations under ERISA §206(d)(3) and Code §414(p) not later than August 17, 2007, which clarify that: (1) a domestic relations order otherwise meeting the requirements to be a qualified domestic relations order, including the requirements of ERISA §206(d)(3)(D) and Code §414(p)(3) will not fail to be treated as a qualified domestic relations order solely because (a) the order is issued after, or revises, another domestic relations order or qualified domestic relations order, or (b) of the time at which it is issued; and (2) any order described in paragraph (1) will be subject to the same requirements and protections which apply to qualified domestic relations orders, including the provisions of ERISA §206(d)(3)(H) and Code §414(p)(7).⁸³

Divorced Spouses and Railroad Retirement Annuities

The Act amends the Railroad Retirement Act to provide for entitlement of a divorced spouse to railroad retirement annuities independent of the actual entitlement of the employee.⁸⁴

Railroad Retirement Benefits to Surviving Former Spouses

The Act amends the Railroad Retirement Act to provide that the surviving spouse's annuity under Tier II railroad retirement benefits, which he or she is receiving pursuant to a divorce decree, is not terminated because of the death of the participant (unless the divorce order so provides).⁸⁵

Requirement for Additional Survivor Annuity Options

Under the Act, if a pension plan participant elects a waiver of the qualified joint and survivor annuity (QJSA) form of benefit or a qualified preretirement survivor annuity form of benefit, the participant can elect a qualified optional survivor annuity, defined as an annuity: (1) for the life of the participant with a survivor annuity for the life of the spouse which is equal to the applicable percentage of the amount of the annuity which is payable during the joint lives of the participant and the spouse; and (2) which is the actuarial equivalent of a single annuity for the life of the participant. Under the Act, if the survivor annuity percentage is less than 75%, the applicable percentage is 75%, and if the survivor annuity percentage is greater than or equal to 75%, the applicable percentage is 50%. For these purposes, the Act defines the term “survivor annuity percentage” as the percentage which the survivor annuity under the plan's QJSA bears to the annuity payable during the joint lives of the participant and the spouse. The Act requires the plan to provide a written explanation of the qualified optional survivor annuity in its required notice to participants.⁸⁶

TITLE XI--Administrative Provisions

Employee Plans Compliance Resolution System

The Act provides the Secretary of the Treasury with full authority to establish and implement the Employee Plans Compliance Resolution System (EPCRS) or any successor program and any other employee plans correction policies, including the authority to waive income, excise or other taxes to ensure that any tax, penalty or sanction is not excessive and bears a reasonable relationship to the nature, extent and severity of the failure. The Act directs Treasury to continue to update and improve the EPCRS or any successor program, giving special attention to: (1) increasing the awareness and knowledge of small employers concerning the availability and use of the program; (2) taking into account special concerns and circumstances that small employers face with respect to compliance and correction of compliance failures; (3) extending the duration of the self-correction period under the Self-Correction Program for significant compliance failures; (4) expanding the availability to correct insignificant compliance failures under the Self-Correction Program during audit; and (5) assuring that any tax, penalty or sanction that is imposed by reason of a compliance failure is not excessive and bears a reasonable relationship to the nature, extent and severity of the failure.⁸⁷

Notice and Consent Period Regarding Distributions

Generally, under present law, an election of a form other than a joint and survivor annuity must be made no earlier than 90 days before the benefit's annuity starting date. The Act changes the consent period for joint and survivor notices and consents from “no earlier than 90 days” to “no earlier than 180 days” before the benefit's annuity starting date.⁸⁸

Reporting Simplification

The Act directs the Secretary of the Treasury to modify the requirements for filing annual returns with respect to one-participant retirement plans to ensure that such plans with assets of $250,000 or less as of the close of the plan year need not file a return for that year. For these purposes, the Act defines a “one-participant retirement plan” as a retirement plan with respect to which the following requirements are met: (1) on the first day of the plan year, (a) the plan covered only one individual (or the individual and the individual's spouse) and the individual owned 100% of the plan sponsor (whether or not incorporated), or (b) the plan covered only one or more partners (including a two-percent shareholder as defined in Code §1372(b) of an S corporation) (or partners and their spouses) in the plan sponsor; (2) the plan meets the minimum coverage requirements of Code §410(b) without being combined with any other plan of the business that covers the employees of the business; (3) the plan does not provide benefits to anyone except the individual (and the individual's spouse) or the partners (and their spouses); (4) the plan does not cover a business that is a member of an affiliated service group, a controlled group of corporations, or a group of businesses under common control; and (5) the plan does not cover a business that uses the services of leased employees. The Act also requires the Secretaries of the Treasury and Labor to provide for the filing of a simplified annual return for any retirement plan which covers less than 25 participants on the first day of a plan year and which meets the requirements described in (2), (4) and (5) above.⁸⁹

Local Educational Agencies and Other Entities

Voluntary Early Retirement Incentive Plans. The Act provides for treatment of certain voluntary early retirement incentive plans maintained by (1) a local educational agency,⁹⁰ or (2) an education association described in Code §501(c)(5) or (6)⁹¹ which principally represents employees of one or more agencies described in (1) above and is exempt from tax under Code §501(a). Under the Act, if (1) such a plan makes payments or supplements as an early retirement benefit, a retirement-type subsidy, or a benefit described in the last sentence of Code §411(a)(9),⁹² and (2) such payments or supplements are made in coordination with a qualified defined benefit plan and a trust exempt from tax under Code §501(a) and which is maintained by an eligible governmental employer or by an education association described above, the plan is treated as a bona fide severance pay plan not providing for the deferral of compensation with respect to such payments or supplements, to the extent such payments or supplements can otherwise be provided under the defined benefit plan (determined as if Code §411 applied to the defined benefit plan). The Act provides an exemption from the age discrimination provisions of the Age Discrimination in Employment Act of 1967 (ADEA) for voluntary early retirement incentive plans described above.

Employment Retention Plans. The Act also creates an exception to the rules governing ineligible plans under Code §457(f) for that portion of any applicable employment retention plan with respect to any participant, i.e., that portion of the plan which provides benefits payable to the participant not in excess of twice the applicable dollar limit determined under Code §457(e)(15). Also, under the Act, a plan is not treated under the Code as providing for the deferral of compensation for any year with respect to that portion of the plan. The Act defines an applicable employment retention plan as an employment retention plan maintained by (1) a local educational agency, or (2) an education association which principally represents employees of one or more such agencies and which is described in Code §501(c)(5) or (6) and exempt from taxation under Code §501(a). The Act defines an employment retention plan as a plan to pay, upon termination of employment, compensation to an employee of a local educational agency or education association for purposes of retaining the employee's services or rewarding such an employee for the employee's service with one or more such agencies or associations.

Under the Act, applicable voluntary early retirement incentive plans and applicable employment retention plans described above are treated under ERISA as welfare plans (and not pension plans) with respect to such payments and supplements.⁹³

No Reduction in Unemployment Compensation as a Result of Pension Rollovers

The Act prohibits states from reducing unemployment compensation for any pension, retirement or retired pay, annuity or similar payment that was rolled over and, thus, is not includible in gross income.⁹⁴

Revocation of Election Relating to Treatment as Multiemployer Plan

The Act allows a plan to revoke its election relating to treatment as a multiemployer plan by August 17, 2007. More specifically, the Act allows a plan to revoke an election to not be treated as a multiemployer plan pursuant to procedures prescribed by the Pension Benefit Guaranty Corporation (PBGC) if, for each of the three plan years before August 17, 2006, the plan would have been a multiemployer plan but for the election. The Act also allows a plan that meets the statutory multiemployer plan criteria (or a plan that was established in Chicago, Illinois, on August 12, 1881, and sponsored by an organization described in Code §501(c)(5) and exempt from tax under Code §501(a)) to elect, pursuant to procedures prescribed by the PBGC, to be a multiemployer plan, if (1) for each of the three plan years immediately before August 17, 2006, the plan met those criteria or is so described; (2) substantially all of the plan's employer contributions for each of those plan years were made or required to be made by organizations that were exempt from tax under Code §501; and (3) the plan was established before September 2, 1974.⁹⁵

Provisions Relating to Plan Amendments.

Under the Act, with respect to any amendment to any pension plan or annuity contract which is made (1) pursuant to any provision under the Act or any regulation issued by the Secretaries of the Treasury or Labor under the Act, and (2) on or before the last day of the first plan year beginning on or after January 1, 2009 (January 1, 2011, for governmental plans as defined in Code §414(d)), such pension plan or contract is treated as being operated in accordance with the terms of the plan during the period described below, and except as provided by the Secretary of the Treasury, the plan does not fail to meet the requirements of Code §411(d)(6) and ERISA §204(g) by reason of such amendment.

The Act provides that this section does not apply to any amendment unless: (1) during the period (a) beginning on the date the legislative or regulatory amendment takes effect (or in the case of a plan or contract amendment not required by such legislative or regulatory amendment, the effective date specified by the plan), and (b) ending on or before the last day of the first plan year beginning on or after January 1, 2009 (January 1, 2011, for governmental plans as defined in Code §414(d)) (or, if earlier, the date the plan or contract amendment is adopted), the plan or contract is operated as if the plan or contract amendment were in effect; and (2) the plan or contract amendment applies retroactively for such period.⁹⁶