The PPA and Defined Contribution Plans

Transcription

1 The PPA and Defined Contribution Plans Vernon P. Saper George L. Whitfield Warner Norcross & Judd LLP Warner Norcross & Judd LLP

2 401(k) Automatic Enrollment Plans 401(k) Safe Harbor Plans New Automatic Enrollment Safe Harbor Plans (Effective Plan Years After 2007) 2

3 401(k) Automatic Enrollment Automatic enrollment before PPA Compensation is reduced unless participant elects otherwise (also called Negative Election ) Reductions at a set uniform percentage of compensation Participants must be able to change the percentage election at any time Reasonable notice must be given prior to first automatic reduction and prior to the beginning of each year. Technical content and delivery rules. 3

4 401(k) Automatic Enrollment Automatic enrollment before PPA cont d May be used only for new hires or for all employees May be used with Roth contributions May be structured to increase the deferral percentage automatically, within limits 4

5 401(k) Automatic Enrollment Why automatic enrollment? Increases participation One study: 22% overall Higher (40% +) among younger and lower-paid 5

6 401(k) Automatic Enrollment Downside: Administration Notices Opt Out; No refund Downside: Legal Concerns May violate state wage withholding laws Fiduciary responsibility for default investments 6

7 401(k) Automatic Enrollment PPA enhancements of auto enrollment Pre-emption of state laws (subject to requirements). Effective August 17, 2006 Amends ERISA '404(c) to allow default fund (under DOL regs.) for auto-enrolled participants New safe harbor rules (discussed below) 7

8 401(k) Automatic Enrollment PPA enhancements cont d Unwind of automatic enrollment if employee elects out within 90 days after first deferral Must apply to all deferrals (plus earnings); matching contributions forfeited Effective: years after December 31, 2007 Refunded deferrals: Not counted for ADP testing Exempt from 401(k) distribution restrictions and 10% early withdrawal tax Taxable in year of distribution 8

9 Safe Harbor Plans Goal: avoid discrimination testing (ADP and ACP) Required employer safe harbor NHCE contributions must be either: Matching: 4% 100% of 1 st 3%, and 50% of next 2%; or Nonelective: 3% 9

10 Safe Harbor Plans Employer safe harbor contributions (cont d) To all NHCEs No conditions (1000 hr., last day, etc.) 100% vested No in-service distribution < 59 ½ May count as top-heavy contribution 10

11 Safe Harbor Plans Technical concerns Content and timing of notices Additional contributions may be subject to vesting (but subject to restrictions) Restrictions on short years Can discontinue during year, by amendment and with notice, but must test for whole year 11

12 New Automatic Contribution Arrangement - ACA New nondiscrimination safe harbor Combines automatic enrollment and safe harbor features ACAs are exempt from ADP deferral testing and ACP match testing Effective for plan years beginning after December 31,

13 New Automatic Contribution Arrangement - ACA Auto-enrollment deferral rates Must be at least 3% for the first year Must increase 1% annually to 6% for 4 th year; not more than 10% Must cover all eligible employees except current employees who previously elected to participate or opted out. Must include new participants 13

14 New Automatic Contribution Arrangement - ACA Safe harbor contribution for NHCEs either: Matching: 3.5% 100% of first 1%; plus 50% of next 5%; or Nonelective: 3% May have to contribute this only for auto enrolled participants; yet get free pass on testing for whole plan! 14

15 New Automatic Contribution Arrangement - ACA Safe Harbor contributions must: Be fully vested after 2 years Comply with 401(k) withdrawal restrictions Contrast with immediate vesting in current safe harbor rules 15

16 New Automatic Contribution Arrangement - ACA Notice Requirement Reasonable notice must be provided Allow participants to make alternate decisions before first deferral Provide information about how investment elections may be made and the default investment in the absence of investment elections 16

17 Automated Plan of Tomorrow Automatic enrollment/safe harbor (or ACA) Automatic investments (default/lifestyle) Automatic contribution increases Automatic rebalancing (lifestyle) Automatic rollover (now $5,000 or less) Safety valve: can always opt out Plan of today: all except ACA (2008) 17

18 Default Investments 18

19 Fiduciary Relief for Default Investments ERISA 404(c) currently provides fiduciary relief for certain participant investment direction Must have at least three investment options each with different risk and return Must be able to change investments at least once every three months Must be provided information regarding investments Special rules for employer stock 19

20 Fiduciary Relief for Default Investments PPA expands ERISA 404(c) fiduciary relief for investment in a default investment fund Effective for plan years beginning in 2007 Applies only to the extent participant has not otherwise directed investment Cannot override participant s actual direction 20

21 Fiduciary Relief for Default Investments Notice requirement Reasonable period before first automatic investment in default fund and before each plan year Notice of rights and obligations under the plan Including the right to control plan assets in the participant s account DOL issued proposed regulations in October 21

22 Safe Harbor Default Investment Alternative An individual account plan that provides for participant direction may use a default investment alternative in the following circumstances: Failure to make an investment election upon initial enrollment in plan; Failure to provide investment instruction following a rollover from another plan; or Failure to provide investment instruction following the elimination of an investment alternative or a change in service provider 22

23 Safe Harbor Default Investment Alternative The plan does not have to be 404(c) plan If the conditions are satisfied, a fiduciary is not liable for any loss that is the direct result of investing a participant s account in a qualified default investment alternative ( QDIA ) 23

24 Safe Harbor Default Investment Alternative The plan must satisfy six conditions: Opportunity to direct the investments in the account Notice at least 30 days in advance of the first investment in the default fund and at least 30 days in advance of each subsequent plan year 24

25 Safe Harbor Default Investment Alternative Material provided to the plan relating to investment in the default fund is provided to the participant Participant may transfer to another investment alternative at least once in any three month period A broad range of investment alternatives is provided in the plan The default investment alternative satisfies the requirements of a QDIA 25

26 Safe Harbor Default Investment Alternative The QDIA must satisfy five conditions: Offer one of three types of investment products: Life-cycle or targeted retirement date fund: A balanced fund A managed account Diversified so as to minimize the risk of large losses 26

27 Safe Harbor Default Investment Alternative Managed by an investment manager or a registered investment advisor A participant may transfer to another investment alternative Generally, a QDIA cannot hold or acquire employer securities 27

28 Safe Harbor Default Investment Alternative The required notice must be written in plain language and contain the following information: Circumstances under which assets may be invested in a QDIA 28

29 Safe Harbor Default Investment Alternative A description of the QDIA, its investment objective, risk and return characteristics, and fees and expenses The right to transfer investment to another alternative under the plan Where the participant can obtain information concerning the investment alternatives available under the plan 29

30 Safe Harbor Default Investment Alternative In selecting a QDIA, the plan fiduciary must carefully consider investment fees and expenses The fiduciary remains subject to the duty to prudently select and monitor the QDIA The big news here is that money market funds and GICs do not qualify 30

31 Safe Harbor Default Investment Alternative Issues Presented Will DOL s pro-life-cycle/balanced fund position hold up? What should sponsors do that have defaulted to capital preservation-only funds? Might DOL approve a one-time transfer out of a money market fund or GIC and into a QDIA? 31

32 Safe Harbor Default Investment Alternative Issues Presented How will the advance notice requirement work for plans What should plans that use asset allocation models, where the underlying funds in the plan are used to populate the models, do? 32

33 Investment Advice 33

34 Investment Advice New prohibited transaction exemption permitting an advisor (acting as a fiduciary) to provide participant-level advice to participants for an additional fee Even if advisor is affiliated with the investments under the plan Advisor is broadly defined for these purposes (banks, insurance companies, registered brokerdealers, their affiliates, etc.) 34

35 Investment Advice Must be provided pursuant to an eligible investment advice arrangement ( EIAA ) Plan sponsors who make an EIAA available receive some relief from liability for offering the arrangement The exemption does not extend to planlevel advice Do notapply these rules to IRAs 35

36 Investment Advice Prior Law Providing investment advice for a fee is a fiduciary act subject to ERISA ERISA s self-dealing prohibited transaction provisions generally prohibit an advisor from providing investment advice for a fee if the advisor (or an affiliate) receives additional fees DOL issued limited regulatory relief indicating: Fee-offset arrangements that eliminated financial incentives would not violate ERISA An advisor could provide advice through an independently developed computer model that providing investment recommendations 36

37 Investment Advice Prior Law Even if the investment advice fit within one of these exceptions, a fiduciary still had responsibility for prudent selection and monitoring of advisors Technical explanation of PPA indicates new investment advice provisions are not intended to replace this existing guidance 37

38 EIAA Under PPA Like prior law, there are two EIAA s Fee neutral arrangement Computer model arrangement To be a fee-neutral EIAA the advisor s fee cannot be affected by the actual investment allocation Similar to existing fee-offset arrangements Also, will include per capita arrangement. For example, $50 per participant. 38

39 Eligible Investment Advice Arrangements A computer model EIAA must: Apply generally accepted investment theories Use relevant information about the participant or beneficiary Use prescribed objective criteria to provide asset allocation of investment options offered under the plan Not be biased in favor of investments offered by the advisor Take into account all investment options under the plan 39

40 Eligible Investment Advice Arrangements An eligible investment expert (i.e., an EIE ) must certify that the computer model meets the five requirements If the computer model approach is chosen, the only advice permitted is the advice generated by the computer model (i.e., no supplemental comments) Transactions must occur solely at the direction of the participant or beneficiary The participant or beneficiary may seek investment advice in addition to the computer model, but only if the advice was not solicited The computer model approach does not apply to IRAs 40

41 Eligible Investment Advice Arrangements In addition to the specific requirements for the computer model and fee-neutral exemptions, there are requirements that apply to both exemptions: The exemption must be authorized by an independent plan fiduciary An independent expert must audit the arrangement at least annually and confirm it fits within one of the exemptions i.e., an Eligible Investment Expert Independent Opinion or an EIEIO Disclosure requirements must be satisfied before the advice is first provided and at least annually thereafter Any applicable securities disclosure laws must be met Compensation received by advisor must be reasonable 41

42 Eligible Investment Advice Arrangements A plan sponsor that makes an EIAA available under a plan will not fail to satisfy ERISA s fiduciary requirements by offering such an arrangement The plan sponsor is still responsible for the prudent selection and monitoring of the advisor, but no duty to monitor the specific investment advice given Applies to advice provided after December 31,

43 Investment Advisors 43

44 The PPA s Effect on Advisors The PPA introduces a new industry term, fiduciary advisor PPA will have the greatest effect on brokerdealers that have taken the hard-line stance that a broker is never a fiduciary If the broker-dealer is going to permit its brokers to advise plan participants, the broker-dealer now will have to formally define a fiduciary standard of care 44

45 The PPA s Effect on Advisors New safe-harbor procedure for plan sponsors, in addition to 404(c): use of a qualified fiduciary advisor Investment advisors should ask plan sponsors if they are seeking insulation from liability under the safe harbors defined by 404(c), by the use of a qualified fiduciary advisor, or both 45

46 The PPA s Effect on Advisors The fiduciary advisor safe harbor requires the plan sponsor to demonstrate that: The fiduciary advisor was prudently selected The advisor acknowledged fiduciary status in writing, disclosed all conflicts of interest and disclosed all forms of compensation The fees paid to the fiduciary advisor are fair and reasonable The advisor is prudently monitored on a continuing basis 46

47 The PPA s Effect on Advisors Will have a profound effect on the investment advisory industry PPA, intentionally or not, defines a minimum fiduciary standard of care for advisors: Fiduciary status has to be acknowledged in writing All conflicts of interest must be disclosed in writing All forms of compensation must be disclosed in writing The services of the investment advisor are independently audited/assessed on an annual basis 47

48 Fiduciary Safe Harbors 48

49 Fiduciary Safe Harbors PPA also establishes new fiduciary safe harbors for mapping and blackout scenarios Under prior law, even if a plan sponsor or fiduciary satisfied ERISA s 404(c) participantdirected investment requirements, the plan sponsor or fiduciary did not have fiduciary protection during mapping and blackout 49

50 Fiduciary Safe Harbors Mapping safe-harbor plan sponsors/fiduciaries will continue to have 404(c) protection if: Between 30 and 60 days before the change: Participants are notified of the impending change Given information about the existing and new investment options and Are given a description of the investment mapping process 50

51 Fiduciary Safe Harbors No contrary investment instructions from the participant A participant s account is reallocated among remaining or new investment options that have reasonably similar investment characteristics (not clear what to do if there are no reasonably similar investment options) Blackout safe-harbor provides that a fiduciary will not have any liability for losses during a blackout as long as the blackout notice requirements have been satisfied Effective for plan years beginning after 2007 and subject to DOL regulations that are to be issued 51

52 Employer Stock Diversification 52

53 Employer Stock Diversification and Notice Plans must permit employees to diversify out of publicly-traded employer securities Not applicable to stand-alone ESOPs What is Publicly-Traded A Participant may direct plan to diversify out of employer securities in which a portion of employee contributions and elective deferrals are invested 53

54 Employer Stock Diversification and Notice A participant with at least 3 years of service may diversify out of employer securities in which employer contributions are invested Must provide at least 3 alternative investment options other than employer securities Each option must be diversified Each option must have different risk and return characteristics 54

55 Employer Stock Diversification and Notice Effective for plan years beginning after December 31, year phase-in transition period for diversifying employer contributions invested in employer securities prior to January 1, % in first plan year; 66% in the second plan year; and 100% in the third and following plan years 55

56 Employer Stock Diversification and Notice Must provide notice to employees At least 30 days before employee has right to diversify Explain right to diversify out of employer securities and describe importance of diversifying account assets in investments IRS will issue a model notice Penalty of up to $100 a day from date of noncompliance for each individual or beneficiary who did not receive notice Effective for plan years beginning after December 31, 2006 (i.e., issue notices now) 56

57 Other Notable PPA Provisions 57

58 EGTRRA Permanence Scheduled sunset: December 31, 2010 Increased contribution limits Compensation limits Deferral limits Benefit/Contribution limits Age 50 catch-up contributions Roth 401(k) contributions 58

59 EGTRRA Permanence Hardship distributions Elimination of 401(k) same desk rule Expanded rollover rules Automatic rollovers for mandatory cashouts Enhanced ESOP dividend deduction 59

60 Excess Contributions No 10% excise tax on corrective distributions if made within applicable correction period 2-1/2 months after close of the plan year 6 months after close of the plan year, in the case of an automatic enrollment arrangement (new) Corrective distributions paid within correction period are treated as received and taxable in the year of distribution (new) Corrective distributions do not have to include gap period income if distributed within applicable correction period (new) Effective for plan years beginning after December 31,

61 Vesting in DC Plans Defined contribution plans (other than leveraged ESOPs) must vest all employer contributions under schedule for matching contributions Cliff vesting: employer contributions must vest after 3 years of service; or Graded vesting: employer contributions must vest at 20% per year, beginning with the second year of service (2-6 year schedule) 61

62 Vesting in DC Plans Effective for contributions for employees with at least 1 hour of service in years after December 31, QUERY: apply to all years to avoid two schedules? Before PPA After PPA Matching Up to: 3 year cliff; or 2-6 year graded Up to: 3 year cliff; or 2-6 year graded Non-Elective Up to: 5 year cliff; or 3-7 year graded Up to: 3 year cliff; or 2-6 year graded 62

63 Periodic DC Benefit Statements DC Plans must furnish periodic benefit statements At least once each calendar quarter to participants who have a right to direct investment of assets in their accounts At least once each calendar year to those with accounts but no right to direct Upon written request to plan beneficiaries not described above (limit: 1 per 12 mos.) 63

64 Periodic DC Benefit Statements Benefit statement must include the following information, based on the latest information available: Total benefits accrued and nonforfeitable benefits, if any, that have accrued or the earliest date on which the benefits will become nonforfeitable Explanation of any permitted disparity or any flooroffset arrangement that may be applied in determining any accrued benefits Value of each investment to which account assets have been allocated, determined as of most recent valuation date 64

65 Periodic DC Benefit Statements Additional information for quarterly statements to participants with right to direct investment of account assets Explanation of limitations or restrictions on right to direct investments Explanation regarding importance of a well-balanced and diversified investment portfolio Statement of risk with respect to holding more than 20% of a portfolio in securities of one entity DOL is required to issue one or more model benefit statements Effective for plan years beginning after December 31,

66 Rollovers by Non-Spouse Beneficiaries A non-spouse beneficiary may roll over distributions from a taxfavored retirement plan into an IRA via a direct rollover (from the plan trustee to the IRA trustee or custodian) Transfer treated as eligible rollover distribution i.e., tax-free Transferee IRA treated as an inherited account Non-spouse beneficiary is not owner of rolled over assets Mary Smith, Deceased, IRA F/B/O John Smith ; NOT John Smith IRA No further rollover of assets Subject to required minimum distribution rules; special rules for surviving spouse beneficiaries do not apply Keep IRA separate from other IRAs of beneficiary Change of vendors requires direct trustee to trustee transfer Effective for distributions after December 31,

67 Rollovers by Non-Spouse Beneficiaries Potential issues: Are plans required to allow this? No (Notice ) Does mandatory 20% withholding apply? No (treated as direct rollover) Is a 402(f) special tax notice required? No (Notice ) Does this apply to Roth 401(k) amounts transferred to an inherited Roth IRA? No 67

68 Direct Rollover to Roth IRA Tax-favored retirement plan distributions can be rolled over directly to a Roth IRA Amount rolled over is includible in gross income 10% tax on early distributions not applicable Before January 1, 2010, the AGI limit and filing status requirement apply (i.e., married taxpayers filing separate returns and taxpayers with AGI over $100,000 cannot roll over amounts to Roth IRAs) On and after January 1, 2010, no AGI limit or filing status requirement Effective for distributions after December 31,

69 Rollovers of After-Tax Contributions After-tax contributions can be rolled over not only to a defined contribution plan or an IRA, but also to a defined benefit plan or a 403(b) tax-sheltered annuity (if allowed by transferee plan) Must be accomplished by a direct trustee-to-trustee transfer Transferee plan must separately account for aftertax contributions and earnings thereon Effective for distributions after December 31,

70 IRA Charitable Rollovers Annual exclusion from gross income up to $100,000 for qualified charitable distributions from an IRA Through December 31, 2007 only Satisfies MRD requirements If fails to qualify, treated as a distribution to participant and a regular charitable contribution Subject to usual limitations 70

71 IRA Charitable Rollovers Six requirements 1. Distribution must be from an IRA Not a SEP or SIMPLE, a 403(b) plan or a qualified plan But IRA holding former plan funds is OK 2. Recipient organization must be a public charity (a church, hospital, museum, or educational organization) Donor advised funds do not count Split interest trusts (e.g., charitable remainder and lead trusts) do not count 71

72 IRA Charitable Rollovers 3. Distribution must occur on or after IRA account owner is age 70½ Within year of age 70½ not sufficient 4. Distribution must be direct from the IRA account to the charity 5. Distribution otherwise must be fully deductible Any non-disregarded quid pro quo will disqualify the entire distribution No charitable gift annuities Must obtain contemporaneous written acknowledgment that no goods or services were provided 72

73 IRA Charitable Rollovers 6. Distribution otherwise must have been includable in account owner s gross income That is, only the taxable portion of any IRA distribution can qualify Note that the distribution is deemed to come first from the taxable portion of the IRA account 73

74 Other Provisions of the PPA IRS is required to expand definition of hardship to include hardship of a beneficiary who is not a spouse or dependent. Effective August 17, 2006; Notice Hardship distributions allowed for funeral expenses and casualty losses (final 401(k) regs) Missing Participants: Terminating individual account and profit sharing plans may transfer unclaimed benefits to the PBGC under ERISA Section 4050, Effective for distributions made after final regulations 74

75 Other Provisions of the PPA Electronic Display of Annual Report Information: Requires part of Form 5500 to be filed in format that allows display on the Internet The DOL to establish web site to display 5500 information 90 days after filing 5500 also must be displayed on sponsor s Intranet site(s) maintained to communicate with employees (not the public), if such site(s) exists Effective for plan years beginning after December 31,

76 Other Provisions of the PPA After 2007, new interest rate and mortality table for converting annuity to lump sum or vice versa Notice and consent period for distributions extended from 90 to 180 days (Notice ) Extending to 180 days is permissive Required: explain right to defer payment and consequences of not deferring MUST CHANGE BENEFIT NOTICES Effective for years after December 31,

77 Other Provisions of the PPA DOL is required to clarify status of certain domestic relations orders Interim final regs issued by DOL April 6, 2007 Domestic relations order that otherwise qualifies as a QDRO will not fail to be a QDRO solely because of the time it is issued (e.g., after death of participant or after divorce) or because it is issued after or revises another QDRO but no take-away 77

78 Other Provisions of the PPA Optional spouse annuity option, if applicable (NA to most DC plans) Old law: 50% to 100% (unchanged) New PPA requirement: If plan option =/> 75%: add 50% option If plan option < 75%: add 75% option Effective: years after December 31, 2007 Deduction limit for combined DC and DB plans liberalized Complex rules May need technical correction 78

79 Other Provisions of the PPA Support and expansion of IRS correction program (EPCRS) PPA amendments, required and optional, must/may be made by end of 2009 plan year: Must operate as if adopted Example: vesting change For 2007 and later, federal tax refunds may be paid directly to an IRA 79

80 PPA Requirements... Vesting requirements (61 62) Benefit statements (63-65) (recordkeeper) Benefit notices (76) (recordkeeper) 5500 in electronic format (75) (5500 provider) New spouse annuity option if applicable (78) 80

81 PPA Options... Automatic enrollment or safe harbor or ACA combination? (3-17) Hardship to non-spouse non-dependent beneficiary? (74); [hardships for funeral costs and/or casualty losses? (74)] Expand benefit notice and consent period from 90 to 180 days? (76) 81

82 PPA Options... Rollover by non-spouse beneficiaries? (66-67) Rollover to Roth IRAs? (68); [add Roth 401(k) accounts to plan?] Other rollovers: (69-73) After-tax? Charitable? (IRA not plan; 2007 only) 82

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86 The PPA and Defined Benefit Plans 2007 Warner Norcross & Judd LLP

87 History of the PPA 87

88 The Pension Plan Phase Out Act? In 2003, PBGC projections were showing that the economic perfect storm could result in a major deficit at the PBGC, a deficit in the range of the S & L bailout Proposed changes to pension law were prepared by both the DOL and the PBGC After review, the Administration released its funding proposal in January

89 Change in Perspective Present Law Long term focus on funding DB plans Limited disclosure PBGC crisis Limited benefit restrictions New Law Short term focus on funding Expanded disclosure PBGC solvency Additional benefit restrictions 89

90 New Minimum Funding Rules of Pension Protection Act of 2006 Dramatic changes in minimum required funding for single employer DB plans Changes to benefit obligations and plan assets values New Funding Target Attainment Percentage (FTAP) Special rules for At-Risk plans Effective date: 2008 with phase-in rules 90

91 Funding Requirements Effective 2008, annual contributions must equal the sum of Target Normal Cost plus amortized portion of the Funding Shortfall Target normal cost = present value of all benefits expected to accrue during the plan year Funding shortfall = present value of accrued benefits as of the beginning of the plan year less the value of plan assets Amortized over seven years Also effective 2008, must utilize a specified interest rate, designated IRS mortality table and with restricted asset smoothing (over two years, formerly five) 91

92 Funding Requirements Effective 2008, quarterly contributions are required if plan has a Funding Shortfall in an amount equal to 25% of the prior year minimum or quarterly amortization of 90% of the current year minimum Effective 2008, minimum funding waivers above $1 million will require: Posting of security Consultation with the PBGC Amortization using the specified minimum contribution interest rate If plan fails to make contributions, there will be a lien if attainment percentage is less than 100%, plan is PBGC covered and the unpaid balance of all payments exceeds $1 million 92

93 Deduction Limit Maximum = Funding Target (all benefits earned as of beginning of plan year) + Target Normal Cost + Cushion Plan Assets Cushion is 50% of plan s Funding Target plus increase due to future compensation increases Combined Limit (Defined Contribution and Defined Benefit Plans) For 2006, counts only contributions to defined contribution plans exceeding 6% of pay Beginning in 2008, does not apply to single employer plans covered by Title IV s PBGC provisions 93

94 At-Risk Plans - Overview The Act introduces new definition of At-Risk plan If a plan is At-Risk : Funding Target is increased due to application of additional actuarial assumptions Funding based restrictions may apply 94

95 At Risk Plan Restrictions Beginning 2011, plan is at risk if Funding Target Attainment Percentage is less than 80% (without at-risk assumptions) and if less than 70% (using at-risk assumptions) The 80% threshold is phased in: 65% for % for % for

96 New Funding Targets and New FTAP Present Law Must attain 90% of CL to avoid additional funding charges Must attain 80% of CL to avoid required additional funding charges and alternative participant notification Must attain 60% of CL to avoid restriction on plan amendment increases New Law Must attain 100% of liabilities to avoid additional funding charges Computation of a new FTAP ratio to avoid limitations on benefit increases, benefit payments, benefit accruals and shutdown benefits Must attain 80% funded ratio to avoid restriction on plan amendment increases Must attain between 60% to 80% funded ratio to make lump sum payments, but security required Must attain 60% funded ratio to make any accelerated or lump sum payments; to continue benefit accruals; to make shutdown benefits 96

97 Small Plan Exception At-Risk rules do not apply to plans with 500 or fewer participants on each day of preceding plan year (plan is deemed not At- Risk ) Must include participants in all DB plans in controlled group 97

98 At Risk Plan Restrictions At-risk assumptions require immediate retirement assumptions for those within 10 years of retirement at highest present value benefit And if a plan is at risk in two of four years, special loading factors require $700 per participant plus 4% of the plan s funding Target If less than 80% funded, beginning in 2007: A plan may not be amended to increase benefits Lump sums are restricted to the lesser of PBGC guaranteed benefit or 50% of otherwise allowable payment PBGC Section 4010 reporting 98

99 At Risk Plan Restrictions If less than 60% funded: Shutdown benefits are prohibited Lump sums and accelerated benefits are prohibited Benefit accruals must be frozen 99

100 Effectiveness in Forcing Better Funding at Plan Termination Previous law might reasonably be described as setting a 90% target level for funding. Clearly the new law raises this bar to 100% When a plan is moving into underfunded status, credit balances are allowed to be used to avoid benefit limitations But, extremely underfunded plans can no longer use credit balances to obtain contribution holidays Several year s of benefit accrual may be removed from a failing sponsor s plan due to required freezes Underfunded sponsors are no longer able to avoid PBGC variable premiums 100

101 Effectiveness of the PPA Will the PPA reduce future claims against the PBGC? Will the PPA force plan sponsors to better fund plans? Will the PPA provide an orderly phase out of the defined benefit pension system? 101

102 Distribution Rules For plan years beginning after 2007, lump sums must be valued using the three segmented yield curve (using spot rates rather than the 24 months average phased in over five years) and the IRS mortality table The maximum lump sum for IRC 415 purposes is valued at an interest rate not less than the greatest of: 5.5% 105% of the minimum lump sum rate Or the plan specified rate Effective in 2007, in-service payment can be made beginning at age 62 Beginning in 2008, must offer a 75% benefit form during the joint lives of the participant and spouse 102

103 Administration Once every three years, must automatically provide a benefit statement to participants Or an annual notice on how to request and obtain a statement Which need not be made available more than once per year Beginning in 2008, Summary Annual Reports are replaced by a notice disclosing: Plan assets v. plan liabilities (currently and for two prior years) Funding status Funding policy Allocation of investments Termination rules PBGC guaranteed benefits 103

104 Administration PBGC premiums increase The flat rate is $30 per participant, adjusted for inflation, beginning in 2007 The variable rate is $9 per $1,000 of unfunded vested benefits, valued using three segment corporate bond yield curve, beginning in 2008 For 2006 and 2007, plans may continue using 85% of the long term corporate bond rate Bankruptcy triggers a $1,250 per participant charge for distress and PBGC initiated terminations for three years following termination or immediately following employer s discharge from bankruptcy 104

105 Terminations PBGC Guarantees For five year phase-in purposes, date of termination is date of filing of bankruptcy For contingent event benefits, five year phase in runs from date of the event, not the amendment adding the benefit 105

106 Cash Balance Plans Effective June 29, 2005, a plan will not violate age discrimination requirements if the accrued benefit is equal to: The hypothetical account balance Or the accumulated percentages of final average compensation Beginning 2008 (2010 for collectively bargained plans), the interest crediting rate cannot exceed the Treasury specified market rate of return Wear-away (greater of pre-conversion benefit or cash balance formula) is prohibited Minimum benefit must be pre-conversion benefit under old formula plus post-conversion benefit Lump sum present value must equal the hypothetical account balance or the accumulated percentage of final average compensation Three year cliff vesting or faster is required for years beginning in 2008 (2010) 106

107 v4 4/30/07 107