PENSION PROTECTION ACT OF 2006-An Overview of Selected Provisions Peter J. Marathas, Jr. Yolanda D. Montgomery Nicole Eichberger Proskauer Rose LLP 0
Reasons For Pension Reform Many factors are responsible for Congressional attention on retirement security, including the collision of the following: Declining stock market values Low interest rates Collapses of corporate giants (e.g., WorldCom and Enron) Decline in use of DB plans EGTRRA is now permanent 1
Pension Protection Act of 2006 Signed into law on August 17, 2006 Comprehensive pension reform designed to simplify, strengthen, and encourage participation in retirement plan savings Transforms the funding for DB plans, makes EGTRRA changes permanent, strengthens diversification rights and investment education provisions, and encourages automatic enrollment in 401(k) plans 2
PPA Defined Benefit Plans Key Changes: Under Act, most DB plans will be subject to a single set of funding rules starting in 2008 replaces two-tiered tiered system currently in place Beginning with the 2008 plan year, an employer maintaining a single-employer defined benefit plan that is not 100% funded would not be required to make a deficit reduction contribution, but would be required to make a minimum contribution that is based on the plan's assets (reduced by credit balances), funding target, and target normal cost and that is sufficient to amortize unfunded plan liabilities over a period of seven years Unlike current law, which requires employers to fund up to 90% of a plan's total liabilities, the Act increases funding target to 100% percent of target or current liabilities 3
PPA Defined Benefit Plans Interest rate assumptions: The Act radically changes the actuarial assumptions and methods used to determine present value, authorizing a new interest rate and a new mortality table Act retains the blended rate of corporate bonds, and introduces a segmented "yield curve" that consists of three different interest rates (based on the un-weighted average of interest rates on investment grade corporate bonds) applicable to benefits payable in different time periods 4
PPA Defined Benefit Plans At-risk Plans: Under-funded plans deemed at-risk under the Act must accelerate their funding beyond the increased amounts under the new rules Plans with fewer than 501 participants are not subject to the at-risk rules In general, a plan is at-risk if: the funding target attainment percentage (i.e., ratio of plan assets (reduced by credit balances) to the funding target for the preceding plan year, determined without regard to at-risk liability) is less than 80%, and the funding target attainment percentage for the preceding plan year, determined by applying the specified at-risk actuarial assumptions, is less than 70 percent 80% is phased in: 65% in 2008, 70% in 2009, 75% in 2010 and 80% in 2011 5
PPA Defined Benefit Plans At-risk plan must assume that employees who would be eligible to elect benefits during the current plan year and the next ten plan years would elect the most valuable form of benefit under the plan In addition, plans that were considered to be at-risk in the current plan year plus two out of the last four years must include an additional load charge of 4% of the plan s funding target plus $700 per plan participant The additional amounts required to be contributed to at-risk plans will be phased in over five years, increasing by 20% per year 6
PPA Defined Benefit Plans Currently, a defined benefit plan or money purchase pension plan is not permitted to provide for in-service distributions before normal retirement age to participants who have not separated from employment The Act amends ERISA and the Code to allow inservice distributions upon attainment of age 62 Deduction limits: For 2007, the Act increases the maximum deductible contribution to single-employer employer DB plans to 150% of current plan liabilities 7
PPA Defined Benefit Plans After 2007, the Act increases the deductible limit to an amount equal to the year's normal cost (generally, the cost of benefits accrued in the year) plus the amount necessary to fully fund the plan's funding target In addition, employers can contribute and deduct a cushion equal to 50% of the funding target plus additional amounts reflecting projections of participants' compensation and statutory compensation limits 8
PPA Introduction of New Type of Plan - the DB/K Plan Under current law, a 401(k) arrangement may not be combined with a defined benefit plan in a single plan The Act allows a small employer ( 500 employees) to establish a combined defined benefit 401(k) plan The plan will be governed by one document with specific accounting of the assets for the defined benefit and defined contribution portions of the trust The defined benefit component must satisfy minimum accrual requirements. If the defined benefit component is a cash balance plan, the accrual must be in the form of minimum pay credits that increase at a specified minimum rate with advancing age The 401(k) component must have automatic enrollment and must meet minimum matching contribution requirements DB/K will be available for plan years beginning after 2009 9
PPA Revised Notice and Disclosure Rules New annual pension funding notice to participants and unions starting in 2008 Emphasis on funded status and multi-year info Replaces notice for plans that owe variable rate premiums 120 days after end of plan year, except for small plans Additional information required on 5500 after 2007 Summary annual report eliminated for pension plans that owe new funding notice 10
PPA Revised Notice and Disclosure Rules Revised criteria specified for PBGC 4010 filings Generally, prior year funding <80%, after subtracting credit balances Must notify participants if subject to filing Benefit statements required Every quarter for DC plans with self-direction on investments, Annually for other DC plans, or Every 3 years for DB plans, with annual availability option DC plans also must provide diversification explanations 11
PPA Defined Contribution Plans Automatic Contribution Arrangements 401(k) plans may provide that elective contributions will be made unless participant elects otherwise (a/k/a automatic enrollment or negative election ) Plan sponsors have been reluctant to adopt the design due to fiduciary liability concerns and state wage laws Act contains several provisions to encourage adoption of such arrangements 12
PPA Defined Contribution Plans Safe harbor for qualified automatic contribution arrangements ( QACA ) deemed to satisfy the ADP/ACP nondiscrimination testing rules 90-day withdrawal right for eligible automatic contribution arrangements ( EACA ) Preemption of conflicting state laws Increased fiduciary liability protection QACA-Withdrawal and Vesting Restrictions To satisfy matching/non-elective contribution requirement: 100% vesting after 2 years of service and 401(k) restrictions on distributions must apply to all employer contributions-employment termination, death, disability, termination of plan, age 59 ½, hardship 13
PPA Defined Contribution Plans EACA & QACA: Notice Requirements Within a reasonable period before each plan (90-30 Rule) year, written notice must be sent to eligible employees informing them of their rights and obligations under plan, and notice must include explanation of: Employee s right to elect not to contribute or to contribute a different amount Default investments in absence of election 14
PPA Defined Contribution Plans Preemption of State Wage Laws Several states have taken the position that their wage laws prohibit automatic contributions to retirement plans Act explicitly provides that these state wage laws are preempted by ERISA if the automatic contribution arrangement meets certain requirements: Contributions invested in accordance with 404(c) regulations Notice requirements are satisfied 15
PPA Defined Contribution Plans ERISA 404(c) Fiduciary Liability Protection Under ERISA s fiduciary liability rules, a fiduciary (e.g., plan administrator) has potential liability for the investments chosen for a participant An important exemption under ERISA 404(c) protects fiduciaries from liability when a participant exercises control over his or her plan assets Before the Act, there were no safe harbor default investments to relieve a fiduciary of liability for automatic plan contributions 16
PPA Defined Contribution Plans ERISA 404(c) Fiduciary Liability Protection Act expands 404(c) fiduciary protection with respect to participants who fail to make an affirmative investment election NOTE: While the failure to make investment elections is prevalent with automatic contribution arrangements, the extended protection applies more broadly Expanded protection effective for plans years beginning after December 31, 2006 17
PPA Defined Contribution Plans ERISA 404(c) Fiduciary Liability Protection Even in absence of an affirmative investment election, participant will be treated as exercising control over his or her assets to the extent the assets are invested in accordance with specific DOL regulations 18
PPA Defined Contribution Plans ERISA 404(c) Fiduciary Liability Protection Regulations require the following 6 conditions: Assets invested in a qualified default investment alternative Participant must have opportunity to direct investment of assets, but did not do so Participant was furnished with appropriate notice 30/30/30 Rule Plan must provide requisite investment material to participant Opportunity to direct investments with same frequency as other plan investments (but no less than quarterly) Plan must offer broad range of investment alternatives 19
PPA Defined Contribution Plans Qualified Default Investment Alternative No investment in employer securities No penalties/restrictions for transferring investment Qualified investment manager/investment company but can now include trustee or named fiduciary Diversified investment to minimize risk of large losses (e.g., life-cycle, targeted-retirement retirement date fund, balanced fund or managed fund) 20
PPA Defined Contribution Plans Notice Content Must Include: Separate Notice Easily Understood Circumstances in which assets will be invested in QDIA If applicable, deferral % and right to opt out Notice of right to self-direct investments Description of default investments, including objectives, risk and return characteristics, and fees and expenses Explanation of where participant may obtain additional information 21
PPA Defined Contribution Plans Investment Advice The Act creates a statutory exemption from ERISA s prohibited transaction rules for investment advice provided to participants New rules are effective after December 31, 2006 The exemption allows a fiduciary advisor to advise participants about their investments, including allocation and use of funds, and the fiduciary advisor may be paid either by plan sponsor or from plan assets New exemption for providing investment advice applies only to a transaction that is both: an eligible exempt transaction, and an eligible investment advice arrangement 22
PPA Defined Contribution Plans An eligible exempt transaction is: Provision of investment advice with respect to a plan investment option Acquisition, holding or sale of security available under plan pursuant to the investment advice Direct or indirect receipt of fees by fiduciary advisor (e.g., brokerage firm, mutual fund company, insurance company, bank, stock broker, etc.) in connection with the provision of advice or acquisition, holding or sale of security pursuant to the advice 23
PPA Defined Contribution Plans An eligible investment advice arrangement is an arrangement under which: Fiduciary advisor s compensation does not vary based on the investment options selected by the participant OR Fiduciary advisor may use a computer investment model, certified by an independent expert, that takes into account the participant s individual characteristics to generate advice on the allocation of the investment options under the plan that is not biased in favor of any product of the fiduciary advisor 24
PPA Defined Contribution Plans Other Exemption Requirements Express authorization by a separate fiduciary Annual audits of the investment advice arrangement Disclosure requirements for the fiduciary advisor Standards for presenting information Maintenance of records for 6-year period 25
PPA Defined Contribution Plans Diversification The Act requires that DC plans must permit participants to diversify investments in publicly-traded employer securities Requirement applies immediately with respect to salary deferrals and after-tax employee contributions, and applies to participants with 3 years of service for all other amounts (e.g., profit sharing and matching contributions) Phase-in provisions o s for employer securities es acquired before 2007 Exceptions for certain one-participant plans and ESOPs Effective for plan years beginning after December 31, 2006 26
PPA Amendment Period The Act provides that a plan can be retroactively amended as long as the plan amendment is adopted before the last day of the first plan year beginning on or after January 1, 2009 NOTE: This remedial amendment period is not available unless the plan is operated as if the amendment were in effect for, and the amendment applies retroactively to, the period beginning on the date the applicable legislative or regulatory changes take effect 27