summary of key provisions

Pension Protection Act of 2006 PENSION RESOURCE CENTER summary of key provisions

CONTENTS EGTRRA Provisions Permanent 2 Automatic Enrollment 3 Investment Advice 4 Increased Portability for Qualified Plans and IRAs 4 Faster Vesting 5 Defined Benefit Plans Funding Requirements 5 Phased Retirement Defined Benefit Plans 5 New Plan Design DB(k) 6 Combined Defined Benefit and Defined Contribution Employer Deduction Limit 6 Expansion of Hardship Withdrawals 6 Diversification Out of Employer Stock 7 Penalty-Free Distributions to Active Duty Reservists 7 Participant Benefit Statements 7 Form 5500-EZ 7 Simplified Form 5500 8 Fiduciary Bond Increase 8 Blackout Notices 8 ERISA 404(c) Limited Protection on Investment Mapping 8 Direct Deposit of a Tax Refund Into an IRA 8 ERISA 404(c) Default Investment Protection 9 75% Joint and Survivor Annuity Option 9 IRA Contributions for Charitable Purposes 9 Tax Free Pension Distributions to Pay Premiums for Health and Long Term Care Insurance 9 Amendments 9

The Pension Protection Act of 2006 ( Act ) summary OF KEY PROVISIONS On August 17, 2006, the Pension Protection Act of 2006 ( Act ) was enacted. The legislation includes a variety of provisions to protect savers and boost retirement savings in IRAs and in defined contribution plans, such as IRC Sec. 401(k) plans, profit sharing plans, 403(b) plans, and governmental 457(b) plans. In all cases, the Act will make it easier for you to use various strategies that will help build retirement assets for you and your heirs. EGTRRA PERMANENCE The Act makes permanent the retirement savings provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). EGTRRA made a number of changes affecting retirement plans and individual retirement accounts. These provisions were scheduled to expire 2010, with the exception of the Saver s Credit, which was due to expire after 2006. The Act removes these expiration dates, making virtually all retirement plan-related EGTRRA changes permanent. The major EGTRRA retirement provisions that 1 would be made permanent rather than sunset at the end of 2010 include:

EGTRRA PERMANENCE EGTRRA PROVISIONS PERMANENT Plan years beginning 2006 Makes permanent the increases in elective deferrals for 401(k), 403(b) and governmental 457(b) plans (inflation-adjusted). Makes permanent the increases in elective deferrals limits for SIMPLE 401(k) and SIMPLE IRAs (inflation-adjusted). Makes permanent the annual benefit limit under a defined benefit plan (inflation-adjusted). Makes permanent the catch-up contributions for individuals age 50 and older (inflation-adjusted). Makes permanent the increases in Traditional and Roth IRA contribution limits (inflation-adjusted). Higher deductible amounts for employer contributions to employee retirement plans (inflation-adjusted). Makes permanent the tax credit for pension plan start-up costs of small employers (maximum $500 per year for the first three years). Percentage limit on total contributions for an individual participant under a defined contribution plan will remain at 100 percent of compensation. Deduction limit for contributions to a defined contribution plan continues at 25 percent of aggregate compensation (up to the compensation limit). Makes permanent the rollovers between different types of retirement plans. Employee elective deferrals will continue to be deductible in full, without regard to deduction limitations. Limitation on contributions to a 457(b) plans continues to be computed separately from the limitation on deferrals under a 401(k) or 403(b) plan. As a result, employees of these entities may make twice the elective deferrals as other individuals. Makes permanent the extension of Roth 401(k) and 403(b) plans. Makes permanent the Saver s Credit. This tax credit was set to expire after the 2006 tax year. Beginning in 2007, the adjusted gross limits are indexed for inflation (rounded to the nearest $500) and provides that a worker may direct IRS to directly deposit any tax refund attributable to the saver s credit into a retirement plan. Makes permanent the increases in compensation that may be considered in calculating contribution/ benefit limits. Extends rules requiring automatic rollover of mandatory cash-out distributions between $1,000 and $5,000. 2 Makes permanent education IRAs. Repeal of the same desk rule. Repeal of the multiple-use test. Plan loans to owner-employees (sole proprietorships, partner or S corporation) allowed.

AUTOMATIC ENROLLMENT Plan Years Beginning After December 31, 2007 The new law makes it easier for employers to automatically enroll their employees into the company s 401(k) plan. In such an arrangement, employees must affirmatively opt-out in order not to participate. Employers make default contribution decisions. Under the safe harbors, 401(k) plans must provide employees with an opportunity to change or elect out of the automatic deferrals and must comply with safe harbor notice requirements. Employers can implement automatic enrollment without applying it to existing employees who have either elected to participate in the plan or elected not to participate in the plan. ADP and ACP nondiscrimination testing and top-heavy rules can be avoided with the adoptions of new safe harbor automatic enrollment designs. Adoption of auto-enrollment is encouraged through the creation of a new Safe-Harbor 401(k) design alternative for 401(k) plans which employ auto-enrollment provisions and incorporate certain minimum default deferral rate requirements and minimum matching contribution requirements. The automatic enrollment safe harbors require the following minimum contributions: 3% of compensation for the 1st plan year; 4% of compensation for the 2nd plan year; 5% of compensation for the 3rd plan year; and 6% of compensation for any plan year thereafter. Alternatively, the deferral could start out at a higher rate as long as it reaches the 6% minimum rate on schedule and does not exceed 10%. The employer must match 100% of the first 1% of pay contributed by the employee, plus 50% of the next 5% of pay (i.e., 3.5% would be the maximum required match). Deferrals in excess of 6% may not be matched. Alternatively, the employer could make a 3% of pay non-elective contribution for all eligible employees. The participants must be 100% vested in employer matching or non-elective contributions after completing 2 years of service. As under current law, they are also subject to withdrawal restrictions applicable to elective deferrals. They cannot be withdrawn for hardships. It allows employers to designate default investment options for automatic contributions without worrying about potential fiduciary liability, provided the default options comply with future Department of Labor regulations. A 401(k), 403(b) and a governmental 457(b) plan with automatic enrollment must allow employees to withdraw their elective contributions within 90 days of their first contribution. When this withdrawal occurs, the withdrawal will be taxed in the year of distributions, no early distribution tax will be imposed, and the withdrawal will not be treated as violating other restrictions imposed on distributions nor counted in ADP tests. 3 The new safe harbor rules for automatic enrollment contributions apply to matching contributions under a 403(b) plan.

INVESTMENT ADVICE Investment Advice provided after December 31, 2006 The Act creates a new prohibited transaction exemption permitting plan fiduciaries to be compensated for giving participants investment advice. A fiduciary that is a registered investment company, bank, insurance company or registered broker-dealer will be allowed to give investment advice if either its fee does not vary based on the investment choices that participants make or its recommendations are based on a computer model certified by an independent third party. A fiduciary advisor, such as an insurance company, bank, investment advisor registered under the Investment Advisors Act of 1940, a U.S. registered broker dealer, and affiliates, employees, agents, and registered representatives of such entities, can provide investment advice to participants and beneficiaries of participant directed plans under the following two scenarios: (1) the fiduciary advisor's fees do not vary based upon the investment option selected. It should be noted that this rule already exists and this provision is merely being added to the statute; or (2) advice can be provided based exclusively on a computer model certified by an independent third party (also known as computer modeling ). Plan sponsors (or similar fiduciaries) still retain fiduciary responsibility for the prudent selection and monitoring of a fiduciary adviser under the Act. The two new exemptions require the plan sponsor (or similar fiduciary): (1) to authorize the investment advice program, and (2) to review an annual audit of the program. The in-house computer model provision will not currently apply to IRAs. Rather, the Act provides detailed procedures for the DOL to follow to determine if IRA computer model advice is feasible, and if not, to determine the circumstances under which investment advice may be provided to IRAs. INCREASED PORTABILITY FOR QUALIFIED PLANS AND IRAS Rollovers by Non-spouse Beneficiaries For Distributions Beginning After December 31, 2006 The new law allows non-spouse beneficiaries to roll over assets inherited from a qualified retirement plan into an IRA. The beneficiary will avoid tax on the rollover, and will be taxed only when the assets are withdrawn. Previously, this tax treatment was available only for people who inherited retirement assets from a deceased spouse. 4 Rollover of After-Tax Amounts After December 31, 2006 The bill would expand the portability of after-tax amounts, allowing such rollovers between different types of employer-sponsored plans [e.g., qualified plan to 403(b) plan, or vice versa]. This also should apply to the issue of rolling over designated Roth accounts under qualified plans into 403(b) plans, and vice versa. Direct Rollovers from Employer-Sponsored plans to Roth IRAs Beginning In 2008 Distributions from qualified plans, tax-deferred annuities, and governmental 457(b) plans (but not IRAs) may be rolled over directly to a Roth IRA, if the current law Roth IRA conversion rules are satisfied. It is important to remember that this will still be a taxable event at the time of the rollover, which could impact how much of the distribution the participant can afford to roll to the Roth IRA.

FASTER VESTING OF EMPLOYER NONELECTIVE CONTRIBUTIONS Plan Years beginning 2006 Employer nonelective contributions to defined contribution plans are subject to faster vesting requirements. (Matching contributions are already subject to these vesting requirements). 100% vesting after 3 years of service; or The vested percentage determined under the following schedule: - 20% after 2 years of service; - 40% after 3 years of service; - 60% after 4 years of service; - 80% after 5 years of service; and - 100% after 6 years of service. DEFINED BENEFIT PLANS FUNDING REQUIREMENTS The new rules, generally apply to plan years beginning in 2008, although transition rules apply to the 2006 and 2007 plan years. The Act completely overhauls the funding rules for defined benefit plans in an attempt to make them more secure. The new rules include the following changes: A plan s funding target has been increased to 100% of the plan's accrued liabilities. After a phase-in period, the interest rate used for plan funding purposes will be based on the highquality corporate bond yield curve, averaged over 24 months. Plan sponsors may elect to use the full yield curve without averaging. In determining the funded status of a plan, asset values can be based on the prior and current year asset values. Unfunded liabilities must be amortized over a seven-year period. The IRS is required to prescribe a mortality table to be used for funding purposes. If a plan is "at-risk", it will be subject to higher required contributions and PBGC premiums. There are new restrictions on the ability of underfunded plans to increase benefits. PHASED RETIREMENT DEFINED BENEFIT PLANS Current rules prohibit defined benefit plans from distributing retirement benefits to active employees before the plan's normal retirement age. The Act allows plans to distribute retirement benefits to active employees who have reached age 62, even if the plan s normal retirement age is later than age 62. For distributions made in plan years beginning after December 31, 2006 5

NEW PLAN DESIGN COMBINATION DEFINED BENEFIT/401(k) PLANS DB(k) Plan years beginning 2009 For plan years beginning in 2010 and later, an eligible combined plan will allow elements of a defined-benefit pension to be combined with those of a 401(k) arrangement into a single plan. The plan will be limited to no more than 500 employees. Key features include: Single plan and trust document. Single Form 5500. Each portion of the plan will be subject to its respective rules under the Internal Revenue Code and ERISA. The defined benefit portion is required to provide either (1) a minimum benefit of 1percent of final average pay per year of service up to 20 years, or (2) a cash balance formula that increases with the participant s age. Full vesting is required after 3 years. The 401(k) portion must constitute an automatic enrollment plan with a default deferral contribution of 4 percent of pay, provide a minimum match of 50 percent on the first 4 percent of pay, immediate vesting, and must satisfy other current safe harbor requirements. Amounts deferred or matched above those minimums will be subject to ADP/ACP testing. Nonelective contributions are permitted, but must be fully vested after 3 years. DB(k) is exempt from ADP/ACP and top-heavy testing. However, each portion of the DB(k) will have to separately satisfy coverage and other nondiscrimination requirements. COMBINED DEFINED BENEFIT AND DEFINED CONTRIBUTION EMPLOYER DEDUCTION LIMIT CHANGE Generally for taxable years beginning after December 31, 2007 Currently, employers that sponsor both defined benefit plans and defined contribution plans face a combined limit on deductible contributions. The limit is the greater of the amount of the required minimum contribution to fund the defined benefit plan or 25% of compensation paid or accrued to plan participants during the year. The deduction limits for employers who maintain both a defined benefit and defined contribution plan have been eased. After 2007, single-employer defined benefit plans that pay PBGC premiums will not be subject to the overall limit. In addition, for years after 2005, the limit will apply to contributions to a defined contribution plan only to the extent that the contributions exceed 6% of compensation. Elective deferrals would continue to be disregarded from the deduction limits. 6 EXPANSION OF HARDSHIP WITHDRAWALS TO NON-SPOUSES AND DEPENDENTS The Act requires the Treasury to issue regulations that would permit hardship withdrawals for hardships or unforeseeable emergencies of a person who is the participant s beneficiary under the plan, even if that beneficiary is not the participant s spouse or dependent. The Act requires the Treasury Department to expand the definition of hardship, within 180 days of the date of enactment.

DIVERSIFICATION OUT OF EMPLOYER STOCK Plan years beginning 2006 The Act limits the ability to mandate investments in employer stock. At least three materially different alternative investment options other than employer stock must be made available. All participants must be allowed to diversify the investment of their elective deferrals and after-tax contributions. Those with three or more years of service must be allowed to diversify the investment of other contributions made on their behalf. In addition, an employee who has a right to diversify out of employer stock must receive 30 days advance notice of such right, effective for plan years beginning in 2007 and later. The Act requires the Treasury Department to issue a model notice. PENALTY-FREE EARLY DISTRIBUTIONS TO ACTIVE DUTY RESERVISTS Under current law, an individual who receives a retirement distribution before age 59 1 2, death, or disability is generally subject to a 10% early withdrawal tax in addition to ordinary income taxes. The Act creates an exception to the additional tax for distributions from an IRA, 401(k) plan, or other similar arrangement to certain reservists who have been called to active duty. To qualify for the exemption, the reservist must have been called up to active duty between September 11, 2001 and December 31, 2007, for a period longer than 179 days. PARTICIPANT BENEFIT STATEMENTS These requirements generally apply to plan years beginning after 2006. Defined contribution plans must provide participants with quarterly benefit statements, if participants direct investments, or annual statements, if participants do not direct investments. For defined benefit plans, plan sponsors must provide a benefit statement every three years or notify participants annually of the availability of a benefits statement. FORM 5500-EZ Plan years beginning 2006 The Act exempts filing for one-participant plans with assets not in excess of $250,000 (rather than the present-law $100,000 threshold). 7

SIMPLIFIED FORM 5500 FOR SMALLER PLANS Plan years beginning 2006 A simplified Form 5500 would have to be available for plans with 25 or fewer participants, if the plan meets coverage without being combined with another plan, and no related group members or leased employees are covered by the plan. FIDUCIARY BOND INCREASE Plan years beginning 2007 ERISA generally requires every plan fiduciary and every person who handles funds to be bonded at no less than 10% of the funds handled with a minimum of $1,000 and maximum of $500,000. The bonding requirement for plans that hold employer securities increases from $500,000 to $1,000,000. BLACKOUT NOTICES Retroactive to the effective date under the Sarbanes-Oxley Act of 2002 Under changes made by the Sarbanes-Oxley Act of 2002, ERISA requires plan administrators to send notice of a blackout period to participants at least 30 days before beginning of the period. A blackout period is generally any period during which a participant s ability to direct assets (or obtain loans or distributions) is temporarily suspended for a period of 3 consecutive days. Under the Act, blackout notices are not required to be sent to single-participant (including plans that cover the spouse of the owner) or partner-only plans (including plans that cover their spouses). 8 ERISA 404(c) LIMITED PROTECTION ON INVESTMENT MAPPING For plan years beginning after December 31, 2007 Frequently, participant-directed Defined Contribution plans decide to eliminate or replace one or more investment funds. Part of that process often involves mapping, or automatically moving the assets in an old fund to a specified new fund with similar investment characteristics. The Act provides that, if certain requirements are met, 404(c) protection will carry over to the investment in the new fund. DIRECT DEPOSIT OF A TAX REFUND INTO AN IRA Taxpayers will be able to instruct the IRS to directly deposit their tax refund into an IRA. The IRS has created Form 8888 that allows taxpayers to designate their federal tax refund into as many as three different accounts, such as checking, savings and retirement account. For taxable years beginning after December 31, 2006

ERISA 404(c) DEFAULT INVESTMENT PROTECTION For plan years beginning after December 31, 2006 Compliance with ERISA 404(c) provides fiduciaries with protection from participants decisions on how they allocate their Defined Contribution plan accounts among investment alternatives. Where participants have failed to exercise this responsibility with respect to assets in their account, the plan must have a default provision for the investment of those assets, and 404(c) protection is not available. The Act directs the Secretary of Labor to issue regulations that will describe the types of default investments that will provide 404(c) protection to fiduciaries. The regulations, which must be issued and finalized very quickly, will contain information on appropriate default investments and the annual notice that must be provided to participants. 75% JOINT AND SURVIVOR ANNUITY OPTION Defined benefit and money purchase pension plans are required to offer an annuity with a 50% survivor annuity. The Act additionally requires such plans to offer an annuity option with a 75% survivor annuity. For plan years beginning after December 31, 2007 (later for collectively bargained plans) IRA CONTRIBUTIONS FOR CHARITABLE PURPOSES Generally, IRA owners who are age 70 1 2 and over may make tax-free IRA distributions (capped at $100,000 annually) to qualified charities. This would not apply to distributions from SEP-IRAs or SIMPLE-IRAs. Applies only to distributions in 2006 and 2007 TAX-FREE PENSION DISTRIBUTIONS TO PAY PREMIUMS FOR HEALTH AND LONG-TERM CARE INSURANCE FOR CERTAIN PUBLIC SAFETY OFFICERS Retired or disabled public safety officers (i.e., law enforcement officers, firefighters, rescue squad or ambulance crew) may make an annual election to exclude up to $3,000 each year of distributions from a governmental plan, TSA or 457(b) plan directly paid to the insurer to cover premiums for such coverage on the taxpayer, spouse or certain dependents. 9 Beginning in 2007 AMENDMENTS Amendments would be required by the end of the 2009 plan year. Governmental plans would have an additional two years to amend.

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