Defined Contribution Plan Changes Effective in 2008
The Pension Protection Act (PPA) of 2006 enacted several changes that apply to retirement plans beginning with the 2008 plan year. Below, we discuss those changes related to defined contribution plans. This analysis excludes discussion of provisions related solely to defined benefit plans. For information on those provisions, contact Alan Jacobs at 212.891.4095. Failed ADP/ACP Test Refunds Prior to 2008, if a participant received a refund of salary deferral contributions or matching contributions due to a failed Actual Deferral Percentage test or Actual Contribution Percentage test, and the refund occurred during the 2½ month period following the end of the plan year, the distribution was taxable in the year for which the contribution was made to the plan (typically the prior tax year). For plan years beginning in 2008, all refunds, including those received within 2½ months after the end of the plan year, are taxable to the participant in the year of the distribution. This change means that plan participants receiving a refund from a calendar year plan after the end of the plan year will no longer have to amend their personal income tax returns in those cases where they had filed their return prior to March 15.
Automatic Contribution Arrangements
An automatic contribution arrangement is a plan provision that automatically enrolls participants into a retirement plan at a specific salary deferral percentage unless the participant affirmatively elects not to contribute. PPA
made changes to the law to encourage employers to adopt automatic contribution arrangements. The Treasury Department released regulations that create two new optional plan designs that are available for plan years
beginning on or after January 1, 2008:
• Qualified Automatic Contribution Arrangement (QACA)
• Eligible Automatic Contribution Arrangement (EACA)
A QACA is a safe harbor plan design that requires minimum automatic salary deferral amounts, specified employer contributions, and participant notices in exchange for the plan sponsor being able to avoid performing
the annual Actual Deferral Percentage (ADP) nondiscrimination test. The Actual Contribution Percentage (ACP) and top-heavy testing may also be considered satisfied if certain requirements are met.
An EACA is a plan design that provides plan sponsors with:
• Preemption of state withholding laws;
• Additional time (six months after the plan year end) to complete ADP and ACP testing; and
• The ability to allow permissible withdrawals in the plan, which gives participants a second opportunity to opt out of the plan within 90 days and withdraw the defaulted deferrals out of the retirement plan.
Previously, statutory protection was uncertain for plan fiduciaries when plan investment options changed and account balances were mapped to new investment options without an affirmative election by plan
participants. For plan years beginning on or after January 1, 2008, PPA provides for potential fiduciary relief of liability for investment outcomes during a change in investment options for plan fiduciaries that intend to have the retirement plan comply with the provisions of ERISA section 404(c) related to participant-directed investments. To qualify for relief, the participant-directed account balances must be mapped to new investment options that have reasonably similar characteristics, including characteristics relating to risk and rate of return, to those of the prior investment options. Additionally, the participant must be given a written notice of the change at least 30 but no more than 60 days before the change. Additionally, the participant must not have elected investment options contrary to the proposed investment options prior to the change.
Changes Applicable to All Qualified Plans
Direct Rollover to Roth IRA
Prior to 2008, participants were not permitted to roll retirement plan distributions directly from an eligible retirement plan to a Roth IRA. Instead, participants were required to roll over the distribution first to a traditional
IRA, and then convert the traditional IRA into a Roth IRA by paying taxes on the traditional IRA. Beginning in 2008, a participant may elect to have retirement plan distributions rolled from an eligible retirement plan directly to a Roth IRA. Eligible retirement plans include traditional IRAs, 401(k)/profit sharing plans, money purchase plans, defined benefit plans, 403(b) plans and governmental 457(b) plans. The entire rollover to the Roth IRA is taxable to the participant (except any portion that represents a return of after-tax contributions). During 2008 and 2009, the direct rollover to a Roth IRA is only available if the participant’s adjusted gross income does not exceed $100,000 and married participants must generally file a joint tax return. Beginning in 2010, the $100,000 income cap and filing status requirement are eliminated. For rollovers to Roth IRAs in 2010, the participant will recognize the rollover amount as income ratably in 2011 and 2012, unless he elects to recognize the entire rollover amount as income in 2010. For rollovers to Roth IRAs after 2010, the entire amount is taxable in the year of the rollover.
Qualified Optional Survivor Annuity
The PPA requires plans that offer life annuities and are subject to the Qualified Joint and Survivor Annuity (QJSA) rules to offer an additional annuity option referred to as a Qualified Optional Survivor Annuity (QOSA) starting in 2008. A qualified optional survivor annuity is a survivor annuity with a survivorship percentage of either 50% or 75% of the annuity amount payable to the participant. The survivorship percentage of the QOSA depends on the survivorship percentage of a plan’s QJSA.
• If a plan’s QJSA has a survivorship percentage of less that 75%, the QOSA must be 75%.
• If a plan’s QJSA has a survivorship percentage of 75% or greater, the QOSA must be 50%
Combined Plan Deduction Limit
Prior to PPA, employers who maintained one or more defined benefit plans and/or one or more defined contribution plans that cover at least some of the same employees were subject to an overall deduction limit
equal to the greater of (1) 25% of the total eligible compensation of all participants or (2) the amount necessary to meet the minimum funding requirements of the defined benefit plan(s) for the year (but not less than the defined benefit plan’s unfunded current liability). The combined limitation did not apply if the only contributions to the defined contribution plan(s) were elective participant salary deferral contributions.
PPA made the following changes:
• The combined deduction limit applies to defined contribution plans only to the extent that the contributions (excluding participant salary deferral contributions) exceed 6% of the compensation of the
eligible plan participants.
• The combined deduction limit does not apply to multiemployer plans.
• Beginning in 2008, single-employer defined benefit plans that are insured by the Pension Benefit
Guaranty Corporation (PBGC) are not subject to the combined deduction limit.