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New U.S. Pension Law: Overview of Funding Rules for ‘At Risk’ and ‘Endangered’ Plans
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September 25, 2006
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By David S. Foster
Thelen Reid Brown Raysman & Steiner LLP
This report summarizes additional provisions of the Pension Protection Act of 2006.
The act significantly modifies the minimum funding requirements for defined benefit plans under the Employee Retirement Income Security Act of 1974 (ERISA) and the Internal Revenue Code, imposes limitations and additional funding requirements on plans that are considered “at risk” or “endangered,” and expands the plan sponsor's obligation to notify plan participants and beneficiaries of the plan's funded status. The act also makes a number of other changes to pension law. Most provisions of the act are effective for plan years beginning after December 31, 2007.
Single-Employer Defined Benefit Plans
In general, the act requires that all single-employer defined benefit plans be fully funded within a seven-year period beginning in 2008. The act also imposes specified interest rates and mortality tables that must be used in the calculation of a plan's costs and liabilities and in determination of the present value of a participant's benefit.
Additional contributions and funding assumptions will be required for those plans deemed to be “at risk.” A plan is “at risk” if the plan's funding ratio generally is less than 80 percent. This 80 percent standard will be phased in over four years (65 percent in 2008, 70 percent in 2009, 75 percent in 2010 and 80 percent in 2011). However, plans with 500 or fewer participants will not subject to the additional “at risk” contributions. In addition, if a plan is “at risk,” there are restrictions on funding of executive compensation.
It is important to note that there is no delay in effectiveness of the additional funding requirements for collectively bargained single-employer defined benefit plans, with the exception of “at risk” plans. For collectively bargained plans, the effective date for limitations on “at risk” plans is delayed until the later of the earlier of the expiration of the collective bargaining agreement or plan years beginning in 2010.
In addition, plans that are considered “at risk” may not be amended to increase benefits. An amendment increasing benefits also is prohibited if, taking into account the amendment, the plan would be considered “at risk.” Plans that are less than 60 percent funded also are prohibited from triggering shutdown benefits and from paying lump sums, and benefit accruals must be frozen.
The requirement that plan administrators provide participants with a summary annual report has been eliminated for all defined benefit plans. Instead, administrators of single-employer defined benefit plans now must send out a funding notice due 120 days after the beginning of the plan year. (Plans with less than 100 participants may send out this notice when the Form 5500 is filed). This notice must be sent to participants, beneficiaries, unions (if a collectively bargained plan) and to the Pension Benefit Guaranty Corp.
Multiemployer Defined Benefit Plans
Under current law, multiemployer plans generally are subject to the same funding requirements as single employer plans. However, multiemployer plans have a longer amortization period (up to 15 years instead of the 7-year period for single-employer plans).
The act adds new funding rules and benefit limitations for multiemployer plans that fall into one of two categories: (1) endangered or (2) critical. The determination is generally based on the funding status of the plan - in general, a plan less than 80 percent funded is either “endangered” or “seriously endangered” and a plan that is less than 65 percent funded is “critical.”
The determination of a plan's status must be made by an actuary within 90 days after the beginning of the plan year. If the actuary determines that a plan is endangered, then the act requires that the plan sponsor adopt a funding improvement plan. If the actuary determines that a plan is critical, the act requires that the plan sponsor adopt a rehabilitation plan. Both types of plans are to provide plan sponsors with a blueprint that is intended to improve the funding status of the plan over a period of 10 to 15 years.
If a plan has been certified critical, then the plan sponsor may provide for cutbacks in benefits, increase employer contributions or both. The act contemplates that the terms of the rehabilitation plan will be subject to bargaining and accordingly provides for a default plan should the parties fail to reach an agreement. Failure to timely implement a rehabilitation plan may subject the plan sponsor to ERISA penalties (up to $1,100 a day) and excise taxes (up to 5 percent of the accumulated funding deficiency) under the Internal Revenue Code. The multiemployer provisions are effective generally for plan years beginning in 2008.
The endangered and critical provisions above will sunset in 2014. However, plans that have adopted funding improvement and rehabilitation plans must continue to follow those plans.
The requirement that plan administrators provide participants with a summary annual report and the ERISA 4011 notice has been eliminated for all multiemployer defined benefit plans. However, a similar funding notice must be provided, within 120 days after the beginning of the plan year, that includes detailed information on the plan's funding status and must provide additional information, including whether the plan is endangered or critical, and how to get a copy of the funding improvement plan or the rehabilitation plan. This notice must be sent to participants, beneficiaries, contributing employers, unions and PBGC. Plans with fewer than 100 participants may send out this notice when the Form 5500 is filed.
Other Provisions
Faster Vesting of Employer Nonelective Contributions: The vesting schedules implemented by EGTRRA for matching contributions apply for all employer nonelective contributions made to a defined contribution plan for plan years beginning after December 31, 2006. For any employee who has an hour of service after the effective date, nonelective contributions made on his or her behalf must vest under either a three-year cliff or a two- to-six-year graded vesting schedule (or another schedule that is at least as favorable). There are special phase-in effective dates for collectively bargained plans and certain ESOPs.
Default Investments Arrangements: Participants who are able to exercise investment control over their accounts and whose accounts are transferred into default investments due to a failure to provide investment directions will continue to be treated as exercising control over such assets and therefore will continue to bear the fiduciary responsibility associated with such investment. In order for a plan to rely on this provision, a plan administrator must provide participants with proper notification. This provision is effective for plan years beginning after December 31, 2006.
Fiduciary Liability During Suspension of Ability to Direct Investments: A participant or beneficiary who is able to exercise control over the assets in his or her account before a “qualified change” in investments options occurs will not be treated as failing to continue to exercise control over such assets as a result of the “qualified change.” A qualified change generally occurs where existing funds are “mapped” to new funds that have similar characteristics for risk and rates of return. In order to rely on this provision, a plan administrator must provide participants with proper notification and comply with "blackout" period requirements. This provision generally is effective for plan years beginning after December 31, 2007, with a special transition effective date for collectively bargained plans.
Diversification of Publicly-Traded Employer Stock: Many defined contribution plans with assets invested in publicly-traded employer securities are required to permit participants (and beneficiaries) to diversify such amounts into other investment alternatives.
Distributions Resulting from Financial Hardship or Unforeseeable Financial Emergencies: The rules for determining whether a participant has incurred a financial hardship (with respect to §401(k) plans or tax-sheltered annuities) or an unforeseeable emergency (with respect to §457 plans and nonqualified deferred compensation plans subject to §409A) are modified to include such hardships or emergencies for participants' beneficiaries. This provision became effective as of August 17, 2006.
After-Tax Amounts in §403 (b) Plans to a Qualified Plan: Effective for taxable years beginning after December 31, 2006, after-tax contributions in §403(b) annuity contracts may be transferred in a direct rollover to a qualified retirement plan, provided that the plan to which the rollover is made continues to separately account for after-tax contributions and earnings.
Direct Rollovers from Retirement Plans to Roth IRAs: Effective for distributions made after 2007, taxpayers may make direct rollovers into Roth IRAs from qualified plans, §403(b) annuities or §457 plans.
Nonspouse Beneficiaries: Effective for distributions made after 2006, nonspouse beneficiaries may make direct rollovers into IRAs from qualified plans, §457 plans or §403(b) annuities. Such IRAs are treated as inherited IRAs of the nonspouse beneficiaries and are subject to the distribution rules applicable for beneficiaries.
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For more information about the issues covered in this report, please contact David S. Foster in our San Francisco office at 415-369-7020 or at dsfoster@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
©2006 Thelen Reid Brown Raysman & Steiner LLP
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