Pension Update January 2010

January 2010

The following highlights the most significant New Developments published in the Pension Plan Guide since the last update on December 31, 2009.

During the past month, the Employee Benefits Security Administration has amended the governing plan asset regulations to provide employers maintaining plans with less than 100 participants at the beginning of the plan year a 7-day safe harbor in which to deposit employee contributions and loan repayments to the plan.

The IRS has: released guidance pursuant to which single-employer defined benefit plans may obtain automatic approval for certain changes in funding methods that result from either a change in the valuation software used to determine the plan's liabilities or from a change in both the enrolled actuary and the business organization providing actuarial services to the plan ("takeover plans"); issued a notice providing methods by which taxpayers may voluntarily correct failures to comply with the document requirements applicable to nonqualified plans under Code Sec. 409A; provided guidance implementing provisions of the Heroes Earnings Assistance and Relief Tax (HEART) Act affecting the pension and employee benefits of military personnel; and released the annual series Revenue Procedures governing procedural matters, such as procedures for issuing determination letters on the qualified status of employee plans and user fees.

NEW DEVELOPMENTS

1. Safe Harbor Allows Employers Maintaining Small Plans 7 Days in Which to Deposit Employee Contributions and Loan Repayments

The Employee Benefits Security Administration has amended the governing plan asset regulations to provide employers maintaining plans with less than 100 participants at the beginning of the plan year a 7-day safe harbor in which to deposit employee contributions and loan repayments to the plan. Under the safe harbor, effective January 14, 2010, participant contributions and loan repayments that are deposited within 7 business days from the date the funds are received or withheld from the participant would be deemed to comply with the ERISA requirement to deposit contributions on the earliest date on which the contributions could be reasonably segregated from the employer's general assets.

The final regulations are substantially unchanged from the proposed rules issued in April 2008. Accordingly, the safe harbor remains limited to plans with less than 100 participants.

ERISA rules for transmitting deferrals to the plan. Amounts that a participant or beneficiary pays to an employer, or amounts that a participant has withheld from wages for contributions to a plan, are, under ERISA Reg. 2510.3-102(a), plan assets as of the earliest date on which the contributions can be reasonably segregated from the employer's general assets. However, the elective deferrals of a 401(k) plan participant become plan assets and must, therefore, be paid to the plan no later than the 15th business day of the month following the month in which the contribution would otherwise have been payable in cash to the participant.

15-day period for transmitting deferrals is not a safe harbor. The 15-day period by which elective contributions must be transmitted to the plan is not a safe harbor, but is the latest date by which deferrals must be deposited. An employer must still contribute a participant's elective deferrals to the plan by the earliest date on which the contributions can be reasonably segregated from its general assets. The regulations, prior to amendment, applied uniformly to all plans, regardless of size and resources.

Safe harbor designed to reduce uncertainty. Prior to issuing the safe harbor, EBSA acknowledged that, despite efforts to clarify the applicable rules, there was continuing confusion among employers and plan advisers as to the time period in which contributions must be forwarded to the plan in order to satisfy the plan asset rules and avoid the attendant penalties for noncompliance. Highlighting EBSA's awareness of the problem was the fact that nearly 90 percent of the applications under the Voluntary Fiduciary Correction Program involve delinquent employee contributions.

Accordingly, in order to provide plan sponsors and plan participants and beneficiaries with a higher degree of certainty with respect to whether an employer has timely deposited employee contributions with the plan, EBSA has authorized a safe harbor, applicable to small plans, pursuant to which participant contributions will be considered to have been timely deposited (i.e., by the earliest date on which the contributions can be reasonably segregated from the employer's general assets) if they are deposited within 7 business days from the date the funds are received or withheld from the participant.

Contributions deposited when placed in participant's account. Participant contributions would continue to be considered deposited when placed in an account of the plan without regard to whether the contributed amounts have been allocated to the accounts of participants or directed to the investments selected by the participants.

Apply safe harbor on deposit-by-deposit basis. The safe harbor is available on a deposit-by deposit basis. Accordingly, the failure to meet the safe harbor during one payroll period will not result in the required application of the general rules (i.e., preclude use of the safe harbor) for the entire plan year.

Safe harbor limited to small plans. The safe harbor is limited to plans with less than 100 participants at the beginning of the plan year. According to EBSA, small plans typically need more time than larger plans in order to segregate participant contributions from their general assets, but, are, on average, capable of consistently depositing employee contributions with the plan by the 7th business day following the date of receipt or withholding.

Extension of safe harbor to loan repayments. The safe harbor may also be applied to amounts paid by a participant or beneficiary or withheld by an employer from a participant's wages for purposes of repaying a participant loan. Thus, under the safe harbor, loan repayments under plans with less than 100 participants would be considered timely deposited if made within 7 business days.

Safe harbor is optional. The final regulations state that use of the safe harbor is not mandatory. Nor is the safe harbor the exclusive means by which an employer may comply with the deposit requirements. Employers that elect not to conform to the safe harbor, however would still need to establish that participant contributions have been deposited as of the earliest date on which the contributions could reasonably have been segregated from the employer's general assets, and manage all the uncertainty attendant compliance with that standard. In addition, in the event the employer fails to timely deposit contributions, losses and interest on the late payments must be calculated from the actual date the contribution could have been reasonably segregated from the employer's general assets. Thus, EBSA cautions loss and interest may not be computed from the end of the safe harbor period.

The final rules were reported in PEN Report 1821 (January 25, 2010). The Preamble to the final regulations is reproduced at Par. 24,808L. The final rules are at Par. 14,139N.

2. IRS Releases Guidance on Automatic Approval of Changes in Funding Method

Single-employer defined benefit plans may obtain automatic approval for certain changes in funding methods that result from either a change in the valuation software used to determine the plan's liabilities or from a change in both the enrolled actuary and the business organization providing actuarial services to the plan ("takeover plans"), according to an IRS announcement.

Automatic approval for takeover plans and valuation software changes. Automatic approval for a change in the funding method under Code Sec. 430 will be provided for takeover plans and valuation software changes if the following conditions, among other requirements, are satisfied: (1) the new method is substantially the same as the method used by the prior enrolled actuary and is consistent with the description of the method contained in the prior actuarial valuation report or prior Schedule SB of Form 5500; (2) the funding target and target normal cost (without regard to any adjustments for employee contributions and plan-related expenses), as determined for the prior plan year by the new enrolled actuary (using the actuarial assumptions of the prior enrolled actuary), are both within 5% of those values as determined by the prior enrolled actuary; and (3) for plan years beginning on or after January 1, 2011, the actuarial value of plan assets, as determined for the prior plan year by the new enrolled actuary (using the actuarial assumptions of the prior enrolled actuary), is within 5% of the value as determined by the prior enrolled actuary.

Automatic approval for valuation software changes. Automatic approval for a change in the funding method under Code Sec. 430 will be provided in situations involving only valuation software changes if, in addition to other conditions, the following requirements are met: (1) there has not been both a change in the enrolled actuary for the plan and a change in the business organization providing actuarial services to the plan; (2) except to the extent automatic approval has been provided for a change in funding method without regard to this announcement, the underlying method is unchanged and is consistent with the information contained in the prior actuarial valuation report and prior Schedule SB of Form 5500; (3) the new valuation software is generally used by the enrolled actuary for the single-employer plans to which the enrolled actuary provides actuarial services; (4) the funding target and target normal cost (without regard to any adjustments for employee contributions and plan-related expenses) under the new valuation software (for either the current plan year or the prior plan year) are each within 2% of the respective values under the prior valuation software (all other factors being held constant); and (5) for plan years beginning on or after January 1, 2011, the actuarial value of assets for the plan under the new valuation software (for either the current plan year or the prior plan year) is within 2% of the value under the prior valuation software (all other factors being held constant).

IRS Announcement 2010-3 was reported in PEN Report 1819 (January 11, 2010) and is reproduced at Par. 17,097T-48.

3. IRS Provides Methods for Nonqualified Plans to Voluntarily Correct 409A Document Failures

The IRS has issued a notice providing methods by which taxpayers may voluntarily correct failures to comply with the document requirements applicable to nonqualified plans under Code Sec. 409A. Taxpayers may generally rely on the guidance for tax years beginning on or after January 1, 2009.

Relief provided for document failures. Unless certain requirements are met, amounts deferred under a nonqualified deferred compensation plan are currently includible in gross income under Code Sec. 409A to the extent that the deferred amounts are not subject to a substantial risk of forfeiture and were not previously included in income. The amounts includible in income are also subject to additional taxes.

Nonqualified deferred compensation plans must comply with Code Sec. 409A in both form and operation. The newly issued guidance primarily addresses the failure to comply with Code Sec. 409A in form (i.e., document failures). Previously issued guidance in Notice 2008-113 (CCH Pension Plan Guide Par. 17,141J) primarily addressed operational failures.

The IRS notice: (1) clarifies that certain language that is commonly included in plan documents will not cause a document failure; (2) provides relief by allowing certain document failures to be corrected without current income inclusion or additional taxes under Code Sec. 409A as long as the corrected plan provision does not affect the operation of the plan within one year following the date of correction; (3) provides relief by limiting the amount currently includible in income and the additional taxes under Code Sec. 409A for certain document failures if correction of the failure affects the operation of the plan within one year following the date of correction; (4) provides relief by allowing certain document failures to be corrected without current income inclusion or additional taxes under Code Sec. 409A if the plan is the service recipient's first plan of that type and the failure is corrected within a limited period following adoption of the plan; and (5) provides transition relief by allowing certain document failures to be corrected without current income inclusion or additional taxes under Code Sec. 409A if the document failure is corrected by December 31, 2010, and any operational failures resulting from the document failure are also corrected in accordance with Notice 2008-113 by December 31, 2010.

IRS Notice 2010-6 was reported in PEN Report 1820 (January 18, 2010) an reproduced at Par. 17,144H.

4. IRS Issues Guidance on HEART Act Benefit Rules for Military Service Members

The IRS has issued guidance, in a question-and-answer format on various provisions of the Heroes Earnings Assistance and Relief Tax (HEART) Act (P.L. 110-245). The HEART Act, enacted in 2008, contained a number of provisions affecting the pensions and employee benefits of military personnel.

The guidance covers HEART Act rules relating to survivor and disability benefits, treatment of differential military pay, distributions from retirement plans to individuals called to active duty, and contributions of military death gratuities to Roth IRAs and Coverdell education savings accounts (ESAs). The IRS has also set out the remedial amendment period for amending plans to comply with these rules

Survivor payments. Code Sec. 401(a)(3), as added by the HEART Act, provides that, if a participant dies while performing qualified military service, his survivors are entitled to any additional benefits that would have been provided under the plan had the participant resumed employment and then terminated employment on account of death. The IRS has clarified that the types of benefits subject to Code Sec. 401(a)(37) include accelerated vesting, ancillary life insurance benefits, and other survivor's benefits provided by the plan that are contingent on a participant's termination of employment due to death. However, the IRS explains, if a participant dies while performing military service but was not entitled to reemployment rights with the employer, Code Sec. 401(a)(37) does not apply in determining survivor benefits.

Disability payments. Code Sec. 414(u)(9), as added by the HEART Act states that, for benefit accrual purposes, an employer sponsoring a retirement plan may, effective for deaths or disabilities occurring on or after January 1, 2007, treat an individual who dies or becomes disabled while in qualified military service as if the individual had resumed employment and then died. The IRS notice clarifies that vesting credit must be provided for the deceased individual's period of qualified military service.

Differential wage payments. For remuneration paid after December 31, 2008, differential wage payments (payments made by an employer to an individual in the uniformed services who is on active duty for more than 30 days that represent all or some of the wages the individual would have received from the employer) are treated as wages for income tax withholding purposes. The HEART Act provides that: (1) an individual receiving a differential wage payment is treated as an employee of the employer making the payment; (2) the differential wage payment is treated as compensation; and (3) there is no violation of any nondiscrimination requirements. However, for purposes of distributions, the individual is treated as having been severed from employment during any period he or she is performing service in the uniformed services.

The IRS has explained that, for purposes of determining contributions and benefits under a retirement plan, differential wage payments need not be treated as compensation. Furthermore, a plan's definition of compensation will not fail to satisfy Code Sec. 414(s) just because differential wage payments are excluded from the plan's definition of compensation for purposes of determining benefits and contributions. An individual is treated as having been severed from employment during any period he or she is performing military service while on active duty for a period of more than 30 days.

Qualified reservist distribution. A taxpayer who receives a distribution from a qualified retirement plan prior to age 59 1/2, death, or disability is generally subject to a 10% additional tax. However, an exception is provided for qualified reservist distributions, which include distributions from an IRA or a distribution attributable to elective deferrals under a 401(k) or 403(b) plan to a member of the reserves who has been called to active duty for a period in excess of 179 days, or an indefinite period.

Initially, the qualified reservist distribution rules applied to individuals ordered or called to active duty after September 11, 2001, and before December 31, 2007. The IRS explained that the HEART Act removed the December 31, 2007 reference. Therefore, the qualified reservist distribution rules no longer have an expiration date.

Rollover of contributions of military death gratuities. Military death gratuities paid to an eligible survivor of a service member and Servicemembers Group Life Insurance (SGLI) payments are excludable from income. Under the HEART Act, the contribution to a Roth IRA or Coverdell ESA of a military death gratuity or an SGLI payment is considered a qualified rollover contribution if made before the end of the one-year period beginning on the date the beneficiary receives the death gratuity or life insurance payment. The IRS notice clarifies that an expansion of the definition of qualified rollovers applies to deaths from injuries occurring on or after June 17, 2008, or to deaths from injuries occurring on or after October 7, 2001, and before June 17, 2008, if the contribution is made no later than June 17, 2009.

IRS Notice 2010-15 was reported in PEN Report 1822 (February 1, 2010) and reproduced at Par 17,144L.

5. Employers are Increasingly Considering Annuities as 401(k) Distribution Option
The number of employers planning to offer annuities to participants in their 401(k) plans is expected to increase, according to a survey by Watson Wyatt. The Watson Wyatt survey, which was conducted in March and April 2009 and included responses from 149 employers, indicates that nearly one in four employers (22 percent) that sponsor DC plans currently offer an annuity as a distribution option, and 10 percent of those who do not offer one are considering adding it. However, although annuities have not been common in 401(k) plans, economic circumstances may lead to an increase in the number of employers considering such a distribution option.

Note: The urgency of the problem of 401(k) plan participants retiring without adequate funds for retirement may be heightened by the fact that, while the majority of employees in employer-sponsored plans are covered by DC plans, most of these plans (in contrast to defined benefit plans) do not offer employees the opportunity to annuitize assets upon retirement. Accordingly, many employees in employer-sponsored plans, upon retirement, may be forced to balance eroded account assets against a decreased average replacement rate of Social Security benefits for earned income, longer life expectancies, and increased health care costs.

Annuitization may provide more secure benefit. An annuity or partial annuity with an opt out feature would reduce the risks of individuals depleting their retirement savings. However, the annuitization of 401(k) plans has been resisted because of high costs and because it may expose employers to fiduciary liability. Accordingly, annuitization remains a controversial option.

Employee resistance to annuities. Few retirees choose an annuity form of benefit or purchase an annuity with their account balances, even when afforded the option. Retirees have expressed liquidity concerns, fearing that an annuity would be an irrevocable commitment that would limit their flexibility in accessing funds needed to address emerging health and other conditions. In addition, employers typically do not explain annuity options during the decumulation period (as opposed to plan investment options during the accumulation period of plan participation) leaving retirees to rely on financial advisers who often stress the risks and inflexibility of annuities while promoting alternative investments. Finally, employees who do withdraw 401(k) assets to purchase an annuity in the private market are often confronted by a variety of products and no means by which to evaluate or compare the times and prices of the increasingly complex options.

The factors discussed above may explain Wyatt's finding that, among employers that do not provide for annuity distributions, 56 percent cite the lack of participant demand for such an option. However, given last year's steep decline in retirement savings, Watson Wyatt suggests that employers can expect employee attitudes towards annuities to shift, as perceptions of risk are heightened.

Employer resistance to complexity of administering annuity options. Employers typically cite administrative complexity (36 percent) as a reason for not providing an annuity option. However, annuities offer benefits for employers, who would find it easier to predict and plan for employee retirement.

Note: Annuities may further grow in popularity following their inclusion among the retirement options being promoted by the Obama Administration’s Middle Class Task Force. At this stage the Administration has not developed a legislative proposal with respect to annuities, such as, for example, requiring employers to automatically deposit a portion of a retiree’s lump sum into a basic annuity or other lifetime income product. However, the Administration appears to be exploring annuities as a means of supplementing Social Security, purchasing long-term care insurance, or merely providing a guaranteed source of retirement income.

The Watson Wyatt Study was reported in PEN Report 1819 (January 11, 2010).

6. IRS Releases Annual Procedural Rulings

The IRS has released its series of annual Revenue Procedures dealing with procedural matters, such as revised procedures for issuing determination letters on the qualified status of employee plans. The guidance supersedes Revenue Procedures issued early in 2009.

The Revenue Procedures include:

revised procedures for letter rulings, information letters, and determination letters;
procedures relating to technical advice;
areas in which rulings will not be issued (domestic areas);
revised procedures for furnishing ruling letters, information letters under the jurisdiction of the Office of the Division Commissioner, Tax Exempt and Government Entities (TE/GE);
revised procedures for furnishing technical advice regarding issues in the employee plans area (including actuarial matters);
revised procedures for issuing determination letters on the qualified status of employee plans;
areas in which rulings will not be issued (international areas); and
up-to-date guidance for complying with the user fee program.

IRS Rev. Procs. 2010-1 to 2010-8 were reported in PEN Report 1820 (January 18, 2010) and reproduced at Pars. 17,299T-21.
17,299T-28.

PEN ENHANCEMENTS

Benefit Practice Portfolio Analyzes Impact of Legislative and Regulatory Changes on 403(b) Plans
The latest Benefit Practice Portfolio examines the effect on 403(b) plans of legislative changes that were designed to make the arrangements more like 401(k) plans. Michael S. Snyder, General Counsel of Hillside Family of Agencies in New York State and well-regarded author and lecturer, notes with regard to legislative changes that "[i]t was clear that Congress wanted to have employees in the not-for-profit sector have the same opportunity for savings as their for-profit counterparts." While legislation and the attendant regulations have increased deferral limits and given employee participants opportunities for greater retirement savings, employer administrators have also become subject to new administrative requirements.

The impact of the new requirements is addressed in "Good News for 403(b) Plans: Insurance Companies Have Caught Up." The Portfolio is available exclusively to internet subscribers and may be accessed by selecting "Pension Explanations" and click on "Benefit Practice Portfolios."

Keeping Up with PPA Guidance
The Pension Protection Act of 2006 represents the most sweeping overhaul to the pension law in more than 30 years. In addition to making myriad changes to the Internal Revenue Code and ERISA, the PPA requires government agencies to issue perhaps hundreds of guidance items over the next several years.

Keeping track of these guidance issuances will be a monumental task for pension and benefit practitioners. CCH has created a valuable search aid --the Table of PPA Guidance --which allows practitioners to quickly locate PPA guidance items. The Table lists official guidance issued by government agency (Internal Revenue Service, Department of Labor, Pension Benefit Guaranty Corporation, and joint agency releases), form of guidance, date of issuance, short description of the guidance, and the CCH paragraph number at which the guidance item may be found in full text. Internet customers can quickly link from the Table to a specific guidance item. The Table of PPA Guidance is designed to help busy practitioners stay abreast of the continuing flow of PPA issuances and is available exclusively to CCH PENSION PLAN GUIDE subscribers.

The Table of PPA Guidance is at PEN Par. 51C.

Comprehensive Plan Reporting and Disclosure Calendar Chart
Employee benefit plans are subject to numerous reporting and disclosure requirements that require information to be provided to plan participants and beneficiaries and filed with the IRS, DOL, PBGC, and other government agencies. Failure to comply with any applicable reporting requirement can result in significant penalties.

In order to assist plan administrators and others in satisfying their reporting obligations, PEN features a plan reporting calendar that neatly capsulizes all the various reporting requirements. The calendar lists the reports required in a calendar year in chronological order. In addition, the calendar highlights the subject matter of a report and indicates both the party required to file the report and the party to whom the report must be directed.

The Plan Reporting Calendar is at PEN Par. 36.

Check "Calendars . Tables . Interest Rates" for Quick Answers
Electronic and print customers of the CCH Pension Plan Guide can find many pertinent pension facts and figures by consulting the handy "Calendars . Tables . Interest Rates" section of the Guide.

Some of the helpful features of this section are:

Current withholding tax tables (PEN Pars. 46, 46A, and 46B)
Cost-of-living adjustment charts for retirement plans, IRAs, and social security (PEN Par 48)
PBGC monthly benefit chart (PEN Par. 49)
Table of Public Laws Amending the Internal Revenue Code and ERISA (PEN Par. 51B)
Table of current and historical interest rates (PEN Par. 52 and following)

Print customers will find the "Calendars . Tables . Interest Rates" division in Volume 1 of their Guide. Internet customers will find the same information by selecting "Pension Plan Guide" under the "CCH Pension Explanations" blue bar, then clicking on "Tables and Other Documents," the first item on the menu.