EMPLOYEE BENEFITS IMPACT OF THE PENSION PROTECTION ACT OF 2006 ON - PDF document

LOWENSTEIN SANDLER PC CLIENT ALERT EMPLOYEE BENEFITS IMPACT OF THE PENSION PROTECTION ACT OF 2006 ON TAX-QUALIFIED PLANS AND OTHER ENTITIES December 2006 Although the Pension Protection duties and responsibilities, including an paving the way for the IRS to issue Act of 2006 (the “Act”), signed important change to ERISA’s long- determination letters on plans that into law by President Bush on standing “plan asset” rules that will have been in limbo for several years. August 17, 2006, is best known impact private equity funds and other • The Act provides a new “safe for the sweeping changes it entities that invest pension funds. harbor” from non-discrimination makes to the funding rules gov- testing for 401(k) plans for plans Following are some of the highlights erning defined benefit pension that permit automatic enrollment of the Act: plans, there also numerous with a minimum matching other changes that will effect • The Act implements funding rule the operation of pension and contribution. changes for both single employer 401(k) plans and the duties and and multiemployer defined benefit • The Act sets forth a new, accelerat- responsibilities of plan adminis- ed vesting schedule for employer pension plans and increases deduc- trators and fiduciaries. contributions under a defined tion limits for contributions to contribution plan. pension plans as an incentive for Signed into law on August 17, 2006, employers to accelerate the funding the Act is a comprehensive pension • The Act requires that defined of such plans. reform bill intended, in large measure, contribution plans of public compa- to improve the funding status of nies allow participants to diversify • The Act prohibits the funding of defined benefit pension plans and the holdings in employer securities. nonqualified deferred compensation financial health of the Pension Benefit arrangements for certain key • The Act allows IRA owners over the Guaranty Corporation (“PBGC”), the employees if the company sponsors age of 70 1 / 2 to take tax free distri- U.S. governmental agency that insures a pension plan that is significantly butions of up to $100,000 for each defined benefit pension plans. underfunded. of 2006 and 2007 for contributions However, the Act also contains numer- to tax exempt charities. • The Act will permit a defined ous provisions that will effect 401(k) benefit pension plan to allow active • The Act expands the deduction and other defined contribution plans, employees to begin commencement limitations on contributions to cash balance pension and other types of their pensions at age 62 even qualified plans. of “hybrid” plans, IRAs, as well as though they have not retired. charities and other tax-exempt organi- zations. In addition, the Act modifies • The Act establishes new rules for many provisions of the Employee “cash balance” pension plans, Retirement Income Security Act resolving much of the uncertainty (“ERISA”) that relate to fiduciary that has surrounded such plans and

LOWENSTEIN SANDLER PC CLIENT ALERT EMPLOYEE BENEFITS • The Act creates a new type of plan, January 1, 2008. In general, the new the “DB/K”, which small employers pension plan funding obligation are can adopt that provides both effective for plan years beginning on defined benefits and defined contri- and after January 1, 2008, subject to butions under a single plan certain transitional or “phase-in” rules. document. Accordingly, employers, fiduciaries and administrators should begin consulting • The Act adds new requirements for with their actuaries, counsel and other notices and other disclosures to plan benefit plan advisors to determine the participants. impact of the Act on their retirement The enclosed chart summarizes many programs and to make appropriate of the Act’s provisions that are likely to changes to ensure compliance. effect most employers, fiduciaries and While this Alert summarizes administrators who sponsor, maintain certain provisions of the Act, the or administer tax qualified retirement application of the law to each plans. The chart also provides some employer’s plans will differ on a observations for employers to consider case-by-case basis. To discuss when evaluating their plans for com- how the Act affects your plans, pliance with the Act. please contact Andrew E. Graw, chair of Lowenstein Sandler’s The Act has varying effective dates, Employee Benefits and with some provisions taking effect Executive Compensation immediately upon its enactment Practice, at (973) 597-2588 or at (August 17, 2006) and others becom- agraw@lowenstein.com. ing effective for plan years beginning on and after either January 1, 2007 or Lowenstein Sandler PC 65 Livingston Avenue 1251 Avenue of the Americas Roseland, NJ 07068 New York, NY 10020 www.lowenstein.com 973 597 2500 212 262 6700

IMPACT OF THE PENSION PROTECTION ACT OF 2006 ON TAX-QUALIFIED PLANS AND OTHER ENTITIES CHANGES AFFECTING SINGLE EMPLOYER DEFINED BENEFIT PENSION PLANS Provision Old Law Provision Pension Protection Act Provision Effect/Comment Funding Changes Under current law, an employer The Act significantly changes the methodology for determining the The new funding rules represent a must make annual minimum contributions that must be made to defined benefit plans effective dramatic change over existing law. contributions to fund benefit for plan years beginning after 2007. The Act increases the funding The summary to the left is just a obligations under a defined benefit target to 100% of target or current liabilities. very brief overview of some of the pension plan. The funding standards changes, which are quite numerous An employer with a plan that is not 100% funded (that is, a plan generally require an employer to and detailed. whose assets are less than the present value of accrued benefit make contributions in amounts liabilities) must make a minimum contribution that is sufficient to All employers with defined benefit sufficient to cover the normal cost of amortize the deficit over a period of seven (7) years. Under a plans will need to have their actuaries funding the plan and to amortize special phase-in rule, the funding targets of a plan that is in assess the impact of the new funding unfunded past service liabilities. existence prior to 2007 are as follows: 92% for 2008, 94% for rules on their defined benefit If a plan is less than 90% funded, 2009, 96% for 2010, 100% for 2011 and later. A plan’s funding pension plans. additional contributions are required. target is generally equal to the present value of accrued Actuaries had some flexibility in benefit liabilities. deciding the assumptions and The Act sets forth actuarial assumptions and methodologies for the methodology for determining determination of required contributions, valuation of plan assets, minimum funding requirements. and evaluation of liabilities.

LOWENSTEIN SANDLER PC CLIENT ALERT Employee Benefits IMPACT OF THE PENSION PROTECTION ACT OF 2006 ON TAX-QUALIFIED PLANS AND OTHER ENTITIES CHANGES AFFECTING SINGLE EMPLOYER DEFINED BENEFIT PENSION PLANS Provision Old Law Provision Pension Protection Act Provision Effect/Comment “At Risk” Plans Not Applicable. Plan sponsors of plans that have more than 500 participants are Defined benefit pension plans with required to make greater contributions to plans that are considered more than 500 participants should “at risk.” A plan is “at risk” if the plan is (1) less than 80% funded consult their actuaries to determine using generally required actuarial assumptions, and (2) less than whether the plan is “at risk.” 70% funded using special actuarial assumptions applicable to at- risk plans. The 80% threshold is phased in over four (4) years. If a plan is at-risk for two (2) of the four (4) preceding plan years, the required contributions are increased by a “loading factor” designed to reflect the cost of purchasing annuities should the plan terminate. Contribution An employer’s tax deduction for For 2006 and 2007 the maximum deduction limitation cannot be Plan sponsors should consider, based Deduction contributions to a defined benefit any less than a plan’s unfunded current liability, after subtracting on their tax position and their plan’s pension plan for a year cannot the value of the plan’s assets from 150% of the current liability of funded status, the availability of Limitation exceed the greater of: (i) the mini- the plan. increased funding deductions, which mum funding contribution for the were expanded to facilitate funding of For plan years beginning after December 31, 2007, the annual plan year, or (ii) the plan’s normal defined benefit plans. deduction limitation is the greater of (i) the minimum contribution cost for the plan year plus the required under the Act or (ii) an alternative amount which includes amount required to amortize a cushion plus the plan’s target normal cost minus the plan’s unfunded liabilities over ten unreduced assets. The cushion is generally equal to the sum of (10) years. 50% of the funding target for the plan year and the amount by Contributions are also subject to a which the funding target would increase for the year if the plan cap called the “full funding limit.” took into account expected future increases in compensation, or “expected increased in benefits in succeeding plan years” for those plans that do not base benefits on past services.