The Internal Revenue Service ("IRS") and the Department of Labor ("DOL") recently issued several pieces of guidance of interest to sponsors of retirement plans, with particular focus on profit sharing and 401(k) plans. Overall the new guidance contains cost-of-living adjustments ("COLAs") for 2010 and provides practical approaches to satisfy operational obligations and document requirements. This recent flurry of regulatory guidance will be helpful in meeting deadlines later this year.
Most Cost-of-Living Adjustments Remain Flat in 2010
The IRS and Social Security Administration announced COLAs for 2010 that become effective for tax and plan years beginning January 1, 2010. Most applicable dollar limitations will remain flat in 2010. Limitations of interest include the following:
· The FICA wage base for 2010 is $106,800, the same as in 2009.
· The annual 401(k), 403(b) and 457 plan contribution limit for 2010 is $16,500, the same as in 2009.
· The annual catch-up contribution for participants age 50 or older for 2010 remains unchanged at $5,500.
· The maximum annual benefit limitation for a defined benefit plan under Section 415(b) of the Internal Revenue Code (the "Code") remains unchanged at $195,000.
· The limitation on annual additions to a defined contribution plan under Code Section 415(c) remains unchanged at $49,000.
· The annual compensation limit for qualified retirement plans remains unchanged at $245,000.
· The annual compensation used to determine which employees are "highly compensated" remains unchanged at $110,000.
· The annual compensation used to determine which employees are "key" employees in a top-heavy plan remains unchanged at $160,000.
· Dollar amounts for determining the maximum account balance in an ESOP subject to a 5-year distribution period remains unchanged at $985,000 and the dollar amount used to determine the lengthening of the 5-year distribution period remains unchanged at $195,000.
· The monthly limit for qualified parking benefits and the combined monthly limit for transit passes and vanpooling expenses remains unchanged at $230.
· The maximum annual exclusion from income under an adoption assistance plan increases by $20 to $12,170. The adjusted gross income phaseout increases by $340 to $185,520 (and is entirely phased out at $222,520).
Action: Employers should review communications to plan participants to assess whether it is necessary to advise eligible employees of the status quo (and increases, if applicable).
Delivery of a Summary Prospectus for a Mutual Fund Satisfies ERISA Section 404(c)
ERISA Section 404(c) shields a plan fiduciary from liability for losses when an individual account plan, such as the typical 401(k) program, permits the participants to exercise investment control over their plan accounts. In order to obtain this protection, Section 404(c) imposes a number of requirements, including providing the participant with sufficient information to make an informed investment decision. When the investment is a mutual fund, the participant is supposed to receive a current prospectus either immediately before or immediately after making the initial investment in the fund.
Previously, the DOL confirmed that the prospectus requirement would be satisfied by delivery of a mutual fund's profile because it provided a clear summary of key information that would be useful to a plan participant making an investment decision. However, earlier this year (January 26, 2009) the SEC published rules that replace the profile with an expanded disclosure for mutual funds, the "Summary Prospectus." This Summary Prospectus is designed to provide mutual fund investors with information that will better assist them when deciding whether to invest in the fund. In addition, in recognition that participants in 401(k) and 403(b) plans are significant investors in mutual funds, the SEC permits the Summary Prospectus to include a statement that it is intended for use in connection with a 401(k) plan, a Section 403(b) plan or a variable contract, and not for use by other investors.
In response to concerns that the Summary Prospectus might not satisfy ERISA's prospectus requirements, the DOL published Field Assistance Bulletin 2009-03 (the "FAB") on September 8, 2009 to assure plan fiduciaries of 401(k) and 403(b) plans (and other participant-directed individual account plans), that they may use a mutual fund's Summary Prospectus to satisfy the prospectus delivery obligations under Section 404(c) of ERISA. Click here for a complete copy of the FAB.
Automatic Enrollment in Section 401(k) Plans
The IRS published two types of guidance to facilitate the design and documentation of 401(k) plans that offer automatic enrollment. Automatic enrollment plans may be attractive for a number of reasons, including improving the participation rates of nonhighly compensated employees which can assist with nondiscrimination testing and, if the automatic enrollment plan is considered "qualified," attaining an exemption from nondiscrimination testing that would otherwise apply. One set of guidance, described below, illustrates when an automatic enrollment plan with an automatic increase in the deferral percentage will qualify as an elective deferral plan but will not be exempt from the discrimination testing. The guidance also provides an example of a plan that provides for automatic increases on a date other than the first day of the plan year and retains the exemption from the discrimination testing.
Automatic increase in deferral percentages – two different designs and two different outcomes. In Rev. Rul. 2009-30, the IRS provides useful guidance for an automatic enrollment feature in a 401(k) plan when the default salary deferral percentage is designed to increase after the first plan year and on a date other than the first day of that plan year. In one arrangement, the salary deferrals begin at 4% of compensation, and after the anniversary date of hire, an employee's default deferral percentage is scheduled to increase by 1% or, if greater, a percentage based on the increase in the employee's base pay. The arrangement caps the default contribution at 11% of pay. All required notices are to be provided to the participant, and the default contributions and associated matching contributions will be invested in a qualified default investment alternative. Because of the formula associated with the automatic increase in the default percentage, there is a non-uniform percentage of compensation for the employees that is not based solely on the number of years after the initial enrollment. Therefore, although this plan design is acceptable as an elective contribution arrangement, the non-uniform increases mean that this type of 401(k) design is not a qualified automatic contribution arrangement ("QACA"). A 401(k) plan with this type of non-uniform automatic increase in the default deferral percentage will remain subject to the ADP and ACP discrimination testing.
In a second arrangement, the salary deferrals begin at 3% of compensation, and after the anniversary date of hire, an employee's default deferral percentage is scheduled to increase by 1%. The arrangement caps the default contribution at 10% of pay. All required notices are to be provided to the participant, and the default contributions and associated matching contributions will be invested in a qualified default investment alternative. Because all employees will have the same default percentage after their initial year of participation, the arrangement is a QACA, exempt from the ADP and ACP testing.
Sample Automatic Enrollment Amendments. A 401(k) plan may provide for automatic enrollment of eligible employees, reduction of an employee's compensation, and contribution of that amount as an elective deferral, all without the employee's affirmative consent, upon satisfaction of various conditions. If the arrangement is a QACA, then the salary deferrals and employer matching contributions will not be subject to discrimination testing (generally know as the ADP and ACP tests). If the arrangement is also an eligible automatic contribution arrangement ("EACA"), it will be possible for an employee to withdraw the automatic deferrals made within the first 90 days of contribution to the plan. In order to offer these arrangements, a plan sponsor must amend its plan and provide timely advance notice to the affected employees.
IRS Notice 2009-65 provides two sample amendments for plan sponsors. The amendment for changes previously implemented may be adopted as late as the last day of the first plan year beginning on or after January 1, 2009 (2011 for a governmental plan).
Action: For a calendar year non-governmental plan, plan amendments should be adopted by December 31, 2009.
One sample amendment adds an automatic contribution arrangement to a Section 401(k) plan and includes an automatic increase in the initial deferral percentage (see the paragraph above, "Automatic increase in deferral percentages – two different designs and two different outcomes" for a description of automatic increases that qualify.) The second sample adds an EACA to a 401(k) plan that also includes an automatic increase in the initial deferral percentage and provides for a withdrawal of the default elective deferrals within the 90-day period. In addition, the second sample clarifies that no spousal consent is necessary for the withdrawal, permits (but does not require) a fee to be charged to process the withdrawal and confirms that any associated matching contributions will be forfeited. Both amendments provide notice requirements. Click here for the sample amendments.
Updated Safe Harbor Notice for Plan Distributions
Plan sponsors are required to provide a notice of the tax consequences of plan distributions to participants and beneficiaries. This notice obligation may be satisfied by providing the safe harbor notice the IRS has generated from time to time. Two new safe harbor notices are found in IRS Notice 2009-68. The new notices reflect changes in recent laws (including EGTRRA and the Pension Protection Act of 2006) including rules related to Roth contributions, mandatory distributions, rollovers to Roth IRAs, rollover rights of nonspouse beneficiaries, new exemptions from the 10% tax on early distributions when amounts are paid to qualified reservists and certain public safety employees (e.g., police, firefighters, emergency medical service personnel) and other changes. In addition, these notices may now be provided as much as 180 days before the date of payment – previously, the notice could only be provided no more than 90 days before the payment date.
The model notices should be revised to exclude provisions that do not apply to a plan. For example, if employer stock is not a permitted investment then provisions relating to the special tax treatment of employer stock should be removed. The first model notice covers distributions that are made from a plan account containing employee pre- and post-tax contributions or employer contributions. The second model notice applies to a distribution from a plan that also includes a designated Roth account. These safe harbor explanations update previous safe harbor explanations contained in Notice 2002-3. However, the explanations in Notice 2002-3 will continue to serve as safe harbor notices through December 31, 2009. The IRS expects to publish a Spanish translation of these safe harbor explanations but gave no indication of when the translations will be available. Click here to obtain a copy of the model notices
Action: Be sure the revised applicable safe harbor notice is used for distribution beginning January 1, 2010.
Liberalized Rollovers from Employer Plans to Roth IRAs
The IRS provides Q&As in Notice 2009-75 discussing the federal tax consequences of rolling over distributions from qualified retirement plans (including 401(a) qualified plans, 403(a) annuity plans, 403(b) plans and 457(b) governmental plans) to Roth IRAs. Rollovers from non-Roth accounts are included in gross income, reduced by any after-tax contributions included in the rollover. Rollovers made from Roth accounts to Roth IRAs are not taxed. In addition, an eligible rollover distribution made before January 1, 2010 that is not a distribution from a Roth account may be rolled over to a Roth IRA only if, in the year of the distribution, the participant's income is less than $100,000 (and, if married, the participant files jointly). However, beginning January 1, 2010, the income limitation no longer applies, and a participant with gross income of $100,000 or more may roll over the distribution into a non-Roth IRA and convert the non-Roth IRA into a Roth IRA. In addition, although the untaxed amount of the distribution will be subject to tax, the federal income tax on these distributions paid in 2010 may be paid over 2 years. Because of the appeal of Roth IRAs, which provide tax-free payment of the tax-deferred earnings on these accounts if certain requirements are met, plan sponsors may find that participants who are eligible for distributions in 2009 will delay their distribution requests until 2010 in order to convert their plan accounts to Roth IRAs. See the paragraph above, "Updated Safe Harbor Notice for Plan Distributions" for safe harbor notices that include Roth rollover information.
PTO Accounts May Be Contributed To Profit Sharing And
401(k) Plans
Annual unused PTO amounts may be contributed to profit sharing and 401(k) plans. Many employers have reviewed their paid time off ("PTO") accounts that fund sick and vacation leave and decided to limit the amounts of unused PTO that may be carried over to a subsequent year. Because employees could have used the PTO, some employers have considered contributing the value of the unused PTO to their profit sharing and 401(k) plans either as a nonelective employer contribution (often referred to as a profit sharing contribution) or as an elective employee 401(k) contribution (if the unused PTO could either be paid in cash or contributed to the 401(k) plan).
In IRS Rev. Rul. 2009-31, the IRS provides clear guidance describing how unused PTO accounts may be contributed to qualified pension, profit-sharing and stock bonus plans. If the PTO account provides a limited carryover to the next year, then the amount that would otherwise be forfeited may be contributed to the plan either as a mandatory nonelective employer contribution (the employee does not have the option of receiving cash) or as an elective contribution (the employee may elect to make the contribution or receive cash). The guidance requires that the amount of the contributions be limited so as not to exceed Code Section 415(c) limits (100% of compensation or, if less, $49,000 for the 2009 and 2010 limitation years), and the dollar equivalent of any remaining PTO must be paid to the employee by February 28 of the following year. In addition, if the contribution is a 401(k) salary deferral, then in addition to the 415(c) limits, it cannot exceed the 401(k) calendar year limit in combination with other employee deferrals for the year. For 2009 and 2010 that limit is $16,500.
Planning Tip: If the PTO amount is a nonelective (profit sharing) contribution, it will have to be tested because the amounts will not be a uniform percentage of pay. This testing requirement creates an additional cost that might not otherwise be incurred. If the amount is a 401(k) deferral, it will be tested the same as other
401(k) deferrals.
For those concerned with the potential for a deferred compensation arrangement under Code Section 409A, the IRS provides welcome relief. If the PTO account is a bona fide sick or vacation pay plan that is exempt from Section 409A, then the deferred payment of the PTO amount from the profit sharing or
401(k) plan will not cause the PTO account to be subject to Section 409A.
Unused PTO amounts may be contributed to profit sharing and 401(k) plans on termination of employment. IRS Rev. Rul. 2009-32 addresses circumstances under which the dollar equivalent of unused PTO may be contributed to a profit-sharing or 401(k) plan upon an employee's termination of employment. The guidance is similar to the requirements described above for active participants with unused PTO. A qualified profit-sharing plan may be amended to require or permit contributions to the plan of the dollar equivalent of unpaid PTO at the participant's termination of employment provided that the contribution does not exceed the Code Section 415(c) limit ($49,000 for the 2009 and 2010 limitation years). The participant will not be taxed on the dollar equivalent of the unused PTO contributed to the plan until distributions are made to the participant from the plan. The remaining amount of the unused PTO (i.e., the amount paid directly to the participant) is taxed in the year paid.
If you are interested in using PTO as a source for profit sharing or 401(k) deferrals, please contact your employee benefits attorney or any of the attorneys listed at the end of this Alert for assistance in designing and drafting an appropriate amendment, and updating your plan's summary plan description so that participants are aware of this new feature.
Additional Guidance on the Suspension and Rollover Rules for 2009 Required Minimum Distributions – Actions Required
The IRS issued Notice 2009-82 to address the waiver of required minimum distributions ("RMDs") in 2009 for participants over age 70 ½ who would normally be required to take them. Recognizing that prior to issuance of this guidance plan sponsors were unsure how to implement suspension of RMDs in 2009, the guidance provides transition relief from January 1 through November 30, 2009 for suspensions of RMDs in 2009 that did not comply with the plan document terms. In addition, because the 2009 RMDs (if paid) are rollover eligible, the guidance also extends the usual 60-day rollover period for those amounts until no earlier than November 30, 2009.
The guidance includes Q&As as well as sample amendments that plan sponsors can use to amend their plans. The amendments permit a plan to offer one of two defaults: either make the 2009 RMD and give the affected participants and beneficiaries the right to elect to suspend the 2009 payment, or suspend the 2009 RMD and also give the affected participants and beneficiaries the right to request the payment. The Q&As provide guidance on the timing rules for payments due to beneficiaries on account of participant deaths in 2008, spousal consent issues if there is a suspension in 2009 and restart in 2010, and a discussion of the rollover rights and tax withholding rules that apply.
Action: Plan amendments must be adopted no later than the last day of the first plan year beginning on or after January 1, 2011, which is December 31, 2011 for calendar year plans. A delayed date applies to governmental plans. However, the written amendment must reflect the actual operation of the plan so plan sponsors should be sure to review their procedures for the 2009 RMDs.
Actions: In order to comply in operation, plan sponsors should:
(1) decide whether affected participants need to request a suspension or request a payment, depending on the default selected by the plan;
(2) send notice to affected participants fairly quickly to permit processing of the non-default approach before the end of 2009, and;
(3) provide rollover information to participants and beneficiaries who received the RMD this year so as to meet the November 30, 2009 deadline for rollovers of those amounts.
