By Dan Condon, Claire Holland and Lynda Galligan

Originally published May 2005

Contents

  1. IRS Permits Grace Period Extension on "Use It or Lose It Rule" for Flexible Spending Plans
  2. IRS Proposes Regulations on Roth 401(k) Contributions
  3. New Bankruptcy Law Affects Employee Benefits
  4. Actuarial Determinations Required for Group Health Plans with Prescription Drug Coverage
  5. Model USERRA Notice Now Available on DOL Website

Under a recent IRS notice, amounts contributed during a plan year to a Section 125 flexible spending plan ("flex plan") may be used to reimburse participants for eligible expenses (e.g., health care or dependent care expenses) incurred during a 2-½ month grace period after the end of the year. Previously, flex plans (which are sometimes called "cafeteria plans") could reimburse participants only for expenses incurred during the plan year and any unused amounts as of the end of the plan year would be forfeited – the so called "use it or lose it" rule. Under the new IRS notice, amounts contributed for a plan year would be forfeited under the "use it or lose it" rule only if they are not used to reimburse eligible expenses incurred during the plan year or during the 2-½ month grace period.

This new rule will apply for a plan year only if the flex plan document is amended before the end of the year to provide for the grace period. The plan may provide for a "run-out period" after the grace period, during which expenses incurred during the plan year and the grace period may be submitted to the plan.

Example: An employer sponsoring a flex plan with a plan year ending December 31, 2005 amends the plan document before the end of the plan year to provide a 2-½ month grace period after the end of the plan year. Employee A participates in the employer’s health flex plan for plan year ending December 31, 2005 and has $200 remaining as an unused balance as of the end of the plan year. During the grace period (January 1, 2006 through March 15, 2006), Employee A incurs $300 of eligible medical expenses. In this situation, $200 is reimbursed from Employee A’s health flex plan balance for the 2005 plan year and, if Employee A participates in the health flex plan for the plan year ending December 31, 2006, the remaining $100 may be reimbursed from Employee A’s health flex plan balance for the 2006 plan year.

2. IRS Proposes Regulations on Roth 401(k) Contributions

Under tax law changes made by the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), participants in 401(k) and 403(b) plans will be able to designate some or all of their elective contributions as so-called "Roth contributions" beginning in 2006. Roth contributions differ from pre-tax elective contributions because they are currently taxable at the time that they are contributed to the plan, but the contributions and earnings on those contributions are not taxable when they are distributed in a "qualified distribution."1 The IRS recently proposed regulations detailing the requirements of Roth 401(k) contributions to 401(k) plans.

In general, the proposed regulations would require that Roth contributions be:

  • made to a 401(k) plan that specifically permits Roth contributions;
  • irrevocably designated as Roth contributions by the employee at the time of the deferral election;
  • included in the employee’s income at the time that the employee would have otherwise received the amount of the contribution as current compensation (e.g., by treating the contribution as wages subject to applicable withholding requirements); and
  • maintained by the 401(k) plan in a separately designated Roth contribution account (to which Roth contributions and withdrawals must be credited and debited, but to which forfeitures may not be credited).

Under the proposed regulations, Roth contributions generally would be subject to the requirements applicable to other elective contributions made to a 401(k) plan, such as the annual dollar limit and the nonforfeitability and required minimum distribution rules. They would also be taken into account for 401(k) ADP testing purposes to the same extent as pre-tax elective deferrals.

The proposed IRS regulations are expected to apply to plan years beginning on or after January 1, 2006. Once the regulations are finalized, a future Employee Benefits Update will provide a more detailed description of the requirements applicable to Roth contributions. In the meantime – as it is anticipated that the final regulations will not differ substantially from the proposed regulations described in this summary – 401(k) plan sponsors should be considering now whether they want to add the ability to make Roth contributions to their plans and discussing with their record keepers the steps that may be necessary if they do wish to permit Roth contributions in 2006.

3. New Bankruptcy Law Affects Employee Benefits

Last month, the President signed into law the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the "New Bankruptcy Law"), which generally will apply to bankruptcies filed on or after October 17, 2005. The New Bankruptcy Law will have an impact on a number of employee benefits issues that may rise in the bankruptcy context – e.g., when a plan participant is in bankruptcy. The summary below highlights aspects of the New Bankruptcy Law that could have an impact on plan participants in bankruptcy, and therefore on the ongoing administration of retirement plans sponsored by employers.

While this brief summary is intended to alert readers to certain aspects of the New Bankruptcy Law that may affect benefits issues, it should be noted that bankruptcy is a highly specialized and complex area of the law that involves substantive, procedural, and practical considerations and limitations; plan sponsors, fiduciaries, or participants encountering these issues (or other bankruptcy issues) should consult with bankruptcy counsel.

Retirement Plan Assets Exempt. In general, when an individual is in bankruptcy all of his assets are available to pay creditors, except to the extent that those assets are properly exempt or excluded under applicable law. The New Bankruptcy Law provides an exemption for the individual’s interest in any tax-qualified (Section 401(a)) plan, Section 403(b) arrangement, Section 457 plan, or (traditional or Roth) IRA.

  • Participant Contributions to Plans Excluded from Bankruptcy. The New Bankruptcy Law provides that, if an employee becomes subject to bankruptcy proceedings, amounts withheld from the employee’s wages (or received by an employer from the employee) for the payment of contributions to an ERISA-covered plan, a governmental or Section 457 plan, or a Section 403(b) annuity are excluded from the amounts available to pay the employee’s creditors in bankruptcy.
  • Plan Loans Not Governed by Bankruptcy Rules. In general, when an individual is in bankruptcy, his debts must be discharged through the bankruptcy process and any mechanisms used to obtain payment of the individual’s debts are automatically stayed. However, under the New Bankruptcy Law, a plan loan made to a participant (consistent with tax law and ERISA requirements) cannot be discharged in bankruptcy, and the employer’s continued withholding of amounts from the participant’s wages to repay the loan is not automatically stayed.

4. Actuarial Determinations Required for Group Health Plans with Prescription Drug Coverage

Employers that sponsor group health plans with prescription drug benefits covering active employees and/or retirees should be working with their actuaries to determine whether such prescription drug coverage is "creditable coverage" under Medicare Part D. "Creditable coverage" is prescription drug coverage which is at least actuarially equivalent to the standard Medicare Part D drug coverage. Employers will need to know whether the coverage they provide is creditable coverage for purposes of sending the required notice described below.

By way of background, Medicare Part D – added by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the "Act") and effective January 1, 2006 – provides prescription drug coverage for Medicare-eligible individuals who elect to participate in Medicare Part D. Medicare-eligible individuals who elect to participate in Medicare Part D will have to pay a monthly premium (yet to be determined). In general, this monthly premium can be increased if the Medicare-eligible individual does not commence participation in Medicare Part D when first eligible and has a period of 63 consecutive days without "creditable coverage."

The Act requires employers that sponsor group health plans with prescription drug coverage to notify plan participants (actives as well as retirees, and their spouses) who are Medicare-eligible individuals whether such prescription drug coverage is "creditable coverage." The notice will be required to be provided by November 14, 2005 and at certain later dates. It is intended that this notice will be used by Medicare-eligible individuals in determining if and when to enroll in Medicare Part D. The relevant federal agency, the Centers for Medicare and Medicaid Services ("CMS"), has indicated it will be issuing guidance describing the timing, form, and content of the required notice, including model language for use by employers and rules for including the notice in summary plan descriptions or other participant communications. The Act also requires employers to provide similar notice to the CMS, in such form and manner as the CMS may prescribe. To date, the CMS has not issued any guidance on the notice requirements. A future Employee Benefits Update will describe that guidance once it is issued by the CMS.

In addition, employers that sponsor retiree group health plans with prescription drug coverage should be working with their actuaries to determine whether such coverage qualifies the employer for a subsidy from the CMS. The subsidy was added by the Act to encourage employers to continue to maintain their retiree prescription drug coverage after Medicare Part D becomes effective.

5. Model USERRA Notice Now Available on DOL Website

As discussed in our January 2005 Employee Benefits Update, the Veterans Benefit Improvement Act of 2004, which expands various rights and benefits under USERRA, mandates, among other things, that employers provide a notice of USERRA rights to all employees entitled to rights and benefits under USERRA. The DOL has recently published a model notice that can be used to satisfy this notice requirement. The model notice is available from the following link: http://www.dol.gov/vets/programs/userra/poster.pdf.

The notice must be posted immediately in those workplace locations where the employer customarily posts notices for employees.

Footnote

1 In general, a "qualified distribution" is a distribution that is paid at least five years after the first year that the participant made a Roth contribution to the plan, so long as the distribution is made on or after the date the participant attains age 59-½, or is attributable to the participant’s being disabled, or is paid to a beneficiary after the participant’s death.

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