Employers sponsoring retirement plans, welfare plans and deferred compensation arrangements should be mindful of certain actions which must take place by December 31 of this year. Although few of these action items entail major undertakings, employers should review their plans and policies to ensure that appropriate action is taken to comply with the laws or to take advantage of new rules that can ease administrative burdens.
- Automatic Cash Out Procedures: Most qualified retirement plans automatically "cash out" a terminated participant's account if the participant has not provided distribution directions and if the amount is less than $5,000. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) amended the Internal Revenue Code of 1986 (the "Code"), by adding Code §401(a)(31)(B), requiring the plan administrator to transfer the mandatory cash out distribution to an individual retirement account if the mandatory distribution amount is greater than $1,000 but less than or equal to $5,000. The Department of Labor issued final "safe harbor" regulations in February 2005 relating to the automatic rollover of certain mandatory distributions from qualified retirement plans that contain a "cash out" feature. The final regulations required that for all mandatory cash outs made on or after March 28, 2005, an employer would have three choices: The employer could (i) implement the safe harbor automatic rollover rules by automatically transferring these distributions to an IRA; (ii) discontinue making any mandatory distributions; or (iii) lower the mandatory distribution dollar amount threshold from "$5,000 or less" to "$1,000 or less." Regardless of which option is chosen (except with respect to certain governmental and church plans), plans must be amended to reflect the employer's practices by the end of the first plan year ending on or after March 28, 2005. For calendar year plans, the deadline for the amendment is December 31, 2005.
- 401(k)/401(m) Final Regulations: The Internal Revenue Service issued final 401(k) regulations which become effective for plan years beginning on or after January 1, 2006. Although plan amendments are not yet required, plans must be operated in accordance with the new rules. There are two key areas that key employers should focus on with respect to these regulations:
- Nondiscrimination testing rules – The regulations clarify that plan sponsors generally may no longer use a targeted "bottom up" method for making qualified nonelective contributions and qualified matching contributions used to correct ADP/ACP testing failures. Also, plan sponsors may now aggregate ESOP and non-ESOP accounts in a 401(k) plan to help the plan pass the ADP/ACP tests.
- Hardship withdrawal rules – Effective January 1, 2006, a plan may permit additional reasons for hardship withdrawals including burial and funeral expenses for a parent, spouse, child or dependent and repair of damage to a participant's primary residence that would qualify for casualty deduction on a tax return.
- Relative Value Disclosures: Earlier this year, the IRS issued regulations under Code §417(a)(3) that provide for expanded disclosures to plan participants of plan distribution options. Effective for any qualified joint and survivor annuity ("QJSA") with an "annuity starting date" that is on or after February 1, 2006, plan sponsors must comply with these regulations by providing participants with notices that include a comparison of the relative value of all optional forms of benefits available under the plan. There is a current requirement to provide these notices if an optional form of benefit is less than the actuarial present value of the QJSA. The comparison must include a description of each available benefit form, the eligibility provisions for each benefit, the financial effect of choosing one form of benefit over another and a description of the relative value of the benefit as compared to the value of the QJSA. All of the information must be presented in a way that can be understood by an average plan participant.
Plan sponsors may provide this information in a manner that is specific to each participant or in a more general manner as long as participants are given an opportunity to request participant-specific information. These notices must be provided to plan participants no more than 90 days and no less than 30 days prior to the participant's annuity starting date. There are similar disclosure requirements for qualified pre-retirement survivor annuities that are to be provided to plan participants at the end of the plan year in which the participant attains age 35. Plan participants who join the plan after age 35 must receive the notice within one year after beginning to participate in the plan.
- Roth 401(k)s: Beginning January 1, 2006, 401(k) plans may offer plan participants the opportunity to make Roth 401(k) contributions. Roth 401(k) contributions are salary reduction contributions made on an after-tax basis. The contributions grow tax free and are not subject to tax upon distribution. Roth 401(k) contributions may be matched by the employer and are subject to the same rules and limitations as regular 401(k) contributions. Roth 401(k) and 401(k) deferral contributions are combined for purposes of determining contribution limits and may not exceed the IRS' annual contribution limit under Code section 402(g) ($15,000 for 2006). Roth 401(k) contributions may appeal to younger employees who are currently in a lower tax bracket and who expect to be in a higher tax bracket upon retirement. Employers that want to implement a Roth 401(k) feature starting January 1, 2006 will need to put together appropriate communication materials so that participants may consider how they will allocate their salary reduction contributions between the traditional 401(k) account and the Roth 401(k) account.
- Hurricane Relief – Katrina, Rita, and Wilma: The IRS and the Department of Labor collaborated to ease the distribution rules under the Internal Revenue Code and ERISA. Participants are able to take loans or hardship distributions from their retirement plan if the participant, his or her spouse, lineal descendants, ascendants, or dependents resided or worked principally in an area affected by Hurricane Katrina. Employers may implement these rules in 2005. Plans must be amended by the end of the 2006 plan year to take advantage of this relief.
- Congress passed the Katrina Emergency Tax Relief Act of 2005 (KETRA) to provide certain tax relief to those in the hurricane affected areas. KETRA allows plan sponsors to make Qualified Hurricane Katrina Distributions to a plan participant who on August 29, 2005, maintained his or her primary residence in a Hurricane Katrina affected area and who suffered economic loss due to Hurricane Katrina. Plan participants may take distributions up to $100,000 without the 10% early distribution penalty which generally applies with respect to distributions taken by active employees prior to age 59½ or terminated participates prior to age 55. KETRA also increases the available plan loan amounts and allows employers to suspend loan repayments for one year.
- DOL and IRS also provided relief from ERISA and tax filing requirements for plan sponsors.
- Plan sponsors affected by Hurricane Katrina with filing deadlines on or after August 29, 2005, (August 24, 2005 for plan sponsors in Florida) have an extension until February 28, 2006.
- Plan sponsors affected by Hurricane Rita with filing deadlines on or after September 23, 2005, have an extension until February 28, 2006.
- Plan sponsors affected by Hurricane Wilma with filing deadlines on or after October 23, 2005, have an extension until February 28, 2006.
- The extension applies to individual, corporate, and S-corporation income tax returns, partnership tax returns, trust income returns employment tax returns, the Form 5500 and other tax returns. The relief does not apply to information returns such as the W-2, 1098 and 1099 forms.
- HIPAA Portability: Effective as of January 1, 2006, calendar-year health plans must comply with the final HIPAA Portability regulations. The final HIPAA Portability regulations add new clarifications and requirements, for example: clarify that coverage under certain public health programs qualify as creditable coverage, and thereby limit the application of preexisting condition exclusions to individuals who had or have such coverage; require written procedures for requesting certificates of creditable coverage; and provide new examples of events giving rise to special enrollment rights. In addition, the final regulations require that an "educational statement" be provided as part of a certificate of creditable coverage regarding HIPAA rights. Although the final regulations do not alter the framework previously established for HIPAA Portability, health plan documents, forms, and procedures should be reviewed to ensure full compliance with the final regulations. Of particular importance to employers, summary plan descriptions must be in full compliance with these rules by January 1, 2006.
- HIPAA Security For Small Plans: Effective April 21, 2006, covered health plans with annual receipts of $5 million or less must comply with the HIPAA Security Rule. (The compliance deadline for covered health plans with annual receipts exceeding $5 million was April 21, 2005.) The HIPAA Security Rule focuses on the confidentiality, integrity, and availability of electronic protected health information (PHI). Steps to compliance will typically include amending business associate agreements and plan documents; selecting a security official; identifying risks associated with the confidentiality and integrity of electronic PHI; implementing security measures to control access to electronic PHI; and planning for contingencies such as fire, flood, vandalism, or system crash. Because compliance with the HIPAA Security Rule will often require the teamwork of information technology and benefits professionals, advanced planning is advised.
New deferred compensation rules promulgated under Section 409A of the Internal Revenue Code became effective January 1, 2005. These rules govern the timing and form of distributions of "deferred compensation" as well as how and when elections to defer pay may be made.
Many forms of compensation which are earned in one year and paid out in another will be subject to these rules. Although the deadline to amend plans to comply with the new rules is December 31, 2006, certain action must be taken this year.
- Amendment Reflecting New Deferral Elections: Under traditional deferred compensation plans, IRS transition guidance permitted new deferral elections to be made by March 15, 2005 (this would have been needed if prior elections had not been made in conformity with 409A.) If such elections have been permitted, plan amendments that conform with permitting such elections are required to be adopted by December 31, 2005.
- Termination of Plan Participation or Deferral Election: Under IRS transition guidance for new 409A, a Plan participant may be permitted to elect to terminate his or her participation in a deferred compensation arrangement or cancel an election to defer compensation provided the election is made by December 31, 2005. If such elections are permitted by the plan sponsor, a conforming plan amendment must be adopted by December 31, 2005.
- Termination of Plan: Under IRS transition guidance for new 409A, an employer may terminate a deferred compensation plan or arrangement by December 31, 2005 and avoid the termination rules that will be effective starting January 1, 2005 that require termination of all similar plans or arrangements and a 5-year hiatus before adoption of a new similar plan or arrangement.
- Stock Option Transition Rule: Stock options and other equity based compensation which would be subject to a 20% excise tax on account of having a below fair market value strike price on the grant date can avoid the tax if exercised on or before December 31, 2005 of if the option or equity grant is amended to eliminate the below fair market value strike price advantage on or before December 31, 2005.
- Bonus Plans: Bonus plans which pay awards after the end of a fiscal year in which the bonus was earned should designate a payment date by the end of the current tax year. Otherwise, payments made later than 2 ½ months following fiscal year-end could be subject to a 20% excise tax.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.