It’s that time of year again…
when retirement plan sponsors need to give their plans the administrative
equivalent of an annual physical exam. There are new limitations to consider
as well as recurring compliance deadlines and fiduciary responsibilities.
All of these matters have become a bit more complicated by the passage of
the Pension Protection Act of 2006.
This newsletter will review the 2007 administrative compliance
requirements and deadlines for qualified plans as well as some of the newly
enacted Pension Protection Act provisions.
New Annual Limits
Participants in 401(k), 403(b) and 457 salary deferral plans should be
notified that the annual deferral dollar limit for 2007 increased to
$15,500, while the additional catch-up contribution, for those age 50 and
over as of the end of the year, remains unchanged at $5,000. The maximum
compensation for plan purposes increased to $225,000. The prior year
compensation level used for determining highly compensated employees remains
at $100,000 while the key employee compensation threshold for officers
increased to $145,000. In defined contribution plans the maximum annual
additions (total contribution allocations) increased to $45,000 per
participant, and the defined benefit plan maximum annual benefit increased
Reporting of Distributions
Participants who received plan distributions during 2006 must be
furnished with Form 1099-R by January 31, 2007 showing the amount of the
distribution, the taxable portion, any taxes withheld and the appropriate
distribution code. Defaulted loans must also be reported on Form 1099-R.
Copy A of these forms must be submitted to the IRS along with transmittal
Form 1096 by February 28.
Qualified plans must perform annual testing to make sure they don’t
unfairly discriminate in favor of "highly compensated employees" (HCEs). An
employee is an HCE if he owns more than 5% of the company (including family
attribution rules) or has compensation in the prior plan year exceeding a
specified level ($100,000 in 2006).
Plans that don’t cover all employee divisions, classifications or the
employees of a related company, or require participants to work a minimum
number of hours or be employed on the last day of the plan year to share in
allocations, may have to test annually for coverage discrimination.
Salary deferral plans, other than safe harbor plans that meet the
employer contribution and notice requirements, must test at the end of each
plan year to insure that employee deferrals and employer matching
contributions aren’t discriminatory. Generally speaking, if the ADP (average
deferral percentage) and the ACP (average contribution percentage) for the
HCEs are within 2% of the ADP and ACP for the non-HCEs, the plan is not
The most common method for correcting a failed ADP or ACP test is to make
corrective distributions of the excess contributions plus earnings. These
corrections must be done within 2½ months of the plan year end in order to
avoid a 10% penalty. The final deadline for making corrective distributions
with the penalty is the last day of the following plan year.
If an employee makes excess deferrals in a calendar year above the annual
dollar limit, such excess is not deductible on the employee’s tax return and
should be distributed to the employee by the following April 15. If not, the
amount will be subject to double taxation: once in the year deferred and
again when distributed.
Top Heavy Testing
A plan is considered top heavy if more than 60% of the benefits belong to
"key employees," who are defined as more than 5% owners (including family
attribution rules), more than 1% owners earning above $150,000 and officers
earning over a specified amount ($145,000 in 2007). An annual test must be
performed to determine if the key employees have more than 60% of the
benefits, after certain adjustments. If so, the plan must meet the top heavy
minimum contribution and vesting requirements.
In order for the nondiscrimination and top heavy tests to be performed,
the employer must compile census information for all employees of the
company. The census should include dates of birth, hire and termination,
total compensation, hours worked, whether the employee is an officer or
owner (or a family member of an owner) and contributions made on behalf of
Under the new law, all plans are required to provide benefit statements
to participants as of the 2007 plan year. Most plans have already been doing
so. The statements must indicate the total accrued benefits and the vested
benefits, if any, or the earliest date on which benefits will become vested.
They must also include an explanation of any permitted disparity or other
offset arrangements used in calculating accrued benefits.
Individual account plans must provide the statements at least annually.
Where participants direct their own investments, statements must be provided
at least quarterly, although the vesting information need only be provided
once a year. The quarterly statements must also contain an explanation of
any limitations or restrictions on investment direction, an explanation of
the importance of a well-balanced and diversified portfolio, including a
statement that holding more than 20% of a portfolio in one security may not
be adequately diversified, and a notice directing participants to the
Department of Labor (DOL) website for more information.
Defined benefit plans must provide benefit statements at least once every
three years to active participants with a vested accrued benefit, or to any
participant upon written request (not more often than once a year).
Alternatively, the three-year requirement will be met if at least once a
year participants are provided with a notice of the availability of a
pension benefit statement and the ways in which one may be obtained.
In Field Assistance Bulletin 2006-03, issued in December, the DOL
clarified that benefit statements can be delivered electronically (as can
other employee notices). It also provided a 45-day safe harbor after the end
of the period during which the statements will be considered timely
While this deadline may be reasonable for the information required on
quarterly statements, it may not be for annual statements. More time may be
needed to update vesting percentages and allocate employer contributions,
which are sometimes not deposited until 8½ months after the plan year ends.
Hopefully, additional guidance from the DOL will be forthcoming before the
end of the year regarding the deadline for issuing annual benefit
Almost all retirement plans, except one-participant plans with assets of
$100,000 or less (increased to $250,000 as of the 2007 plan year), are
required to file an annual report, Form 5500, with the DOL. The due date is
the last day of the seventh month after the end of the plan year (July 31
for calendar year plans). The deadline can be extended 2½ months by filing
Form 5558 by the original due date.
Plans that covered 100 or more participants at the beginning of the year
(large plans) must have the plan audited by an independent accountant and
attach the audit report to Form 5500. In a salary deferral plan, all
eligible participants are counted, whether or not they contribute to the
A summary annual report, which is a brief summary of Form 5500, must be
provided to each participant or beneficiary within nine months of the plan
year end. This deadline is extended 2½ months if an extension was filed for
All fiduciaries who handle plan assets are required to be bonded for at
least 10% of the market value, up to a maximum of $500,000. Small plans (up
to 100 participants) with certain types of investments (such as limited
partnerships) may need additional bonding to avoid being subject to the
audit requirement for large plans discussed above. Fiduciaries should review
the plan asset values at least once a year to determine if the bond coverage
needs to be increased. The amount of the bond in force is reported on Form
Various notices are required to be provided to plan participants
including the following:
- Plans with automatic enrollment provisions must notify participants at
least 30 days before they become eligible and 30 days before each
subsequent plan year of the default participation and investment options.
- Summary plan descriptions (SPDs) must be distributed to each
participant within 120 days of the adoption of a new plan (or 120 days of
the effective date, if later). Ongoing plans must give an employee the SPD
within 90 days of becoming a participant.
- Safe harbor 401(k) plans must provide a notice between 30 and 90 days
before the next plan year begins informing participants that the plan
intends to satisfy one of the safe harbor contribution requirements in the
following year, thereby becoming exempt from ADP/ACP testing.
Alternatively, employers may issue a "maybe" notice stating that the plan
may become safe harbor by making a 3% nonelective contribution next year.
An additional notice must be given out 30 days before the end of the plan
year if the employer decides to actually make the contribution.
The new law made numerous changes affecting plan distributions:
- New vesting rules are effective in 2007 for defined contribution
plans. They must now meet one of the top heavy schedules: a six-year
graded or three-year cliff schedule. Plan distributions should be
calculated taking into account the new vesting requirements.
- Hardship distributions were expanded to allow plans to consider the
financial needs of a participant’s primary beneficiary, even if such
beneficiary is not a spouse or dependent.
- Distribution notices containing tax and joint and survivor annuity
information can now be given out from 30-180 days before the distribution
begins. The contents of the notices must be revised to include additional
- Effective in 2007, plans may allow nonspouse beneficiaries to roll
over death benefit distributions to an IRA. But while a spouse can delay
distributions until age 70½, the nonspouse beneficiary must begin
distributions from the IRA immediately.
The Pension Protection Act made numerous changes impacting plan
administration effective in 2007. Plan administrators need to take a careful
look at the changes and make the necessary preparations. New annual limits
should be communicated to participants in salary deferral plans so they can
make educated decisions about their deferral elections. Census information
including all employees should be compiled as soon as possible after the
plan year ends so that discrimination testing can be performed and any
corrective distributions can be made in a timely manner.
[top of page]