Welcome to Peeples & Kohler, P.C.
Representing sponsors of qualified retirement plans
Design, Implementation, Maintenance
Richard H. Peeples Allison M. Kohler
5580 Peterson, Suite 145 Dallas, Texas 75240
Winter 2008
Tel: (972) 503-9441 Fax: (972) 503-9442 WEB PAGE: www.peepleshilburn.com
As you know, over the past decade, Congress, the IRS and the DOL have made numerous changes to retirement plan rules. All of these changes must be incorporated in your plan documents. You have already adopted "good faith" amendments for most of these law changes, and must now adopt a complete restatement of your base plan document.
The IRS has announced a two-year "window" during which all 401(k) and other defined contribution plans will have to be restated to incorporate changes from the past several years (including the 2001 EGTRRA legislation and various post-EGTRRA laws and regulations). The window began on May 1, 2008 and will end on April 30, 2010. This restatement will consolidate the "good faith" amendments to your existing plan and also add additional, legal language required by the IRS.
Our base plan document has been updated for these changes and received approval from the IRS on March 31, 2008. We began restating client plans in June of 2008, and have established internal procedures for monitoring our progress. If you have not already received individual correspondence describing the restatement process and the related fees, you will receive such correspondence in the first half of next year. As always, we remain committed to providing high-quality, cost-effective service
The Pension Protection Act of 2006 (PPA) continues to have substantial impact on the operation of defined contribution and defined benefit plans.
Defined Contribution Rules: Beginning with the 2007 plan year, all qualified plans are required to furnish periodic benefit statements to participants and beneficiaries. Defined contribution plans that do not permit participant direction of investments must provide an annual benefit statement which must be furnished on or before the due date for filing the Form 5500. Defined contribution plans that permit participant direction of investments must prepare and distribute quarterly statements. DOL guidance provides that this notice must be furnished within 45 days following the end of the statement period. Defined benefit plans must provide a periodic benefit statement once every three years.
The benefit statement furnished by defined contribution plans must include: (1) the participant's account balance and vested percentage, (2) an explanation of any permitted disparity (i.e., integration with Social Security) that may be applied in determining benefits and (3) the value of each investment to which assets in the participant's account have been allocated. In addition, defined contribution plans that permit participant direction of investments must also include: (a) an explanation of any plan limitations or restrictions on any right of the participant or beneficiary to direct an investment (limitations imposed by the brokerage firm are not required to be included), (b) an explanation of the importance of having a balanced and diversified portfolio and (c) a notice directing the participant or beneficiary to the DOL website for sources of information on individual investing and diversification.
You should consult with your plan administrative firm and your financial advisors (or investment brokers) to determine who will provide the required information and prepare the benefit statement. The penalty for failure to provide the statements can be up to $110 per day per participant.
Defined Benefit Rules: Beginning with the 2007 plan year, the rules governing the funding of defined benefit plans changed dramatically. With few exceptions, there is now a range of deductible funding each year, with a minimum and maximum funding amount. This will often allow employers to contribute and deduct certain amounts in advance of the benefits actually being earned. In addition, where an employer or affiliated employer group sponsors and contributes both to defined benefit and 401(k)/profit sharing plans, the deduction limit has been increased generally to the greater of (1) 31% of eligible compensation of the participants benefiting under the plans or (2) the required defined benefit funding amount plus an amount contributed to the 401(k)/profit sharing plan up to 6% of considered compensation. Salary deferral amounts are deductible in addition to this limit.
Beginning with the 2008 plan year, a single methodology for determining a plan's funded status has been mandated for virtually all defined benefit plans. A plan's funded status is determined annually by calculating plan liabilities and comparing that to the value of the plan assets. If the liabilities exceed assets, the plan has an asset "shortfall". If there is an asset shortfall, a contribution must be made to pay off the shortfall over a seven-year period. This contribution is in addition to the minimum required funding amount which equals the cost of the benefits earned by participants during the year. Where the value of plan assets is less than 80% of the plan's current liabilities, there will be restrictions on the payment of benefits in forms other than annuities, e.g., lump sums. Further, neither benefit levels nor the value of benefits can be increased. More stringent rules apply if the value of assets is less than 60% of the current liabilities. Finally, between 2008 and 2012, the interest rate standard used in calculating the present value of a participant's benefit in a defined benefit plan will change.
Because of these complicated funding rules and the ramifications of the funding status of a defined benefit plan, it is very important to keep in touch with your financial advisor, us and your administrative firm if your financial situation changes.
We will continue to provide more information on the various PPA provisions in future newsletters. If you have specific questions about any of these provisions, feel free to contact us.
Since the mid-1990's, the government has provided special benefits for employee/participants who have an absence from employment on account of military service and then later return as an employee. The HEART Act, signed into law on June 17, 2008, has expanded these benefits for employees/participants who die or become disabled while in military service and has also added additional benefits. Under HEART's rules, an employer may be required to make special contributions for a military veteran returning as an employee, and/or give vesting to a former employee/participant who dies or becomes disabled while performing military service. In addition, plan provisions can be added to allow distributions to certain military reservists. Because the rules are very fact specific, we recommend that you contact us or your administrative firm if you rehire an employee who left your employment to serve in the military, or if a former employee died or became disabled while in military service, after January 1, 2007.
In virtually all plans, if you rehire an employee who previously worked for your business (or a predecessor or related business, such as a prior sole proprietorship), her prior employment is counted in determining her eligibility for the plan. This applies even if the prior employment occurred before the plan existed. This also applies even if the employee is only rehired on a "fill-in", temporary or part-time basis. Normally, a rehired employee who had previously met the eligibility requirements is eligible immediately as of her date of re-employment.
The following examples illustrate this. Both examples assume a plan with a 12 month/1000 hour eligibility requirement.
Employee Mary worked for your sole proprietor business from 1990 through 1994 (and had over 1000 hours in a 12-month period). You incorporated in 2001 and established a retirement plan in 2003. If your corporation rehires Mary on October 1, 2008, she is eligible to participate in the plan immediately on October 1, 2008, her date of rehire.
If a rehired employee is eligible and you have a safe harbor 401(k) plan, you must give her the Safe Harbor Notice and Salary Reduction Agreement form on her date of rehire. You will also need to give her a copy of the current Summary Plan Description. If you fail to do so, you will be required to make corrective contributions for the rehired employee in accordance with the IRS program known as Employee Plans Compliance Resolution System (EPCRS). These contributions will be immediately 100% vested.
In many small businesses family members provide services to the business. Like other employees, they can be compensated for their services. That compensation is a legitimate deduction for the business, but only so long as those services are ordinary and necessary to the business and the total compensation is reasonable for the personal services provided. It is important to keep records showing that the rate of compensation for the family member is comparable to the rates paid to other employees performing similar functions. In addition, we believe it is important to document any family member as an employee by keeping a complete personnel file on each family member employee. We also believe it is important to keep track of the hours performed by the family member for personal services related to the business by maintaining an accurate time log.
If you have questions about this, we recommend that you contact your tax and/or financial advisor.
As discussed in last year's newsletter, the IRS issued guidance in 2007 relating to "partial terminations" of qualified retirement plans. The guidance provides that a partial termination is presumed to occur whenever 20% or more of the active participants in the plan terminate employment during a plan year. These rules are important because if a partial termination occurs, all participants who terminate during the plan year will become 100% vested in their account balance/accrued benefits.
The partial termination rules are only concerned with "employer-initiated" terminations. An "employer-initiated" termination is defined to include generally any termination other than on account of death, disability or retirement on or after normal retirement age. However, the employer may provide evidence (such as a written letter of resignation) that a termination was purely voluntary and thus not "employer-initiated".
Not every situation in which at least 20% of the participants terminate employment will trigger a partial termination it is a facts and circumstances test. Factors such as turnover for the employer during prior years and the extent to which terminated employees were replaced, whether the new employees performed the same functions, had the same job classification and received comparable compensation, are all relevant factors to consider when determining whether a partial termination has occurred.
Because it is a fact-specific analysis, your plan administrative firm may ask you to provide additional information on any terminations reported on your census. If you have questions about these rules, please feel free to contact us.
If you sponsor a 401(k) plan with the Roth (after-tax) feature, then a participant is able to prospectively designate that all or a portion of her salary deferrals will be made to a Roth 401(k) Account. These deferrals are called "designated Roth contributions" or "DRCs". Any portion of salary deferrals that the participant does not designate as DRCs will be traditional pre-tax deferrals.
Distribution Rules: Because the tax consequences of a distribution from a participant's Roth 401(k) Account are different from those of the participant's other plan accounts, the IRS has adopted special rules applicable to distributions from Roth 401(k) Accounts. These rules establish whether a Roth distribution is "qualified", meaning the investment earnings are tax-free, or "non-qualifying", meaning the investment earnings are subject to tax. These rules also establish certain procedures that must be followed whenever a participant rolls over her Roth 401(k) Account to an individual Roth IRA or to a Roth 401(k) Account in another 401(k) plan.
Form W-2 Reporting: DRCs must be separately reported on a participant's Form W-2. The IRS has instructed preparers to report DRCs in box 12 with code AA (pre-tax deferrals are reported with code D). In addition, because DRCs are made with after-tax dollars, they should also be included in the amount of taxable compensation reported in box 1 of the Form W-2. If incorrect information is reported on a Form W-2, the employer is subject to fines, which can be substantial, particularly since this might be considered to be tax fraud.
The Safe Harbor Notice is the key document in the annual operation of a safe harbor 401(k) plan. The notice describes in simple terms the major provisions of the plan.
A new participant must be given the Safe Harbor Notice (and preferably also the Summary Plan Description and Salary Reduction Agreement form) 30 to 90 days before her plan entry date. Check your Summary Plan Description to identify the entry dates for your plan. For most calendar year plans, the entry dates are January 1 and July 1. So, if a new participant will enter the plan on July 1, 2009, you should give her the Safe Harbor Notice sometime between April 2 and June 1 of 2009.
In addition to providing the initial notice, a Safe Harbor Notice must be given annually to all plan participants. The notice must be given 30 to 90 days before the plan year begins (thus, between approximately October 2 and December 1 for a calendar year plan). Your plan administrative firm will assist you in providing this notice.
If you do not timely distribute the Safe Harbor Notice to each newly eligible employee (including rehired employees) and allow salary deferrals to be made, you have caused, at the very least, an operational error which must be corrected. The IRS program known as the Employee Plans Compliance Resolution System (EPCRS) sets out an appropriate correction method and involves making corrective contributions for the affected employee(s). This will result in increased funding costs and administrative and legal expenses to you. If you have questions about which employees are eligible to participate in the plan, we recommend you contact your financial advisor, plan administrative firm or us for assistance.
The IRS establishes annual limits on amounts that can be contributed to retirement plans. These limits continue to increase. For 2008, the dollar limits for making salary deferrals to 401(k) plans (called the 402(g) limit), including "catch-up" contributions, are $15,500 and $5,000, respectively. "Catch-up" contributions are additional deferrals that participants who are 50 or older at any time during the year can make to a 401(k) plan.
The IRS recently released the 2009 dollar limits. These limits are indexed for inflation after 2009.
402(g) limit $16,500
catch-up limit $5,500
annual compensation limit $245,000
defined contribution plan dollar limit $49,000
defined benefit plan dollar limit $195,000
The assets of your 401(k) plan include the amounts that participants have requested your business withhold from their wages to defer into the plan. DOL regulations state that participant salary deferrals (including DRCs, if applicable) must be transmitted (i.e., deposited into or a check mailed) to the plan trust account as of the earliest date on which it is reasonably possible to do so.
In the summer of 2008, the DOL issued guidance establishing a safe harbor to meet the "earliest date" standard. Consistent with our prior recommendations, the DOL considers participant salary deferrals to be timely if transmitted to an account of the plan no later than 7 business days after the pay date. This safe harbor also applies to loan payments withheld from a participant's pay.
Please be aware that the DOL continues to take a proactive role in policing the late deposit of salary deferral (and loan payment) amounts. Thus, you may receive a letter from the DOL regarding salary deferral amounts that have been reported as late on Form 5500. Generally, the DOL letter will invite you to participate in a voluntary correction program. However, in some cases, plan sponsors are being notified that their plan has been selected for an audit. If you are contacted by the DOL, we recommend that you contact your plan administrative firm or us immediately.
There are many legal issues that arise in connection with any "non-traditional" investments. Basically, this includes any investment that is not in publicly traded stocks, bonds, mutual funds or qualified group pooled trusts. Examples include real estate investments, partnership interests, non-publicly traded stocks or loans. With respect to plan investments, we have identified three legal issues that often require analysis - fiduciary duties, prohibited transaction rules and plan asset regulations. In addition, non-traditional investments raise administrative issues concerning valuation and reporting of the non-traditional asset and the required coverage amount under the plan's ERISA bond.
If you are considering investing plan assets in a "non-traditional" investment, please contact your financial advisor or us for a general review of the legal issues. In certain circumstances, we may also advise a more thorough analysis of your specific facts and circumstances.
As every American is aware, we are currently living in unstable economic times. On account of recent market volatility, there is heightened focus on plan fiduciaries and their investment and other plan management decisions.
We believe that a key issue involves the impact to the plan whenever a participant is to be paid out of the plan, either on account of termination of employment or as an in-service distribution. It may no longer be prudent to make distributions based on the prior year's valuation (i.e., the prior December 31 value of the participant's account) as has been the status quo in the past. Whenever a participant is eligible to receive a distribution from the plan, a plan fiduciary should consider whether an interim valuation of the plan is warranted in order to avoid a disproportionate share of the extraordinary investment losses (or gains) being allocated to the remaining participants in the plan.
We recommend that you contact your plan administrative firm and your financial advisor to discuss this option prior to making any substantial distribution from the plan.
Any change in your business structure (incorporation, new partner, split in partnership, etc.) or establishment or purchase of an interest in another business may impact your qualified retirement plan. Please let us know about any change in your business structure as soon as possible. Also, please notify us of any changes regarding your office, mailing or email address, your telephone or fax number (including area code), or your plan advisors so that we may keep our records up to date.
It has finally happened! David Hilburn is now fully retired and enjoying this new chapter in his life. While he still maintains a residence in Texas, he is spending a substantial amount of time in Arizona. He is no longer a shareholder or Of Counsel to the firm. While David will certainly be missed, Allison Kohler and Richard Peeples will continue to work with our many clients. We remain committed to providing quality legal services at a reasonable fee
This newsletter contains general information and should not be used to resolve legal questions regarding specific fact situations.