IRS guidance for automatic rollovers has been issued (Notice 2005-5). The Department of Labor previously issued guidance establishing a fiduciary "safe harbor" for setting up the rollover IRAs needed to implement the EGTRRA requirement that mandatory distributions of more than $1,000 from qualified retirement plans must be paid in a direct rollover to an IRA, effective March 28, 2005, unless the intended recipient provides other instructions. Now, the IRS has issued coordinating guidance.

The IRS guidance includes two kinds of administrative relief. Plans will have until the end of the first plan year ending on or after March 28, 2005, to adopt a good faith amendment reflecting the automatic rollover rules, even though the rules are effective March 28, 2005. A sample amendment for this purpose is included in the Notice.

Also, a plan will not be considered to have failed to operate according to its terms (including the automatic rollover provisions) with respect to mandatory distributions because it does not process them due to a lack of sufficient administrative procedures, including establishing the IRAs needed to accept automatic rollovers, provided any "late" mandatory distributions are made no later than December 31, 2005.

The IRS guidance also states that the automatic rollover rule added to Code Section 401(a)(31) by EGTRRA also applies to governmental and church plans, but delays compliance for those plans until after the close of the first legislative session (or church convention) of the body which has the authority to amend the plan that begins on or after January 1, 2006. It is not yet clear what a "church convention" is, or what the effective date is for a church plan that is amended other than by a "church convention."

Final rules under Code Sections 401(k) and 401(m) are issued (T. D. 9169). This massive (232 pages) restatement of the rules for 401(k) plans brings the rules current with developments in the law since the prior rules were issued in 1991. The most substantial changes in the law related to the methods for testing the amount of elective contributions, matching contributions, and employee contributions for nondiscrimination, according to the IRS announcement of the new rules. The guidance retains the restrictions in the proposed rules on the use of the "bottom-up leveling" approach to satisfy the ADP and ACP tests. Also consistent with the proposed regulations, the former requirement to disaggregate the ESOP and non-ESOP portions of a 401(k) plan and apply two separate ADP and ACP tests has been eliminated. Under the final rules, an employer is allowed permissively to aggregate the two plan components. This change may be adopted beginning for plan years ending on or after December 29, 2004, provided the plan applies all of the rules of the final regulations to the first plan year for which it is adopted and all subsequent plan years.

Funeral expenses and certain expenses relating to the repair of damage to the employee’s principal residence are added to the list of deemed (safe harbor) heavy financial needs for hardship distribution purposes. The rules have also been modified to allow medical expenses and post-secondary education expenses to be determined for an employee, spouse, or dependent without taking into account the 2004 statutory changes made to Code Section 152’s definition of "dependent." The definition of dependent for heavy financial need due to medical expenses is also expanded to include a non-custodial child who is subject to the support test under amended Code Section 152(e) for a child of divorced parents. The final regulations apply for plan years beginning on or after January 1, 2006.

IRS issued 1,700 letters warning against certain abusive tax practices to S corporations sponsoring ESOPs and employing fewer than 10 persons. The letter points out that the special rules prohibiting certain practices by small S corporation ESOPs become effective on January 1, 2005. IRS also issued proposed and temporary regulations (REG-129709-3 and T. D. 9164) that impose income and excise taxes on S corporations making prohibited ESOP allocations.

The Department of Labor issued guidance on the fiduciary duties of directed trustees holding publicly traded securities of the employer (Field Assistance Bulletin 2004-03). Typical situations are where there is an employer stock investment option in a 401(k) plan of a publicly traded employer, or where the pension plan of a publicly traded company holds shares of employer stock that are subject to the direction of a plan fiduciary other than the directed trustee. The Department of Labor has, for years, considered directed trustees to be ERISA plan fiduciaries, while directed trustees consider themselves to be merely agents of the plan’s fiduciaries. In this guidance, the Labor Department reiterates its view that directed trustees are ERISA fiduciaries, but then narrowly circumscribes their fiduciary responsibilities.

An update on defined benefit pension plan statistics paints a gloomy picture for the future of pensions. According to Bloomberg.com, citing PBGC data, there were 114,000 defined benefit plans in 1986 and there are about 30,000 today. In 1978, when 401(k) plans began, 11% of total contributions to all types of retirement plans were made by employees. By 1999, 70% of all contributions to 401(k) plans and 51% of all contributions to defined benefit plans were made by employees. (We think that percentage is probably lower today because more employers have had to make cash contributions to their pensions because of the decline in asset values in recent years.) The article also noted that IBM recently said that it will offer a 401(k) plan to employees hired on and after January 1, 2005, instead of a defined benefit plan.

If you administer a retirement plan, be sure to read this item. Form SSA is an obscure schedule that is filed along with annual Form 5500s to report to the Social Security Administration the names and benefit information of employees who leave vested benefits in a retirement plan when they terminate employment. The Social Security Administration then reports the benefit information to these persons when they apply for Social Security benefits, telling them they "may" have entitlement to benefits from a retirement plan and that they "should" contact the plan administrator (name and address provided) to apply for those benefits. In one recent case brought to the attention of our office, the former spouse of a former plan participant received a letter telling her that "you or the worker whose name appears at the top of this letter may be entitled to benefits" from our client’s pension plan.

We don’t know quite how such a letter to a former spouse came about, but the message to plan sponsors seems to be clear: You are going to have to be able to prove that benefits were properly paid out, in some cases many years in the past, in order to deal expediently with past participants (and perhaps their former spouses) who send in these letters from the Social Security Administration saying, "pay me." This can be a daunting task, given that records may not have been retained and given that the plan sponsor may have been bought, sold, merged, and reorganized many times over in the interim.

The instructions to Form SSA have said for years that a plan "may" use the form to report revisions to pension information for a participant previously reported on Form SSA (reporting that the vested deferred benefits were actually paid—for example on early retirement). An interesting change has been made in the 2004 Form 5500 instructions regarding the use of Form SSA. For the first time, the instructions say (on page 57), that it is required that you file follow-up Form SSAs to report participants who previously were reported but who are no longer entitled to deferred vested benefits. (There is no indication in the instructions that this requirement is retroactive.) Filing follow-up Form SSAs seems to us to be a very good idea because, if the information the Social Security Administration has is not up to date, their notification letters may be misleading and create extra work for plan administrators.

It may also be appropriate to retain records of benefit payments to all participants until the point at which the recipient qualifies for Social Security benefits, just to be sure the plan can respond to former participants who send the plan copies of notification letters from Social Security.

Employee Welfare Benefit Plans: December 2004 Developments

Final HIPAA portability rules are issued by the Department of Labor, Department of Health and Human Services, and the Department of the Treasury. These rules were initially issued on an interim basis in 1997 and can be found at 69 Fed. Reg. 78719. Additional portability rules are also proposed at 69 Fed. Reg. 78799. According to the agency announcements, the final rules are similar to the 1997 interim rules but make some changes. For example, certificates of creditable coverage will be required to include an educational statement on the HIPAA rights of beneficiaries. The final rules contain model language for the required educational statements. The HIPAA final rules become effective for plan years beginning on or after July 1, 2005.

Veterans Benefits Improvements Act of 2004 was signed on December 10, 2004 (Pub. L. No. 108-454). The Act extends the maximum period for health plan continuation to 24 months under the Uniformed Services Employment and Reemployment Rights Act ("USERRA") and adds a notice requirement for employers. The previous maximum period for health plan continuation had been 18 months. The Act creates a longer protection period than is usually available under COBRA (18 months). The Act applies to elections made on or after December 10, 2004. The new notice requirement is effective March 10, 2005, and may be satisfied by posting in the work place a copy of the notice that will be provided for this purpose by the Department of Labor. Affected workers may have rights under both COBRA and USERRA, and are entitled to protection under the law that provides the greater protection.

Executive Compensation Matters: December 2004 Developments

Preliminary guidance on new Code Section 409A, applicable to nonqualified deferred compensation, was issued by the IRS (Notice 2005-1). We provided a brief overview of the guidance in a special edition of this Newsletter on December 21, 2004, available at www.foley.com/employeebenefits. As reported there, the Notice offered excellent guidance for making the transition to the new rules during 2005. More comprehensive guidance will be issued this year.

The Financial Accounting Standards Board has issued a final rule on stock option expensing (FASB Statement No. 123 (revised 2004), Share-Based Payment). According to the FASB announcement, "Statement 123(R) will provide investors and other users of financial statements with more complete and neutral financial information by requiring that the compensation cost relating to share-based payment transactions be recognized in financial statements." Public entities will be required to apply Statement 123(R) as of the first interim or annual reporting period that begins after June 1, 2005. Currently, approximately 750 public companies in the U. S. are voluntarily applying Statement 123(R)’s fair-value based method of accounting for share-based payments or have announced plans to do so.

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.