United States: A Summary of Important 2006 Rule Changes for Retirement and Welfare Benefit Plans

A number of changes relating to qualified retirement plans (including 401(k) plans) and employee welfare benefit plans will become effective either on January 1, 2006 or later during 2006. This Alert summarizes some of the more important of these upcoming changes.

The Internal Revenue Service issued comprehensive regulations for 401(k) plans that will become effective, and compliance will become mandatory, January 1, 2006. This is the first comprehensive rewrite of the 401(k) regulations since 1991 and incorporates changes under several laws, including GUST, TRA 97, and EGTRRA. The new regulations also incorporate guidance on automatic enrollment, safe harbor 401(k) plans and SIMPLE 401(k) plans.

All 401(k) plans must comply in operation with the new regulations with the first plan year beginning on or after January 1, 2006. Therefore, for calendar year plans, the effective date will be January 1, 2006.

Amendments to comply with the regulations will be required in accordance with a proposed IRS procedure that has yet to be finalized. See New Amendment and Determination Letter Procedures Expected below.

The new regulations address issues such as prefunded contributions, targeted QNECs or QMACs, requiring income to be included in certain corrective distributions, and new hardship withdrawal events and guidance.

Effective January 1, 2006, 401(k) plans are permitted, but not required, to offer Roth 401(k) accounts to participants, as discussed in an earlier Cooley Alert . Roth 401(k) accounts do not increase the maximum amount that may be contributed by a participant to the 401(k) plan, but they do allow the participant to designate whether to make all or some portion of the contribution on the traditional pre-tax basis (contributions and earnings taxed when distributed from the plan) or the new Roth 401(k) post-tax basis (contributions not taxed when distributed and earnings not taxed when distributed if the distribution is a "qualified distribution").

If you are interested in adding Roth 401(k) accounts to your 401(k) plan, you should contact the entity or person that is responsible for amending your plan and record keeping for your plan to discuss the necessary plan amendment and separate record keeping.

New amendment and determination letter procedures expected

In 2004, the IRS indicated its intent to adopt a rolling 5-year amendment period and determination letter cycle for qualified retirement plans. As of the date of this Alert, the IRS has not announced the final version of its guidance.

The rolling 5-year cycle would require qualified retirement plans to be amended for tax law changes and other qualification requirements only once every five years and would provide a 12-month window during which the plans may request a new determination letter. The amendment year for a plan and the determination letter application year for the plan will coincide. The first cycle is expected to begin in 2006, but until final guidance is issued, it is not possible to determine a plan’s amendment/determination letter year.

As under current rules, qualified retirement plans would be required to comply in operation with all applicable qualification requirements, regardless of which year of the 5-year cycle is the plan’s amendment year.

The rules for updating terminating plans and filing determination letters on terminating plans will not change substantially. On-going plans will not be prohibited from submitting determination letter applications in an "off" year, but those applications will be processed last by the IRS and so will take longer to receive a response.

New disclosure requirements for qualified retirement plans and 403(b) tax deferred annuity plans, that were postponed in 2004, are scheduled to become effective for annuity starting dates that begin on or after February 1, 2006. These disclosure rules are complex and will affect primarily defined benefit plans, money purchase pension plans and 403(b) tax deferred annuity plans. However, profit sharing plans and 401(k) plans that offer annuity forms of distribution also will be subject to these rules. If your plan offers annuities as a form of benefit, you should contact your plan record keeper or trustee to discuss the disclosure documentation that will be required beginning with distributions to participants on or after February 1, 2006.

New regulations that were issued in a coordinated package by the Internal Revenue Service, the Department of Labor and the Department of Health and Human Services late in 2004 will become effective for health plans for plan years beginning on or after July 1, 2005. The primary focus of these regulations is the limits on preexisting conditions in group health plans. These regulations do not significantly change the interim rules that have been in effect since 1997.

However, the new regulations do require that a notice educating participants with respect to their HIPAA pre-existing condition rights must be provided. New HIPAA Certificates with the educational explanation must be provided on and after the effective date of the regulations. The explanations are to be incorporated into the HIPAA Certificate of Group Health Plan Coverage. The regulations provide model language to help plan sponsors meet this educational requirement, although it is expected that health insurers and health plan administrators will take the lead in providing the required notice.

As discussed in an earlier Cooley Alert , the "use it or lose it" period for flexible spending accounts offered under cafeteria (Section 125) plans may be extended for up to 2½ months following the end of the plan year.

This is an optional extension that may, or may not, be offered by a plan. If participants rarely forfeit amounts, or forfeit only small amounts, under their dependent care or health care spending accounts, then adopting the extension may not be desirable. However, if participants frequently forfeit amounts, or forfeit large amounts, adopting an extension may help participants avoid or reduce such forfeitures.

In order to allow the extension under your cafeteria plan, the plan must be amended.

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.