Current developments in employee benefits.

• Jurisdiction: United States
• Date: 01 November 1996
• Author: Walker, Deborah

The past year brought significant changes to the employee benefits area. This two-part article summarizes those changes and suggests planning opportunities for employers sponsoring benefit plans. Part I, below, discusses changes related to qualified retirement plans, excluding the changes enacted as part of the Small Business job Protection Act. Part II, to be published in December, will examine changes related to employee stock ownership plans, compensation, Sec. 403(b) plans and welfare benefits plans.

Qualified Plan Distributions

Final Regs. Secs. 1.401(a)(31)-1, 1.402(f)-1 and 31.3405(c)-1 provide guidance on direct rollover options and the 20% withholding tax on plan distributions not directly rolled over(1); Temp. Regs. Secs. 1.411(a)-11T and 1.417(e)-1T were also issued to offer guidance on the notice requirements.(2) Most employers want to coordinate the timing of the direct rollover notice with the participant and spousal consent notices.

The Unemployment Compensation Amendments (UCA) were enacted in July 1992; UCA Section 522(a) added Sec. 401(a)(31) and modified Secs. 402 and 3405 to require plans to give employees taking a distribution a choice between a (1) direct rollover into an individual retirement account (IRA) or another qualified retirement plan and (2) direct payout option. (UCA Sections 521 and 522 added an equivalent rule for Sec. 403(b) plans.) Under the UCA, if an employee could but does not choose a direct rollover, the plan administrator must withhold 20% of the distribution as income tax withholdng The disclosure rules were therefore amended to require that notice be given before the distribution, so that a participant has sufficient information to make an informed choice. In general, notice to participants and spouses has to be given no less than 30 days and no more than 90 days before the annuity starting date.

Notice 93-26(3) permitted most profit-sharing and stock bonus plans to allow employees to waive the 30-day waiting period (provided employees had notice of such period). Temp. Regs. Sec. 1.417(e)-1T (b)_(2)(3)(i) extends the 30-day waiver rule to plans subject to spousal consent, provided certain conditions are met. The regulations do not eliminate or change the 90-day period, thus, the employee must receive a Sec. 402(f) notice no more than @O days before a distribution. (Some daily valuation plans have addressed the 90-day requirement by sending out notice with each quarterly benefit statement.) Regs. Sec. 1.402(f)-1, Q&A-4, makes clear that posting the notice on an employee information board does not constitute giving notice within 90 days, and reiterates the Sec. 402(f) (1) requirement that notice be in writing. (Daily valuation companies had asked for an annual written notice supplemented by electronic bulletin board availability; the IRS has not approved this approach.)

Under Temp. Regs. Sec. 1.417 (e)-1T(b), assuming a plan has received an "affirmative distribution election" (i.e., an affirmative election as to the form of distribution, to which the spouse consents, if necessary), the employee (with spousal consent) can waive the 30-day waiting period; distributions can begin no less than seven days after the qualified joint and survivor annuity (QJSA) notice was given to the participant. The participant and spouse must be told that they have 30 days to reconsider whether to waive the QJSA and consent to a different form of distribution, and that they can revoke their election up to the annuity starting date. The participant (and spouse) must have, the right to revoke the election until the later of the annuity starting date or the end of the seven-day period that begins the day after QJSA notice is given. The annuity starting date must be after the date QJSA notice is given.

Example 1: Prior to the issuance of the regulations, G, a newly laid-off employee, enters the human resources department at her firm, asks for a distribution from the pension plan in which she participates, and is given all the applicable forms. G would be advised that, assuming all of the paperwork is timely completed, she would receive a distribution at the end of 30 days (thus, in the absence of a severance package, G would have to survive for one month without pay). After the regulations, G can enter the human resources department on a Friday, receive the forms, be advised that the annuity starting date is Monday and that if G so elects, she can receive the distribution in one week (assuming all of the paperwork is timely completed).

It is not clear how many plans can take advantage of the new rule; presumably, daily valuation companies can now sell their voice response/fast distribution systems to money purchase an defined benefit plans. In most quarterly or annual valuation plans, the 30-day period is not usually a concern, because the plan will not make a payment until after the next valuation date.

Other noticeable changes from previously issued guidance are highlighted below: * According to Regs. Sec. 1.402(c)-2, Q&A-3, ancillary benefits and benefits not protected by Sec. 411(d)(6) are included in the definition of eligible rollover distribution and cannot be excluded in determining the amount available for rollover or for mandatory 20% withholding. * Reg. Sec. 1.402(c)-2, Q&A-5(d) adds examples slightly clarifying the definition of "substantially equal periodic payments" (a distribution that consists of substantially equal periodic payments over at least 10 years is exempt from the direct rollover and mandatory withholding rules). The general rule is that if a payment stream is expected to significantly change over time, it may not be "substantially equal." The regulations reiterate that the calculation methods in Notice 89-25(4) (for determining whether the 10% early distribution tax applies) can be used. The regulations further provide that a defined contribution plan can calculate the term of a distribution using a "declining balance of years" method. If the plan intends to use a flat payment until the account is exhausted, this calculation must use reasonable actuarial assumptions to determine whether the payments are likely to run for more than 10 years. * In response to questions from defined benefit plan administrators concerning plans with a Social Security supplement, Regs. Sec. 1.402(c)-2, Q&A-5(b) provides that payments reduced when Social Security payments are made are still "substantially equal," unless the reduction will be more than the anticipated Social Security benefits. * Many commentators raised questions about plans (mostly union-type plans) that issue "13th checks" if the fund has done well in a particular year or pays supplements in certain years and not in others (usually under collective bargaining agreements). The general rule is that such additional payments are independent of the normal payment stream and thus are eligible rollover distributions. However, Regs. Sec. 1.402(c)-2, Q&A-6(b) (2) provides a safe harbor, under which supplemental payments are not independent payments if they are (1) given to all similarly situated annuitants and (2) not more than the greater of (a) 10% of the annual payment or (b) $750. In addition, Regs. Sec.1.402(c)-2, Q&A-6(b) notes that corrective payments are not independent payments.

Example 2: A plan miscalculates an annuity payment and for two years pays out a smaller amount than required. In the third year, the plan makes a lump-sum payment to make up the difference. This is not an independent payment subject to the direct rollover rules.

* Based on comments from frustrated payors, Regs. Sec. 1.401(a)(31)-1, Q&A-17(b) allows plan administrators to assume that the $5,000 death benefit exclusion applies to the benefit being paid, thus, up to the first $5,000 of payments can be ignored in determining 20% withholding on death-benefit payments. * Regs. Sec. 1.401(a)(31)-1, Q&A-7 and -13(b) clarify administrative provisions added to the proposed regulations to ease the burdens of plan administrators. First, the plan can provide a "default" procedure for employees who fail to make an affirmative distribution election if the employee is notified of such procedure (some plans make default distributions into IRAs, avoiding the 20% withholding administrative problems). Second, a plan receiving a direct rollover will generally not be tainted by taking in an illegal rollover (e.g., a rollover of a minimum required distribution) if it obtains a letter from the sending plan indicating that the latter has a determination letter. Regs. Sec. 1.401(a)(31)-1, Q&A-6(b) provides that a plan may not have direct rollover rules that "substantially impair" the right to take a direct rollover. Some employers have established rules that "encourage" employees to take distributions rather than rollovers (e.g., one employer required an opinion from "competent counsel" stating that the receiving plan was qualified). * Regs. Secs. 1.402(c)-2, Q&A-2 and 31.3405(c)-1, Q&A-8 provide that a plan may permit a direct rollover to a define benefit plan (Sec. 402(c)(8)(B) says "defined contribution plan"). Regs. Sec. 31.3405(c)-1, Q&A-3 provides that plans may offer the option of withholding more than 20% of the distribution (thereby relieving employees of estimated tax filings); withholding less than 20% is not an option.

Sec. 404(a)(6) and the All-Events Test

An Industry Specialization Program (ISP) Coordinated Issue Paper for the Retail Industry(5) (ISP Paper) states that contributions to a Sec. 401(k) plan or Sec. 401(m) matching contributions are not deductible by the employer for a specific tax year if attributable to compensation earned by plan participants after the end of such year. The ISP Paper expands the rationale of Rev. Rul. 90-105,(6) which addressed the application of Sec. 404(a)(6) to the deduction of Sec. 401(k) and (m) contributions and concluded that such contributions are not deductible in a given tax year if attributable to...