Retirement plans and executive compensation.

• Author: Walker, Deborah
• Position: Compensation and Benefits Update, part 1

This is the first of a two-part his describing statutory, regulatory, and judicial changes in compensation and benefits over the past year. This part focuses on qualified retirement plans and executive compensation. Most of the changes involved pension plans, although enforcement attention on 401(k) plans increased, and the Labor Department issued and revised disclosure rules. The next part, in the December issue, will focus on health plan changes and employment taxes.

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Sec. 401(k) Plans

Listing of Required Modifications

Last revised in 2006, the Listing of Required Modifications (LRM) (1) for cash or deferred arrangements was recently updated by the IRS to include provisions that satisfy the relevant qualification requirements through the Small Business Jobs Act of 2010. (2) The LRM is primarily intended to assist the IRS in reviewing plan documents and helping to evaluate whether plan language meets certain requirements, but it is also helpful for those drafting or reviewing plans or plan amendments to be sure all required changes are made.

The updates include new provisions on eligible automatic contribution arrangements, as well as modifications to provisions on the Sec. 402(g) limit, gap-period income on corrective distributions (i.e., excess deferrals, excess contributions, and excess aggregate contributions), qualified reservist distributions, and safe-harbor matching contributions. The IRS also recently updated the LRM for defined contribution plans. There are also packages for traditional IRAs, Roth IRAs, 403(b) plans, defined benefit plans, and cross-testing provisions. (3)

Sponsor Survey Results

In 2009, the IRS surveyed 1,200 randomly selected 401(k) plan sponsors to better understand the 401(k) plan marketplace and to determine potential areas of noncompliance. The sponsors were required to complete a detailed questionnaire. The IRS has released a preliminary report of its findings from the examination of the plans. (4) It does not cite areas of noncompliance but reveals interesting information about the current structure of 401(k) plans, including:

* 86% use a preapproved plan document;

* 96% allow catch-up contributions;

* 68% provide matching contributions (and 58% require one year of service to be eligible for matching contributions);

* 54% require one year of service (and 64% require attainment of age 21) to be eligible to make 401(k) elective deferral contributions;

* 60% use the current-year method for the actual deferral percentage test;

* 62% allow in-service withdrawals;

* 65% permit plan loans;

* 1% have investments in employer securities; and

* 73% have a third-party administrator responsible for making timely plan amendments.

Profit Sharing Plans Offering Deferred Annuity Options

Rev. Rul. 2012-3 (5) provides guidance on the qualified joint and survivor annuity (QJSA) and qualified preretirement survivor annuity (QPSA) rules for a profit sharing plan that offers a deferred annuity contract as an investment option. The ruling describes three alternative plan designs and determines when the plan becomes subject to the QJSA and QPSA requirements and whether the plan has to provide the written QPSA explanation required by Sec. 417(a)(3) or obtain spousal consent for waiving the QPSA.

In general, the plan becomes subject to the rules when the participant can no longer transfer his or her assets from the deferred annuity contract to any other available investment option or demand a single-sum distribution. A plan subject to the rules does not have to provide the notice if it fully subsidizes the cost of the QPSA and the option to waive the QPSA or appoint a non-spouse beneficiary is not available.

Longevity Annuities

The IRS is proposing to modify the minimum required distribution rules to facilitate the purchase of longevity annuities. Under the proposed rules, (6) qualifying longevity annuity contracts (QLACs) could be excluded from the account balance used to calculate the minimum required distributions for those arrangements. A QLAC is an annuity contract (other than a variable contract, equity-indexed contract, or other similar contract) purchased from an insurance company that allows for distributions to begin on a specified date no later than age 85; whose premiums do not exceed 25% of the account balance, or, if less, $100,000; that has no commutation benefit (such as a period certain or refund of premiums); and has limited death benefits. Specifically, the only benefit permitted to be paid after the employee's death would be a life annuity payable to the surviving spouse equal to 100% of the annuity amount payable to the employee. In the case of any other beneficiary, the life annuity would have to satisfy the minimum incidental death benefit limitations under Sec. 401(a)(9)(G), which would limit the beneficiary's life annuity payments to an "applicable percentage" of the amount payable to the employee. The contract would also have to state that it intends to be a QLAC.

Pension Plans

Moving Ahead for Progress Act Amendments

On July 6, 2012, President Barack Obama signed into law the Moving Ahead for Progress in the 21st Century Act (MAP-21). (7) For single-employer pension plan sponsors, MAP-21 includes an interest rate stabilization provision (8) that should significantly reduce plan sponsors' minimum funding obligations in the short term--beginning in 2012. In 2013, however, a series of substantial increases to Pension Benefit Guaranty Corp. (PBGC) premiums for single- and multiemployer plans will begin to take effect as well.

Basically, the act amended Sec. 430(h)(2) and Employee Retirement Income Security Act (ERISA) Section 303(h)(2) to limit the segment rates used to calculate liabilities for pension funding and other purposes. The limit is based on a 25-year average segment rate to be determined and published by the Treasury Department. Each segment rate for a given month cannot be less than the "applicable minimum percentage" or more than the "applicable maximum percentage" of the relevant 25-year average. The applicable minimum and maximum percentages form a corridor that gradually widens over a five-year implementation period, as shown in the exhibit.

This corridor applies when calculating a plan's target normal cost, shortfall amortization base, and funding target under the minimum funding rules. It also applies when calculating a plan's adjusted funding target attainment percentage (AFTAP) under the Sec. 436 benefit restriction rules. It does not apply for purposes of:

* Calculating the maximum deduction limit for single-employer plans under Sec. 404(o);

* Calculating lump-sum distributions under Sec. 417(e);

* Determining if a plan has excess pension assets that can be transferred to a retiree health account pursuant to Sec. 420;

* Calculating a plan's unfunded vested benefits under the PBGC variable-rate premium rules; and

* Determining if a plan sponsor is subject to the ERISA Section 4010 information-reporting requirements.

Plans covered by ERISA may also be required to include information in their annual funding notices about the corridor's effect on their funding obligations. The additional information is required for any plan year beginning after Dec. 31, 2011, and before Jan. 1,2015, if the plan's funding target using the corridor is less than 95% of what the funding target would have been without the corridor; the plan's funding shortfall without the corridor would be greater than $500,000; and the plan had 50 or more participants on any day during the preceding plan year.

These changes generally apply to years beginning after 2011. The act permits plan sponsors to use the prior-law interest rate assumptions for the 2012 plan year and to first apply the new rules in 2013. A plan sponsor that makes this election can do so for all purposes or solely for determining the plan's AFTAP for 2012.

Beginning in 2013, the flat-rate PBGC premium for single-employer plans increases from $35 to $42 per participant. In 2014, the flat-rate premium will rise to $49 per participant and be adjusted for inflation in 2015 and beyond. The single-employer program's variable-rate premium--currently $9 per $1,000 of unfunded vested benefits--will be adjusted for inflation beginning in 2013. Additionally, the inflation-adjusted $9 per $1,000 of unfunded vested benefit variable-rate premium will be increased by $4 in 2014 and by $5 in 2015. However, a $400-per-participant variable-rate premium cap will apply beginning in 2013. The cap amount also will be adjusted for inflation beginning in 2014. Flat-rate premiums for multiemployer plans will be increased by $3 per participant beginning in 2013.

Sec. 436 Compliance Deadline Extended

Notice 2011-96 (9) gave sponsors of defined benefit plans more time to adopt amendments to comply with the Sec. 436 funding-based limits on accruals and accelerated benefit payments. Before the notice was issued in November 2011, the deadline was the last day of the plan year beginning in 2011. The notice extended the deadline to the latest of: (1) the last day of the first plan year that begins in 2012; (2) the last day of the plan year for which Sec. 436 is first effective for the plan; or (3) the due date, including extensions, of the employer's tax return for the tax year that contains the first day of the plan year for which Sec. 436 is first effective for the plan. For most plans, the deadline will be the last day of the plan year beginning in 2012. However, filing a determination letter application for an individually designed plan accelerates the deadline, as determination letter applications filed on or after Feb. 1, 2012, require the restated plan to incorporate an interim amendment to comply with Sec. 436.

The notice also provided a sample amendment that, if timely adopted with changes only as permitted, would satisfy the Sec. 436 requirements and not cause a violation of the Sec. 411(d)(6) anti-cutback...