United States: Employee Benefits Report: The Pension Protection Act Of 2006—Defined Contribution Plans

The Pension Protection Act of 2006 (the "PPA," the "Act") was signed by President Bush on August 17, 2006. The Employee Benefits practice group of Thelen Reid & Priest LLP has issued a series of reports that summarize selected provisions of the Act. The following is the sixth in the series and summarizes significant modifications primarily affecting defined contribution plans.

The vesting schedules implemented by EGTRRA for matching contributions apply for all employer nonelective contributions made to a defined contribution plan for plan years beginning after December 31, 2006. For any employee who has an hour of service after the effective date, nonelective contributions made on his or her behalf must vest under either a three-year cliff or a two to six year graded vesting schedule (or another schedule that is at least as favorable). There are special phase-in effective dates for collectively bargained plans and certain ESOPs.

Participants who are able to exercise investment control over their accounts and whose accounts are transferred into default investments due to a failure to provide investment directions will continue to be treated as exercising control over such assets and therefore will continue to bear the fiduciary responsibility associated with such investment. In order for a plan to rely on this provision, a plan administrator must provide participants with proper notification. This provision is effective for plan years beginning after December 31, 2006.

A participant or beneficiary who is able to exercise control over the assets in his or her account before a "qualified change" in investments options occurs will not be treated as failing to continue to exercise control over such assets as a result of the "qualified change." A qualified change generally occurs where existing funds are "mapped" to new funds that have similar characteristics for risk and rates of return. In order to rely on this provision, a plan administrator must provide participants with proper notification and comply with "blackout" period requirements. This provision is generally effective for plan years beginning after December 31, 2007, with a special transition effective date for collectively bargained plans.

Many defined contribution plans with assets invested in publicly-traded employer securities are required to permit participants (and beneficiaries) to diversify such amounts into other investment alternatives. See the forthcoming Benefits Report regarding changes affecting ESOPs for further information.

The rules for determining whether a participant has incurred a financial hardship (with respect to Section 401(k) plans or tax-sheltered annuities) or an unforeseeable emergency (with respect to Section 457 plans and nonqualified deferred compensation plans subject to Section 409A) are modified to include such hardships or emergencies for participants’ beneficiaries. This provision became effective as of August 17, 2006.

• After-tax Amounts in 403(b) Plans to a Qualified Plan. Effective for taxable years beginning after December 31, 2006, after-tax contributions in 403(b) annuity contracts may be transferred in a direct rollover to a qualified retirement plan; provided that the plan to which the rollover is made continues to separately account for after-tax contributions (and earnings thereon).

• Direct Rollovers from Retirement Plans to Roth IRAs. Effective for distributions made after 2007, taxpayers may make direct rollovers into Roth IRAs from qualified plans, 403(b) annuities or 457 plans.

• Nonspouse Beneficiaries. Effective for distributions made after 2006, nonspouse beneficiaries may make direct rollovers into IRAs from qualified plans, 457 plans or 403(b) annuities. Such IRAs are treated as inherited IRAs of the nonspouse beneficiaries and are subject to the distribution rules applicable for beneficiaries.

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.