United States: Recent Developments for Qualified Retirement Plans; Final HIPAA Portability Rules Announced

The Department of Labor had previously issued guidance establishing a fiduciary "safe harbor" for setting up the rollover IRAs needed to implement the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") requirement that mandatory distributions of more than $1,000 from qualified retirement plans ("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 new Internal Revenue Service ("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.

In addition, 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.

Final rules under Internal Revenue Code ("Code") Sections 401(k) and 401(m) have been issued. 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 relate 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 average deferral percentage ("ADP") and average contribution percentage ("ACP") tests.

Consistent with the proposed regulations, the former requirement to disaggregate the Employee Stock Option Plan ("ESOP") and non ESOP components of a 401(k) plan and apply two separate ADP and ACP tests has been eliminated. Under the final rules, an employer is permissively allowed to aggregate the plan's two components. This change may be adopted beginning with 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 has also been 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 has 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. The 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.

An update on defined benefit pension plan statistics paints a gloomy picture for the future of pensions. According to Bloomberg.com, citing Pension Benefit Guaranty Corporation 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 believe 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 with care the instructions to Form SSA. Form SSA is an obscure schedule that is filed along with annual Form 5500s to report to the Social Security Administration ("SSA") the names and benefit information of employees who leave vested benefits in a retirement plan when they terminate employment. The SSA 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 are unaware of how such a letter to a former spouse came to be sent, 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, 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 SSA stating, "pay me." This can be a daunting task, given that records may not have been retained and the plan sponsor may have been bought, sold, merged, and reorganized many times over in the interim.

The instructions to Form SSA have for years stated 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 state that the plan is required to file a follow-up Form SSA to report participants who were previously reported but who are no longer entitled to deferred vested benefits. (There is no indication in the instructions that this requirement is retroactive.)

Even without this new requirement, we recommend filing follow-up Form SSAs because, if the information the SSA has is not current, its 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 ensure the plan can respond to former participants who send the plan copies of notification letters from Social Security.

Final HIPAA portability rules have been issued by the Department of Labor, Department of Health and Human Services, and the Department of the Treasury which were initially issued on an interim basis in 1997. Additional portability rules have also been proposed. According to these 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, and these rules contain model language for the required statements. The HIPAA final rules become effective for plan years beginning on or after July 1, 2005.

The Veterans Benefits Improvements Act of 2004 ("Act") signed on December 10, 2004, 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), and 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 a copy of the notice (in the work place) which will be provided 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 them the greater protection.

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