SunGard Relius

The IRS just released Notice 2007-7 which provides guidance on a number of PPA provisions which became effective in 2006 or in 2007. The Notice addresses the following subjects:

Beneficiary Hardship Distributions. Under PPA, a 401(k) plan using the “safe harbor” deemed “immediate and heavy need” hardship events, may provide a distribution to a participant based on the hardship of the participant’s plan beneficiary. Under the Notice, the plan may make a “beneficiary hardship” distribution beginning August 17, 2006. The hardship events which qualify for beneficiary hardship treatment include medical, educational and funeral expenses. The “beneficiary” for this purpose includes any “primary beneficiary,” which means someone who is “named as a beneficiary under the plan” and who has an unconditional right to some or all of the participant’s account upon the participant’s death. This means that a contingent or secondary beneficiary would not qualify. It appears that a primary beneficiary could be one whom the participant designates or a plan “default” beneficiary. The same rules apply to 403(b) plans. This PPA hardship rule also applies to “unforeseeable emergency” distributions under a 457(b) plan or a 409A plan. The final 409A regulations will address this change.

Non-spouse Beneficiary Rollover. Prior to PPA, a non-spouse beneficiary could not roll over the participant’s account to any other plan. PPA permits a plan to offer a non-spouse beneficiary the option to directly roll over the distribution to an “inherited IRA,” within the meaning of Code §408(d)(3)(C). The types of plans which may offer this rollover option include a Code §401(a) qualified plan, a Code §§403(a) or (b) plan or an eligible governmental 457 plan. The inherited IRA must be titled in a manner that reflects the decedent and the beneficiary, such as “Jessica Jones, as beneficiary of William Jones.” Unlike direct rollover rights in favor of a participant or a surviving spouse, a plan is not required to offer the non-spouse rollover option. This option is a right or feature, which if offered, must be available on a nondiscriminatory basis. A defined contribution plan terminated under the DOL’s fiduciary safe harbor rules for missing beneficiaries will be considered to offer this option regardless of the plan terms. A non-spouse beneficiary rollover is not subject to the direct rollover rules of Code §401(a)(31), the notice requirements of Code §402(f) or to 20% mandatory withholding under Code §3405(c). Since a non-spouse beneficiary rollover must be direct, if the beneficiary receives the distribution, he/she cannot roll it over. A proper trust beneficiary (with designated beneficiaries under Code §401(a)(9)) also may roll over a distribution to an IRA with the trust established as the IRA beneficiary. A non-spouse beneficiary may not roll over any required minimum distribution (“RMD”). If the participant dies before his/her required beginning date (“RBD”), the plan determines the RMD based either on the 5-year rule or on the life expectancy rule, in accordance with Treas. Reg. §1.401(a)(9)-3, Q/A-4. Under the 5-year rule, a beneficiary could roll to an IRA for the first 4 years after the year of the participant’s death, without concern for the RMD rules. However, in this case, the beneficiary must apply the 5-year rule to the IRA RMDs. If death occurs after the RBD, the “lifetime” RMD for the year of death is not eligible for rollover. For subsequent years, any RMD determined under Treas. Reg. §1.401(a)(9)-5, Q/A-5, is not eligible for rollover. RMDs to the beneficiary from the inherited IRA which receives the rollover are determined under Code §401(a)(9)(B) and the regulations thereunder. The IRA RMDs are calculated under either the 5-year or life expectancy method, depending on which method applied under the distributing plan.

Note: Although a plan electing to permit non-spouse rollovers is not required to provide a 402(f) notice, the plan administrator may elect to do so as a means of timely communicating this right to the beneficiary. Failure to provide the notice may affect whether the right is effectively available under the nondiscrimination regulations.

Vesting of Nonelective Contributions. PPA requires top-heavy or more generous vesting for nonelective contributions made for plan years beginning after December 31, 2006. A plan amendment made to satisfy the PPA vesting rules must satisfy Code §411(a)(10), requiring no reduction of the pre-amendment vested percentage and affording an election of schedules to participants with 3 or more years of vesting service. However, no election is required where a participant’s vesting at any time, under the amended schedule, cannot be less than the percentage determined without regard to the PPA amendment. A plan may elect to provide for “bifurcated” vesting with the PPA schedule applying only to nonelective contribution made for post-2006 plan years and the pre-PPA schedule continuing to apply to pre-2007 plan year contributions. If a plan uses bifurcated vesting, the Notice provides that a contribution is a pre-2007 contribution (and therefore subject to pre-PPA vesting rules) if the plan allocates the contribution as of a date within a pre-2007 plan year and the contribution is not subject to a condition the participant has not satisfied by the end of that plan year, even if the employer does not make the contribution until 2007.

Distribution Notices. PPA requires changes to distribution notices (including joint and survivor annuity rule notices) given in plan years that begin after December 31, 2006, regardless of the actual distribution date. Under the PPA changes, a distribution notice may remain in effect for up to 180 days instead of 90 days as under pre-PPA law. In addition, the notice must contain a description of the consequences of a participant’s failure to postpone the distribution. The plan must modify its distribution notices to provide this description for any notice given after the 2006 plan year. However, until 90 days after the IRS issues regulations on the subject, the plan administrator need only make a “reasonable attempt” to comply. The Notice provides a safe harbor for the “description of the consequences” statement. To meet the safe harbor, the description must be written in a manner reasonably calculated to be understood by the average participant. In the case of a defined contribution plan, it must include: (i) a description of the plan investment options and fees available if distribution is deferred; and (ii) the portion of the SPD that contains any special rules that might affect materially the participant’s decision to defer. The Notice does not give any example of the latter, but this might include special taxation available such as income averaging. In the case of a defined benefit plan, the notice must include the same SPD “material information” and, in lieu of investment information, it must describe how much larger benefits will be if the participant defers distribution. That description may be one that includes the financial effect of deferral as described under Treas. Reg. §1.417(a)(3)-1(d)(2)(i).

IRA Distributions to Charity. In 2006 and 2007 only, PPA permits an individual who is 70½ to cause his/her IRA to make a distribution directly to a qualified charity, without the distribution being taxable to the IRA owner. The rule applies only to IRA distributions which the owner otherwise would include in gross income. While the individual may not take a charitable contribution deduction for such amounts, the distributions do apply toward the RMD otherwise required for that calendar year. The PPA provisions apply even to 2006 IRA distributions made before the PPA enactment date. The limit on the amount of such distributions is $100,000 per year. An individual with more than one IRA must aggregate all such distributions in applying the limit. Each spouse in a couple who files jointly has his/her own $100,000 limit. Any taxable IRA distribution (except from a SEP or from a SIMPLE IRA to which an employer contributes for the taxable year of the qualified charitable distribution), including the taxable portion of a Roth IRA distribution, qualifies for this special tax treatment. An IRA beneficiary who is 70½ also may take advantage of the PPA IRA distributions to charity rule. Qualified distributions are not subject to withholding under Code §3405 and the IRA trustee or custodian may rely on the reasonable representations of the IRA owner that the distribution is qualified. The IRA may make the distribution directly to the charity or the IRA owner may receive the distribution check and deliver it to the charity, provided that the check is made payable to the charity. If the distribution does not qualify under the PPA rules, it is treated as taxable to the IRA owner under Code §408 or Code §408A and then treated as a charitable contribution under Code §170.

Interest Rate Assumptions for Lump Sum Distributions from Defined Benefit Plans. Code §415(b)(2)(B) requires an actuarial adjustment to benefits payable in a form other than a straight life annuity to determine if the benefit complies with the Code §415(b) limit. PPA amended Code §415(b)(2)(E)(ii) to provide that the interest rate assumption must not be less than the greatest of: (i) 5.5%; (ii) the rate that would provide a benefit of not more than 105% of the benefit that would be provided if the Code §417(e)(3) rate were the assumed rate; or (iii) the plan specified rate. Concerning this PPA change, the Notice provides effective date rules, anti-cutback guidance and correction rules for excess distributions.

Distributions to Public Safety Employees. PPA contains an exception to the Code §72(t) 10% penalty for distributions from a governmental defined benefit plan to a “qualified public safety employee” who separates from service after age 50. The Notice defines a “public safety employee” and provides other information about this penalty exception, including reporting on Form 1099-R.

Distributions to Public Safety Officers to Pay for Health Insurance Premiums. PPA excludes from gross income distributions from “eligible government plans” used to pay “qualified health insurance premiums” of an “eligible retired public safety officer.” The Notice provides definitions of these terms and provides other details regarding the operation of this provision.

We will be discussing Notice 2007-7 and other PPA-related administrative matters at our upcoming Participant Forms and Notices programs offered in February.