Preparing Your Benefits Plans for 2006
As the year-end approaches, employers who sponsor retirement, welfare, and deferred compensation plans need to be aware of deadlines and changes for 2006:
- 401(k)/401(m) Final Regulations.--The IRS has issued final 401(k) regulations that become effective for plan years beginning on or after January 1, 2006. Although plan amendments are not yet required, plans will need to be operated in accordance with the new regulations. There are a couple of key areas to consider. First, plan sponsors generally may no longer use the targeted "bottom-up" method for making qualified non-elective contributions and qualified matching contributions to correct ADP/ACP nondiscrimination testing failures, which may make corrections through employer contributions more expensive. With respect to hardship distributions, a plan may permit additional reasons for hardship withdrawals including burial and funeral expenses for a parent, spouse, child, or dependent and repair of damage to a participant's primary residence that would qualify for a casualty deduction on a tax return. Hardship distributions forms may need to be revised accordingly.
- Relative Value Disclosures.--The IRS has issued regulations that provide for expanded disclosures to plan participants of plan distribution options. The regulations are effective for a qualified joint and survivor annuity (as well as a qualified pre-retirement survivor annuity) with an annuity starting date that is on or after February 1, 2006. Plan sponsors will soon have to provide a comparison of the relative value of all optional forms of benefits available under the plan. The comparison must include a description of each available benefit form, the eligibility provisions for each benefit, the financial effect of choosing one form of benefit over another, and a description of the relative value of the benefit as compared to the value of the annuity. If your plan has standardized forms for benefit payments options, they should be reviewed and revised as necessary before February 1.
- Roth 401(k)s.--Beginning January 1, 2006, 401(k) plans may permit Roth 401(k) contributions. Roth 401(k) contributions are salary reduction contributions made on an after-tax basis. The contributions grow tax-free and are not subject to tax upon distribution. Roth 401(k) contributions may be matched by the employer and are subject to the same limitations as regular 401(k) contributions. Roth 401(k) and 401(k) deferral contributions are combined for purposes of determining contribution limits and may not exceed the IRS annual contribution limit ($15,000 + $5,000 for catch-up contributions in 2006). Employers that want to implement a Roth 401(k) feature starting January 1, 2006, will need to put together communication materials so that participants may consider how they will allocate their salary reduction contributions between the traditional 401(k) account and the Roth 401(k) account.
- Automatic Cash-Outs.--Qualified retirement plans ordinarily provide for the automatic "cash out" of a terminated participant's account if the participant has not provided distribution directions and the amount is $5,000 or less. Under the Economic Growth and Tax Relief Reconciliation Act of 2001, plan administrators are required to transfer cash-out distributions to an individual retirement account if the distribution amount is greater than $1,000 but less than or equal to $5,000 and made on or after March 28, 2005. The Department of Labor has issued final "safe harbor" regulations for such distributions. Although the IRS has recently extended the deadline for the plan amendment necessary to implement the change until the due date for filing the employer’s tax return, plan sponsors may want to get their plan documents in order before year-end.
- Hurricane Relief.--The IRS and the Department of Labor have worked together to ease the distribution requirements for retirement plans. A participant is able to take a loan or hardship distribution from a retirement plan if the participant, his or her spouse, lineal descendants, ascendants, or dependents resided or worked principally in an area affected by Hurricane Katrina. Plan loan procedures, loan forms, and hardship forms may need to be revised accordingly. Employers may implement these changes in 2005, but plans may need to be amended by the end of the 2006 plan year to take advantage of the relief.
- Medicare Part D Notice.--By November 15, 2005 (and annually thereafter), health plans that provide prescription drug coverage to individuals eligible for Medicare Part D (including retirees, active employees, spouses and dependents) were required to provide a notice of creditable coverage. The notice informs Medicare-eligible individuals whether the value of the health plan's prescription drug coverage equals or exceeds the value of Medicare prescription drug coverage (that is, whether the health plan's coverage is "creditable coverage"). Model notices have been issued to assist health plans in meeting the requirement, although they may require some modifications. Even though the deadline has passed, there is no penalty for failing to provide the notice, and plans still have time to notify participants before Medicare Part D open enrollment ends on May 15, 2006.
- HIPAA Portability.--Effective as of January 1, 2006, calendar-year health plans must comply with the final HIPAA portability regulations. The final regulations provide some clarifications and add new requirements. The regulations contain a revised model certificate of creditable coverage form that includes an “educational statement.” They require that plans have written procedures for requesting certificates of creditable coverage. The regulations provide sample language regarding the general (initial) notice of pre-existing condition exclusions and new model language for the notice of special enrollment rights. Group health plans, summary plan descriptions, and plan forms should be reviewed before January 1, 2006, to make sure they are consistent with the new requirements.
- HIPAA Security For Small Plans.--Effective April 20, 2006, covered health plans with annual receipts of $5 million or less must comply with the HIPAA Security Rule. (The compliance deadline for covered health plans with annual receipts exceeding $5 million was April 20, 2005.) The HIPAA Security Rule focuses on the confidentiality, integrity, and availability of electronic protected health information (EPHI). Steps to compliance will typically include amending business associate agreements and plan documents; selecting a security official; identifying risks associated with the confidentiality and integrity of EPHI; implementing security measures to control access to EPHI; and planning for contingencies such as fire, flood, vandalism, or a system crash. Because compliance with the HIPAA Security Rule will often require the input of information technology and benefits professionals, advanced planning is advised beginning with a security assessment.
- Deferred Compensation.--New deferred compensation rules promulgated under Section 409A of the Internal Revenue Code became effective January 1, 2005. Although the deadline to amend plans to comply with the new rules is December 31, 2006, certain actions must be taken before and during 2006. If a deferred compensation arrangement permitted deferral elections for 2005 to be made up to March 15, 2005, based on the IRS transition guidance, the plan needs to be amended by December 31, 2005, to make sure its provisions are consistent with such elections. Also, an individual may be permitted to elect to terminate his or her participation in a deferred compensation arrangement or cancel an election to defer compensation provided the election is made by December 31, 2005; if such elections are permitted, a conforming plan amendment must be adopted by December 31, 2005. Furthermore, an employer may terminate a deferred compensation plan or arrangement by December 31, 2005, and avoid the termination rules that were effective starting January 1, 2005, which require termination of all similar plans or arrangements and a 5-year waiting period before adoption of a new similar plan or arrangement. For performance-based compensation subject to Section 409A, the performance criteria must be established within 90 days after the commencement of the performance period, which will ordinarily be the first calendar quarter of the year. In 2006, plan documents will need to be brought into compliance with 409A, and certain other changes to deferral elections will be permitted until December 31, 2006.