DESCRIPTION OF THE CHAIRMAN’S MARK OF 

THE “NATIONAL EMPLOYEE SAVINGS AND 

TRUST EQUITY GUARANTEE ACT OF 2005” 

Scheduled for a Mark Up 

Before the 

SENATE COMMITTEE ON FINANCE 

on July 26, 2005 

Prepared by the Staff 

of the 

JOINT COMMITTEE ON TAXATION 

July 22, 2005 

JCX-56-05 
ii

CONTENTS 

Page

INTRODUCTION .......................................................................................................................... 1 

I. DIVERSIFICATION RIGHTS AND OTHER DEFINED CONTRIBUTION 

PARTICIPANT PROTECTIONS ...................................................................................... 2 

A. Employee Diversification Rights for Defined Contribution Plans Holding Employer 

Securities......................................................................................................................... 2 

B. Notice of Freedom to Divest Employer Securities or Real Property.............................. 9 

C. Periodic Pension Benefit Statements for Defined Contribution Plans.......................... 11 

D. Notice to Participants and Beneficiaries of Blackout Periods ...................................... 15 

E. Additional IRA Contributions for Certain Employees ................................................. 19 

II. PROVIDING INVESTMENT ADVICE AND INVESTMENT EDUCATION TO 

PLAN PARTICIPANTS................................................................................................... 21 

A. Investment Education Requirements for Defined Contribution Plan Participants ....... 21 

B. Information Relating to Investment in Employer Securities ........................................ 25 

C. Safe Harbor for Independent Investment Advice Provided to Plan Participants.......... 27 

D. Treatment of Employer-Provided Qualified Retirement Planning Services................. 29 

III. IMPROVEMENTS IN FUNDING RULES FOR SINGLE-EMPLOYER DEFINED 

BENEFIT PENSION PLANS AND RELATED PROVISIONS ..................................... 31 

A. Minimum Funding Rules for Single-Employer Defined Benefit Pension Plans .......... 31 

B. Benefit Limitations Under Single-Employer Defined Benefit Pension Plans .............. 49 

C. Increase in Deduction Limits ........................................................................................ 57 

D. Interest Rate Assumption for Determination of Lump-Sum Distributions................... 60 

E. Interest Rate Assumption for Applying Benefit Limitations to Lump-Sum 

Distributions.................................................................................................................. 63 

F. Restrictions on Funding of Nonqualified Deferred Compensation Plan when 

Employer’s Defined Benefit Pension Plan is Underfunded.......................................... 65 

G. Defined Benefit Pension Plan Benefits Provided in Combination with a Qualified 

Cash-or-Deferred Arrangement .................................................................................... 68 

H. Studies........................................................................................................................... 74 

1. Study on revitalizing the defined benefit plans......................................................... 74 

2. Study on floor-offset ESOPs..................................................................................... 74 

IV. DISCLOSURE AND BENEFIT STATEMENT REQUIREMENTS FOR SINGLEEMPLOYER DEFINED BENEFIT PENSION PLANS.................................................. 76 

A. Actuarial Reports and Summary Annual Reports......................................................... 76 

B. Periodic Pension Benefit Statements for Defined Benefit Pension Plans..................... 79 

V. IMPROVEMENTS IN FUNDING RULES FOR MULTIEMPLOYER DEFINED 

BENEFIT PLANS ............................................................................................................ 83 
iii

A. Increase in Deduction Limits ........................................................................................ 83 

B. Multiemployer Plan Funding Notice............................................................................. 85 

C. Permit Qualified Transfers of Excess Pension Assets to Retiree Health 

Accounts by Multiemployer Plan ................................................................................. 87 

VI. IMPROVEMENTS IN PBGC GUARANTEE PROVISIONS ........................................ 89 

A. Increases in PBGC Premiums for Single-Employer Plans ........................................... 89 

B. Rules Relating to Bankruptcy of Employer .................................................................. 93 

C. Limitation on PBGC Guarantee of Shutdown and Other Benefits ............................... 96 

D. PBGC Premiums for Small and New Plans.................................................................. 98 

E. Authorization for PBGC to Pay Interest on Premium Overpayment Refunds ........... 100 

F. Rules for Substantial Owner Benefits in Terminated Plans........................................ 101 

G. Acceleration of PBGC Computation of Benefits Attributable to Recoveries from 

Employers ................................................................................................................... 102

VII. SPOUSAL PENSION PROTECTION........................................................................... 104 

A. Study of Spousal Consent for Distributions from Defined Contribution Plans.......... 104 

B. Division of Pension Benefits Upon Divorce............................................................... 106 

C. Protection of Rights of Former Spouses under the Railroad Retirement System....... 108 

D. Modifications of Joint and Survivor Annuity Requirements ...................................... 109 

VIII. IMPROVEMENTS IN PORTABILITY AND DISTRIBUTION RULES FOR 

DEFINED CONTRIBUTION PLANS........................................................................... 111 

A. Purchase of Permissive Service Credit ....................................................................... 111 

B. Rollover of After-Tax Amounts in Annuity Contracts ............................................... 114 

C. Application of Minimum Distribution Rules to Governmental Plans ........................ 115 

D. Waiver of 10-Percent Early Withdrawal Tax on Certain Distributions from 

Pension Plans for Public Safety Employees ............................................................... 117 

E. Rollovers by Nonspouse Beneficiaries of Certain Retirement Plan Distributions ..... 118 

F. Faster Vesting of Employer Nonelective Contributions............................................. 120 

G. Allow Direct Rollovers from Retirement Plans to Roth IRAs.................................... 121 

H. Elimination of Higher Early Withdrawal Tax on Certain SIMPLE Plan 

Distributions................................................................................................................ 123 

I. SIMPLE Plan Portability ............................................................................................ 125 

J. Eligibility for Participation in Eligible Deferred Compensation Plans....................... 127 

K. Benefit Transfers to the PBGC ................................................................................... 128 

L. Missing Participants.................................................................................................... 130 

IX. ADMINISTRATIVE PROVISIONS.............................................................................. 131 

A. Updating of Employee Plans Compliance Resolution System ................................... 131 

B. Extension to all Governmental Plans of Moratorium on Application of Certain 

Nondiscrimination Rules............................................................................................. 133 

C. Notice and Consent Period Regarding Distributions .................................................. 134 
iv

D. Pension Plan Reporting Simplification....................................................................... 136 

E. Voluntary Early Retirement Incentive and Employment Retention Plans 

Maintained by Local Educational Agencies and Other Entities ................................. 138 

F. No Reduction in Unemployment Compensation as a Result of Pension Rollovers ... 141 

G. Withholding on Certain Distributions from Governmental Eligible Deferred 

Compensation Plans.................................................................................................... 142 

H. Provisions Relating to Plan Amendments................................................................... 143 

X. UNITED STATES TAX COURT MODERNIZATION................................................ 145 

A. Tax Court Procedure ................................................................................................... 145 

1. Jurisdiction of Tax Court over collection due process cases .................................. 145 

2. Authority for special trial judges to hear and decide certain employment 

status cases.............................................................................................................. 146 

3. Confirmation of Tax Court authority to apply doctrine of equitable recoupment.. 146 

4. Tax Court filing fees ............................................................................................... 147 

5. Appointment of Tax Court employees.................................................................... 148 

6. Expanded use of practice fees................................................................................. 150 

B. Tax Court Pension and Compensation........................................................................ 151 

1. Judges of the Tax Court .......................................................................................... 151 

2. Special trial judges of the Tax Court ...................................................................... 153 

XI. OTHER PROVISIONS................................................................................................... 157 

A. Transfer of Funds Attributable to Black Lung Trust Funds to Combined Benefit 

Fund ............................................................................................................................ 157 

B. Tax Treatment of Company-Owned Life Insurance (“COLI”) .................................. 159 
1

INTRODUCTION 

The Senate Committee on Finance has scheduled a markup of an original bill, the 

“National Employee Savings and Trust Equity Guarantee Act of 2005” on July 26, 2005. This 

document,1

 prepared by the staff of the Joint Committee on Taxation, provides a description of 

the bill. 

 1

 This document may be cited as follows: Joint Committee on Taxation, “Description of the 

Chairman’s Mark of the National Employee Savings and Trust Equity Guarantee Act of 2005” (JCX-56-

05), July 22, 2005. 
2

I. DIVERSIFICATION RIGHTS AND OTHER DEFINED CONTRIBUTION 

PARTICIPANT PROTECTIONS 

A. Employee Diversification Rights for Defined Contribution Plans 

Holding Employer Securities 

Present Law

In general

Defined contribution plans may permit both employees and employers to make 

contributions to the plan. Under a qualified cash or deferred arrangement (commonly referred to 

as a “section 401(k) plan”), employees may elect to make pretax contributions to a plan, referred 

to as elective deferrals. Employees may also be permitted to make after-tax contributions to a 

plan. In addition, a plan may provide for employer nonelective contributions or matching 

contributions. Nonelective contributions are employer contributions that are made without 

regard to whether the employee makes elective deferrals or after-tax contributions. Matching 

contributions are employer contributions that are made only if the employee makes elective 

deferrals or after-tax contributions. 

Under the Internal Revenue Code (the “Code”),2

 elective deferrals, after-tax employee 

contributions, and employer matching contributions are subject to special nondiscrimination 

tests. Certain employer nonelective contributions may be used to satisfy these special 

nondiscrimination tests. In addition, plans may satisfy the special nondiscrimination tests by 

meeting certain safe harbor contribution requirements. 

The Code requires employee stock ownership plans (“ESOPs”) to offer certain plan 

participants the right to diversify investments in employer securities. The Employee Retirement 

Income Security Act of 1974 (“ERISA”) limits the amount of employer securities and employer 

real property that can be acquired or held by certain employer-sponsored retirement plans. The 

extent to which the ERISA limits apply depends on the type of plan and the type of contribution 

involved. 

Diversification requirements applicable to ESOPs under the Code

An ESOP is a defined contribution plan that is designated as an ESOP and is designed to 

invest primarily in qualifying employer securities and that meets certain other requirements 

under the Code. For purposes of ESOP investments, a “qualifying employer security” is defined 

as: (1) publicly traded common stock of the employer or a member of the same controlled 

group; (2) if there is no such publicly traded common stock, common stock of the employer (or 

member of the same controlled group) that has both voting power and dividend rights at least as 

great as any other class of common stock; or (3) noncallable preferred stock that is convertible 

into common stock described in (1) or (2) and that meets certain requirements. In some cases, an 

 2

 All references to the “Code” are to the Internal Revenue Code. All section references and 

descriptions of present law refer to the Code unless otherwise indicated. 
3

employer may design a class of preferred stock that meets these requirements and that is held 

only by the ESOP. 

An ESOP can be an entire plan or it can be a component of a larger defined contribution 

plan. An ESOP may provide for different types of contributions. For example, an ESOP may 

include a qualified cash or deferred arrangement that permits employees to make elective 

deferrals.3

Under the Code, ESOPs are subject to a requirement that a participant who has attained 

age 55 and who has at least 10 years of participation in the plan must be permitted to diversify 

the investment of the participant’s account in assets other than employer securities.4

 The 

diversification requirement applies to a participant for six years, starting with the year in which 

the individual first meets the eligibility requirements (i.e., age 55 and 10 years of participation). 

The participant must be allowed to elect to diversify up to 25 percent of the participant’s account 

(50 percent in the sixth year), reduced by the portion of the account diversified in prior years. 

The participant must be given 90 days after the end of each plan year in the election 

period to make the election to diversify. In the case of participants who elect to diversify, the 

plan satisfies the diversification requirement if: (1) the plan distributes the applicable amount to 

the participant within 90 days after the election period; (2) the plan offers at least three 

investment options (not inconsistent with Treasury regulations) and, within 90 days of the 

election period, invests the applicable amount in accordance with the participant’s election; or 

(3) the applicable amount is transferred within 90 days of the election period to another qualified 

defined contribution plan of the employer providing investment options in accordance with (2).5

ERISA limits on investments in employer securities and real property

ERISA imposes restrictions on the investment of retirement plan assets in employer 

securities or employer real property.6 A retirement plan may hold only a “qualifying” employer 

security and only “qualifying” employer real property. 

Under ERISA, any stock issued by the employer or an affiliate of the employer is a 

qualifying employer security.7

 Qualifying employer securities also include certain publicly 

traded partnership interests and certain marketable obligations (i.e., a bond, debenture, note, 

certificate or other evidence of indebtedness). Qualifying employer real property means parcels 

 3

 Such an ESOP design is sometimes referred to as a “KSOP.” 

4

 Sec. 401(a)(28). The present-law diversification requirements do not apply to employer 

securities held by an ESOP that were acquired before January 1, 1987. 

5

 IRS Notice 88-56, 1988-1 C.B. 540, Q&A-16. 

6

 ERISA sec. 407. 

7

 Certain additional requirements apply to employer stock held by a defined benefit pension plan 

or a money purchase pension plan (other than certain plans in existence before the enactment of ERISA). 
4

of employer real property: (1) if a substantial number of the parcels are dispersed geographically; 

(2) if each parcel of real property and the improvements thereon are suitable (or adaptable 

without excessive cost) for more than one use; (3) even if all of the real property is leased to one 

lessee (which may be an employer, or an affiliate of an employer); and (4) if the acquisition and 

retention of such property generally comply with the fiduciary rules of ERISA (with certain 

specified exceptions). 

ERISA also prohibits defined benefit pension plans and money purchase pension plans 

(other than certain plans in existence before the enactment of ERISA) from acquiring employer 

securities or employer real property if, after the acquisition, more than 10 percent of the assets of 

the plan would be invested in employer securities and real property. Except as discussed below 

with respect to elective deferrals, this 10-percent limitation generally does not apply to defined 

contribution plans other than money purchase pension plans.8

 In addition, a fiduciary generally 

is deemed not to violate the requirement that plan assets be diversified with respect to the 

acquisition or holding of employer securities or employer real property in a defined contribution 

plan.9

The 10-percent limitation on the acquisition of employer securities and real property 

applies separately to the portion of a plan consisting of elective deferrals (and earnings thereon) 

if any portion of an individual’s elective deferrals (or earnings thereon) are required to be 

invested in employer securities or real property pursuant to plan terms or the direction of a 

person other than the participant. This restriction does not apply if: (1) the amount of elective 

deferrals required to be invested in employer securities and real property does not exceed more 

than one percent of any employee’s compensation; (2) the fair market value of all defined 

contribution plans maintained by the employer is no more than 10 percent of the fair market 

value of all retirement plans of the employer; or (3) the plan is an ESOP. 

Description of Proposal

In general

Under the proposal, in order to satisfy the plan qualification requirements of the Code 

and the vesting requirements of ERISA, certain defined contribution plans are required to 

provide diversification rights with respect to amounts invested in employer securities or 

employer real property. Such a plan is required to permit applicable individuals to direct that the 

portion of the individual’s account held in employer securities or employer real property be 

invested in alternative investments. Under the proposal, an applicable individual includes: 

(1) any plan participant; and (2) any beneficiary who has an account under the plan with respect 

 8

 The 10-percent limitation also applies to a defined contribution plan that is part of an 

arrangement under which benefits payable to a participant under a defined benefit pension plan are 

reduced by benefits under the defined contribution plan (i.e., a “floor-offset” arrangement). 

9

 Under ERISA, a defined contribution plan is generally referred to as an individual account plan. 

Plans that are not subject to the 10-percent limitation on the acquisition of employer securities are referred 

to as “eligible individual account plans.” 
5

to which the beneficiary is entitled to exercise the rights of a participant. The time when the 

diversification requirements apply depends on the type of contributions invested in employer 

securities or employer real property. 

Plans subject to requirements

The diversification requirements generally apply to an “applicable defined contribution 

plan,”10 which means a defined contribution plan holding publicly-traded employer securities 

(i.e., securities issued by the employer or a member of the employer’s controlled group of 

corporations11 that are readily tradable on an established securities market). 

For this purpose, a plan holding employer securities that are not publicly traded is 

generally treated as holding publicly-traded employer securities if the employer (or any member 

of the employer’s controlled group of corporations) has issued a class of stock that is a publiclytraded employer security. This treatment does not apply if neither the employer nor any parent 

corporation12 of the employer has issued any publicly-traded security or any special class of 

stock that grants particular rights to, or bears particular risks for, the holder or the issuer with 

respect to any member of the employer’s controlled group that has issued any publicly-traded 

employer security. For example, a controlled group that generally consists of corporations that 

have not issued publicly-traded securities, may include a member that has issued publicly-traded 

stock (the “publicly-traded member”). In the case of a plan maintained by an employer that is 

another member of the controlled group, the diversification requirements do not apply to the 

plan, provided that neither the employer nor a parent corporation of the employer has issued any 

publicly-traded security or any special class of stock that grants particular rights to, or bears 

particular risks for, the holder or issuer with respect to the member that has issued 

publicly-traded stock. The Secretary of the Treasury has the authority to provide other 

exceptions in regulations. For example, an exception may be appropriate if no stock of the 

employer maintaining the plan (including stock held in the plan) is publicly traded, but a member 

of the employer’s controlled group has issued a small amount of publicly-traded stock. 

The diversification requirements do not apply to an ESOP that: (1) does not hold 

contributions (or earnings thereon) that are subject to the special nondiscrimination tests that 

apply to elective deferrals, employee after-tax contributions, and matching contributions; and 

(2) is a separate plan from any other qualified retirement plan of the employer. Accordingly, an 

ESOP that holds elective deferrals, employee contributions, employer matching contributions, or 

 10 Under ERISA, the diversification requirements apply to an “applicable individual account 

plan.” 

11 For this purpose, “controlled group of corporations” has the same meaning as under 

section 1563(a), except that, in applying that section, 50 percent is substituted for 80 percent. 

12 For this purpose, “parent corporation” has the same meaning as under section 424(e), i.e., any 

corporation (other than the employer) in an unbroken chain of corporations ending with the employer if 

each corporation other than the employer owns stock possessing at least 50 percent of the total combined 

voting power of all classes of stock with voting rights or at least 50 percent of the total value of shares of 

all classes of stock in one of the other corporations in the chain. 
6

nonelective employer contributions used to satisfy the special nondiscrimination tests (including 

the safe harbor methods of satisfying the tests) is subject to the diversification requirements 

under the proposal. The diversification rights applicable under the proposal are broader than 

those applicable under the Code’s present-law ESOP diversification rules. Thus, an ESOP that is 

subject to the new requirements is excepted from the present-law rules.13

The diversification requirements under the proposal also do not apply to a one-participant 

retirement plan. A one-participant retirement plan is a plan that: (1) on the first day of the plan 

year, covers only one individual (or the individual and his or her spouse) and the individual owns 

100 percent of the plan sponsor (i.e., the employer maintaining the plan), whether or not 

incorporated, or covered only one or more partners (or partners and their spouses) in the plan 

sponsor; (2) meets the minimum coverage requirements without being combined with any other 

plan that covers employees of the business; (3) does not provide benefits to anyone except the 

individuals (and spouses) described in (1); (4) does not cover a business that is a member of an 

affiliated service group, a controlled group of corporations, or a group of corporations under 

common control; and (5) does not cover a business that uses leased employees. It is intended 

that, for this purpose, a “partner” includes an owner of a business that is treated as a partnership 

for tax purposes. In addition, it includes a two-percent shareholder of an S corporation.14

Elective deferrals and after-tax employee contributions

In the case of amounts attributable to elective deferrals under a qualified cash or deferred 

arrangement and employee after-tax contributions that are invested in employer securities or 

employer real property, any applicable individual must be permitted to direct that such amounts 

be invested in alternative investments. 

Other contributions

In the case of amounts attributable to contributions other than elective deferrals and aftertax employees contributions (i.e., nonelective employer contributions and employer matching 

contributions) that are invested in employer securities or employer real property, an applicable 

individual who is a participant with three years of service,15 a beneficiary of such a participant, 

or a beneficiary of a deceased participant must be permitted to direct that such amounts be 

invested in alternative investments. 

The proposal provides a transition rule for amounts attributable to these other 

contributions that are invested in employer securities or employer real property acquired before 

the first plan year for which the new diversification requirements apply. Under the transition 

 13 An ESOP will not be treated as failing to be designed to invest primarily in qualifying 

employer securities merely because the plan provides diversification rights as required under the 

provision or greater diversification rights than required under the provision. 

14 Under section 1372, a two-percent shareholder of an S corporation is treated as a partner for 

fringe benefit purposes. 

15 Years of service is defined as under the rules relating to vesting (sec. 411(a)). 
7

rule, for the first three years for which the new diversification requirements apply to the plan, the 

applicable percentage of such amounts is subject to diversification as shown in Table 1, below. 

The applicable percentage applies separately to each class of employer security and to employer 

real property in an applicable individual’s account. The transition rule does not apply to plan 

participants who have three years of service and who have attained age 55 by the beginning of 

the first plan year beginning after December 31, 2005. 

Table 1.–Applicable Percentage for Employer 

Securities or Employer Real Property Held on Effective Date 

Plan year for which 

diversification applies: 

Applicable 

percentage: 

 First year 33 percent 

 Second year 66 percent 

 Third year 100 percent 

The application of the transition rule is illustrated by the following example. Suppose 

that the account of a participant with at least three years of service held 120 shares of employer 

common stock contributed as matching contributions before the diversification requirements 

became effective. In the first year for which diversification applies, 33 percent (i.e., 40 shares) 

of that stock is subject to the diversification requirements. In the second year for which 

diversification applies, a total of 66 percent of 120 shares of stock (i.e., 79 shares, or an 

additional 39 shares) is subject to the diversification requirements. In the third year for which 

diversification applies, 100 percent of the stock, or all 120 shares, is subject to the diversification 

requirements. In addition, in each year, employer stock in the account attributable to elective 

deferrals and employee after-tax contributions is fully subject to the diversification requirements, 

as is any new stock contributed to the account. 

Rules relating to the election of investment alternatives

A plan subject to the diversification requirements is required to give applicable 

individuals a choice of at least three investment options, other than employer securities or 

employer real property, each of which is diversified and has materially different risk and return 

characteristics. It is intended that other investment options generally offered by the plan also 

must be available to applicable individuals. 

A plan does not fail to meet the diversification requirements merely because the plan 

limits the times when divestment and reinvestment can be made to periodic, reasonable 

opportunities that occur at least quarterly. It is intended that applicable individuals generally be 

given the opportunity to make investment changes with respect to employer securities or 

employer real property on the same basis as the opportunity to make other investment changes, 

except in unusual circumstances. Thus, in general, applicable individuals must be given the 

opportunity to request changes with respect to investments in employer securities or employer 

real property with the same frequency as the opportunity to make other investment changes and 

that such changes are implemented in the same timeframe as other investment changes, unless 

circumstances require different treatment. For example, in the case of a plan that provides 
8

diversification rights with respect to investments in employer real property, if the property must 

be sold in order to implement an applicable individual’s request to divest his or her account of 

employer real property, a longer period may be needed to implement the individual’s request 

than the time needed to implement other investment changes. Providing a longer period is 

permissible in those circumstances. 

Except as provided in regulations, a plan may not impose restrictions or conditions with 

respect to the investment of employer securities or employer real property that are not imposed 

on the investment of other plan assets (other than restrictions or conditions imposed by reason of 

the application of securities laws). For example, such a restriction or condition includes a 

provision under which a participant who divests his or her account of employer securities or 

employer real property receives less favorable treatment (such as a lower rate of employer 

contributions) than a participant whose account remains invested in employer securities or 

employer real property. On the other hand, such a restriction does not include the imposition of 

fees with respect to other investment options under the plan, merely because fees are not 

imposed with respect to investments in employer securities. 

Effective Date

The proposal is generally effective for plan years beginning after December 31, 2005. In 

the case of a plan maintained pursuant to one or more collective bargaining agreements, the 

proposal is effective for plan years beginning after the earlier of (1) the later of December 31, 

2006, or the date on which the last of such collective bargaining agreements terminates 

(determined without regard to any extension thereof after the date of enactment), or 

(2) December 31, 2007. 

A special effective date applies with respect to employer matching and nonelective 

contributions (and earnings thereon) that are invested in employer securities that, as of 

September 17, 2003: (1) consist of preferred stock; and (2) are held within an ESOP, under the 

terms of which the value of the preferred stock is subject to a guaranteed minimum. Under the 

special rule, the diversification requirements apply to such preferred stock for plan years 

beginning after the earlier of (1) December 31, 2006; or (2) the first date as of which the actual 

value of the preferred stock equals or exceeds the guaranteed minimum. When the new 

diversification requirements become effective for the plan under the special rule, the applicable 

percentage of employer securities or employer real property held on the effective date that is 

subject to diversification is determined without regard to the special rule. For example, if, under 

the general effective date, the diversification requirements would first apply to the plan for the 

first plan year beginning after December 31, 2005, and, under the special rule, the diversification 

requirements first apply to the plan for the first plan year beginning after December 31, 2008, the 

applicable percentage for that year is 100 percent.
9

B. Notice of Freedom to Divest Employer Securities or Real Property 

Present Law

Under ERISA, a plan administrator is required to furnish participants with certain notices 

and information about the plan. This information includes, for example, a summary plan 

description that includes certain information, including administrative information about the 

plan, the plan’s requirements as to eligibility for participation and benefits, the plan’s vesting 

provisions, and the procedures for claiming benefits under the plan. Under ERISA, if a plan 

administrator fails or refuses to furnish to a participant information required to be provided to the 

participant within 30 days of the participant’s written request, the participant generally may bring 

a civil action to recover from the plan administrator $100 a day, within the court’s discretion, or 

other relief that the court deems proper. 

The Code contains a variety of notice requirements with respect to qualified plans. Such 

requirements are generally enforced by an excise tax. For example, in case of a failure to 

provide notice of a significant reduction in benefit accruals, an excise tax of $100 a day is 

generally imposed on the employer. If the employer exercised reasonable diligence in meeting 

the requirements, the excise tax with respect to a taxable year is limited to no more than 

$500,000. 

Description of Proposal

In general

The proposal requires a new notice under the Code and ERISA in connection with the 

right of an applicable individual to divest his or her account under an applicable defined 

contribution plan of employer securities or employer real property, as required under the 

proposal relating to diversification rights with respect to amounts invested in employer securities 

or employer real property. Not later than 30 days before the first date on which an applicable 

individual is eligible to exercise such right with respect to any type of contribution, the 

administrator of the plan must provide the individual with a notice setting forth such right and 

describing the importance of diversifying the investment of retirement account assets. Under the 

diversification proposal, an applicable individual’s right to divest his or her account of employer 

securities or employer real property attributable to elective deferrals and employee after-tax 

contributions and the right to divest his or her account of employer securities or employer real 

property attributable to other contributions (i.e., nonelective employer contributions and 

employer matching contributions) may become exercisable at different times. Thus, to the extent 

the applicable individual is first eligible to exercise such rights at different times, separate 

notices are required. 

The notice must be written in a manner calculated to be understood by the average plan 

participant and may be delivered in written, electronic, or other appropriate form to the extent 

that such form is reasonably accessible to the applicable individual. The Secretary of Labor is 

directed to prescribe a model notice to be used for this purpose within 180 days of enactment of 

the proposal. 
10

Sanctions for failure to provide notice

Excise tax

Under the proposal, an excise tax generally applies in the case of a failure to provide 

notice of diversification rights as required under the Code. The excise tax is generally imposed 

on the employer if notice is not provided.16 The excise tax is $100 per day for each participant or 

beneficiary with respect to whom the failure occurs, until notice is provided or the failure is 

otherwise corrected. If the employer exercises reasonable diligence to meet the notice 

requirement, the total excise tax imposed during a taxable year will not exceed $500,000. 

No tax will be imposed with respect to a failure if the employer does not know that the 

failure existed and exercises reasonable diligence to comply with the notice requirement. In 

addition, no tax will be imposed if the employer exercises reasonable diligence to comply and 

provides the required notice within 30 days of learning of the failure. In the case of a failure due 

to reasonable cause and not to willful neglect, the Secretary of the Treasury is authorized to 

waive the excise tax to the extent that the payment of the tax would be excessive or otherwise 

inequitable relative to the failure involved. 

ERISA civil penalty

In the case of a failure to provide notice of diversification rights as required under 

ERISA, the Secretary of Labor may assess a civil penalty against the plan administrator of up to 

$100 a day from the date of the failure. For this purpose, each violation with respect to any 

single applicable individual is treated as a separate violation. 

Effective Date

The proposal generally applies to plan years beginning after December 31, 2005. Under 

a transition rule, if notice under the proposal would otherwise be required before 90 days after 

the date of enactment, notice is not required until 90 days after the date of enactment.

 16 In the case of a multiemployer plan, the excise tax is imposed on the plan. 
11 

C. Periodic Pension Benefit Statements for Defined Contribution Plans 

Present Law

In general

Under ERISA, a plan administrator is required to furnish participants with certain notices 

and information about the plan.17 If a plan administrator fails or refuses to furnish to a 

participant information required to be provided to the participant within 30 days of the 

participant’s written request, the participant generally may bring a civil action to recover from 

the plan administrator $100 a day, within the court’s discretion, or other relief that the court 

deems proper. 

The Code contains a variety of notice requirements with respect to qualified plans. Such 

requirements are generally enforced by an excise tax. For example, in case of a failure to 

provide notice of a significant reduction in benefit accruals, an excise tax of $100 a day is 

generally imposed on the employer. If the employer exercised reasonable diligence in meeting 

the requirements, the excise tax with respect to a taxable year is limited to no more than 

$500,000. 

Pension benefit statements

ERISA provides that a plan administrator must furnish a benefit statement to any 

participant or beneficiary who makes a written request for such a statement. The benefit 

statement must indicate, on the basis of the latest available information: (1) the participant’s or 

beneficiary’s total accrued benefit; and (2) the participant’s or beneficiary’s vested accrued 

benefit or the earliest date on which the accrued benefit will become vested. A participant or 

beneficiary is not entitled to receive more than one benefit statement during any 12-month 

period. 

Statements to participants on separation from service 

A plan administrator must furnish a statement to each participant who: (1) separates from 

service during the year; (2) is entitled to a deferred vested benefit under the plan as of the end of 

the plan year; and (3) whose benefits were not paid during the year. The statement must set forth 

the nature, amount, and form of the deferred vested benefit to which the participant is entitled. 

The plan administrator generally must provide the statement no later than 180 days after the end 

of the plan year in which the separation from service occurs. 

 17 Governmental plans and church plans are exempt from ERISA, including requirements to 

provide notices or information to participants.
12 

Description of Proposal

Requirements for benefit statements

Under the proposal, the administrator of a defined contribution plan is required under the 

Code and ERISA to provide a benefit statement (1) to a participant or beneficiary who has the 

right to direct the investment of the assets in his or her account, at least quarterly, (2) to any other 

participant or other beneficiary who has his or her own account under the plan, at least annually, 

and (3) to other beneficiaries, upon written request, but limited to one request during any 

12-month period.18

The benefit statement is required to indicate, on the basis of the latest available 

information: (1) the total benefits accrued; (2) the vested accrued benefit or the earliest date on 

which the accrued benefit will become vested; and (3) an explanation of any offset that may be 

applied in determining accrued benefits under a plan that provides for permitted disparity or that 

is part of a floor-offset arrangement (i.e., an arrangement under which benefits payable to a 

participant under a defined benefit pension plan are reduced by benefits under a defined 

contribution plan). With respect to information on vested benefits, the Secretary of Labor is 

required to provide that the requirements of the proposal are met if, at least annually, the plan: 

(1) updates the information on vested benefits that is provided in the benefit statement; or 

(2) provides in a separate statement information as is necessary to enable participants and 

beneficiaries to determine their vested benefits. 

The benefit statement must also include the value of each investment to which assets in 

the individual’s account are allocated (determined as of the plan’s most recent valuation date), 

including the value of any assets held in the form or employer securities or employer real 

property (without regard to whether the securities or real property were contributed by the 

employer or acquired at the direction of the individual). A quarterly benefit statement provided 

to a participant or beneficiary who has the right to direct investments must also provide: (1) an 

explanation of any limitations or restrictions on any right of the individual to direct an 

investment; and (2) a notice that investments in any individual account may not be adequately 

diversified if the value of any investment in the account exceeds 20 percent of the fair market 

value of all investments in the account. 

The benefit statement must be written in a manner calculated to be understood by the 

average plan participant. It may be delivered in written, electronic, or other appropriate form to 

the extent that such form is reasonably accessible to the recipient. For example, regulations 

could permit current benefit statements to be provided on a continuous basis through a secure 

plan website for a participant or beneficiary who has access to the website. 

 18 In the case of a tax-sheltered annuity (sec. 403(b)) that is not a plan established or maintained 

by the employer, the benefit statement generally must be provided by the issuer of the annuity contract. 

The benefit statement requirements do not apply to a one-participant retirement plan The term “oneparticipant retirement plan” is defined as under the provision requiring plans to provide diversification 

rights with respect to employer securities and employer real property.
13 

The Secretary of Labor is directed, within 180 days after the date of enactment of the 

proposal, to develop one or more model benefit statements, written in a manner calculated to be 

understood by the average plan participant, that may be used by plan administrators in 

complying with the requirements of ERISA and the Code. The use of the model statement is 

optional. It is intended that the model statement include items such as the amount of 

nonforfeitable accrued benefits as of the statement date that are payable at normal retirement age 

under the plan, the amount of accrued benefits that are forfeitable but that may become 

nonforfeitable under the terms of the plan, information on how to contact the Social Security 

Administration to obtain a participant’s personal earnings and benefit estimate statement, and 

other information that may be important to understanding benefits earned under the plan. 

Sanctions for failure to provide information

Excise tax

Under the proposal, an excise tax generally applies in the case of a failure to provide a 

benefit statement as required under the Code. The excise tax is generally imposed on the 

employer if a required benefit statement or model form is not provided.19 The excise tax is $100 

per day for each participant or beneficiary with respect to whom the failure occurs, until the 

benefit statement or model form is provided or the failure is otherwise corrected. If the employer 

exercises reasonable diligence to meet the benefit statement, the total excise tax imposed during 

a taxable year will not exceed $500,000. 

No tax will be imposed with respect to a failure if the employer does not know that the 

failure existed and exercises reasonable diligence to comply with the benefit statement 

requirement. In addition, no tax will be imposed if the employer exercises reasonable diligence 

to comply and provides the required benefit statement within 30 days of learning of the failure. 

In the case of a failure due to reasonable cause and not to willful neglect, the Secretary of the 

Treasury is authorized to waive the excise tax to the extent that the payment of the tax would be 

excessive or otherwise inequitable relative to the failure involved. 

ERISA enforcement

The ERISA remedies that apply in the case of a failure or refusal to provide a participant 

with information under present law apply if the plan administrator fails to furnish a benefit 

statement required under the proposal. That is, the participant or beneficiary is entitled to bring a 

civil action to recover from the plan administrator $100 a day, within the court’s discretion, or 

such other relief that the court deems proper. 

 19 In the case of a multiemployer plan, the excise tax is imposed on the plan. In the case of a taxsheltered annuity (sec. 403(b)) that is not a plan established or maintained by the employer, the tax is 

generally imposed on the issuer of the annuity contract. 
14 

Exception for governmental and church plans

The proposal contains an exception from the benefit statement under the Code for a 

governmental plan or a church plan. In addition, such plans are generally exempt from ERISA. 

Accordingly, the benefit statement and investment notice requirements do not apply to a 

governmental plan or a church plan. 

Effective Date

The proposal is generally effective for plan years beginning after December 31, 2006. In 

the case of a plan maintained pursuant to one or more collective bargaining agreements, the 

proposal is effective for plan years beginning after the earlier of (1) the later of December 31, 

2007, or the date on which the last of such collective bargaining agreements terminates 

(determined without regard to any extension thereof after the date of enactment), or 

(2) December 31, 2008. 
15 

D. Notice to Participants and Beneficiaries of Blackout Periods 

Present Law

In general

The Sarbanes-Oxley Act of 200220 amended ERISA to require that the plan administrator 

of an individual account plan21 provide advance notice of a blackout period (a “blackout notice”) 

to plan participants and beneficiaries to whom the blackout period applies.22 Generally, notice 

must be provided at least 30 days before the beginning of the blackout period. In the case of a 

blackout period that applies with respect to employer securities, the plan administrator must also 

provide timely notice of the blackout period to the employer (or the affiliate of the employer that 

issued the securities, if applicable). 

The blackout notice requirement does not apply to a one-participant retirement plan, 

which is defined as a plan that (1) on the first day of the plan year, covered only the employer 

(and the employer’s spouse) and the employer owns the entire business (whether or not 

incorporated) or covers only one or more partners (and their spouses) in a business partnership 

(including partners in an S or C corporation as defined in section 1361(a) of the Code), (2) meets 

the minimum coverage requirements without being combined with any other plan that covers 

employees of the business, (3) does not provide benefits to anyone except the employer (and the 

employer’s spouse) or the partners (and their spouses), (4) does not cover a business that is a 

member of an affiliated service group, a controlled group of corporations, or a group of 

corporations under common control, and (5) does not cover a business that leases employees.23

Definition of blackout period

A blackout period is any period during which any ability of participants or beneficiaries 

under the plan, which is otherwise available under the terms of the plan, to direct or diversify 

assets credited to their accounts, or to obtain loans or distributions from the plan, is temporarily 

suspended, limited, or restricted if the suspension, limitation, or restriction is for any period of 

more than three consecutive business days. However, a blackout period does not include a 

suspension, limitation, or restriction that (1) occurs by reason of the application of securities 

laws, (2) is a change to the plan providing for a regularly scheduled suspension, limitation, or 

 20 Pub. L. No. 107-204 (2002). 

21 An “individual account plan” is the term generally used under ERISA for a defined 

contribution plan. 

22 ERISA sec. 101(i), as enacted by section 306(b) of the Sarbanes-Oxley Act of 2002. Under 

section 306(a), a director or executive officer of a publicly-traded corporation is prohibited from trading 

in employer stock during blackout periods in certain circumstances. Section 306 is effective 180 days 

after enactment. 

23 Governmental plans and church plans are exempt from ERISA. Accordingly, the blackout 

notice requirement does not apply to these plans. 
16 

restriction that is disclosed through a summary of material modifications to the plan or materials 

describing specific investment options under the plan, or changes thereto, or (3) applies only to 

one or more individuals, each of whom is a participant, alternate payee, or other beneficiary 

under a qualified domestic relations order. 

Timing of notice

Notice of a blackout period is generally required at least 30 days before the beginning of 

the period. The 30-day notice requirement does not apply if (1) deferral of the blackout period 

would violate the fiduciary duty requirements of ERISA and a plan fiduciary so determines in 

writing, or (2) the inability to provide the 30-day advance notice is due to events that were 

unforeseeable or circumstances beyond the reasonable control of the plan administrator and a 

plan fiduciary so determines in writing. In those cases, notice must be provided as soon as 

reasonably practicable under the circumstances unless notice in advance of the termination of the 

blackout period is impracticable. 

Another exception to the 30-day period applies in the case of a blackout period that 

applies only to one or more participants or beneficiaries in connection with a merger, acquisition, 

divestiture, or similar transaction involving the plan or the employer and that occurs solely in 

connection with becoming or ceasing to be a participant or beneficiary under the plan by reason 

of the merger, acquisition, divestiture, or similar transaction. Under the exception, the blackout 

notice requirement is treated as met if notice is provided to the participants or beneficiaries to 

whom the blackout period applies as soon as reasonably practicable. 

The Secretary of Labor may provide additional exceptions to the notice requirement that 

the Secretary determines are in the interests of participants and beneficiaries. 

Form and content of notice

A blackout notice must be written in a manner calculated to be understood by the average 

plan participant and must include (1) the reasons for the blackout period, (2) an identification of 

the investments and other rights affected, (3) the expected beginning date and length of the 

blackout period, and (4) in the case of a blackout period affecting investments, a statement that 

the participant or beneficiary should evaluate the appropriateness of current investment decisions 

in light of the inability to direct or diversify assets during the blackout period, and (5) other 

matters as required by regulations. If the expected beginning date or length of the blackout 

period changes after notice has been provided, the plan administrator must provide notice of the 

change (and specify any material change in other matters related to the blackout) to affected 

participants and beneficiaries as soon as reasonably practicable. 

Notices provided in connection with a blackout period (or changes thereto) must be 

provided in writing and may be delivered in electronic or other form to the extent that the form is 

reasonably accessible to the recipient. The Secretary of Labor is required to issue guidance 

regarding the notice requirement and a model blackout notice. 
17 

Penalty for failure to provide notice

In the case of a failure to provide notice of a blackout period, the Secretary of Labor may 

assess a civil penalty against a plan administrator of up to $100 per day for each failure to 

provide a blackout notice. For this purpose, each violation with respect to a single participant or 

beneficiary is treated as a separate violation. 

Code requirements

The Code does not contain a notice requirement with respect to blackouts. However, the 

Code contains a variety of other notice requirements with respect to qualified plans. Such 

requirements are generally enforced by an excise tax. For example, in case of a failure to 

provide notice of a significant reduction in benefit accruals, an excise tax of $100 a day is 

generally imposed on the employer. If the employer exercised reasonable diligence in meeting 

the requirements, the excise tax with respect to a taxable year is limited to no more than 

$500,000. 

Description of Proposal

In general

The proposal amends the Code to include a blackout notice requirement similar to the 

present law ERISA requirement and makes certain modifications to the ERISA notice 

requirement. The blackout notice requirement under the Code does not apply to a oneparticipant retirement plan, a governmental plan, or a church plan.24

Definition of blackout period

The proposal also revises the definition of blackout period under the Code and ERISA. 

The definition of blackout period is revised to include a suspension, limitation, or restriction of 

any ability of participants or beneficiaries to direct or diversify assets credited to their accounts, 

or to obtain loans or distributions from the plan, that is otherwise available under the plan, 

without regard to whether the ability is specifically provided for in the terms of the plan. 

Definition of one-participant retirement plan

The proposal clarifies the definition of a one-participant retirement plan not subject to the 

blackout notice requirement. Under the proposal, for purposes of the blackout notice 

requirements under the Code and ERISA, the definition is conformed to the definition that 

applies under the proposal relating to diversification, thus clarifying that such a plan covers only 

an individual (or the individual and his or her spouse) who owns 100 percent of the plan sponsor 

(i.e., the employer maintaining the plan), whether or not incorporated, or covers only one or 

more partners (or partners and their spouses) in the plan sponsor. For this purpose, a partner 

 24 In the case of a tax-sheltered annuity (sec. 403(b)) that is not a plan established or maintained 

by the employer, the blackout notice generally must be provided by the issuer of the annuity contract. 
18 

includes an owner of a business that is treated as a partnership for tax purposes and a two-percent 

shareholder of an S corporation. 

Excise tax for failure to provide notice

Under the proposal, an excise tax is generally imposed on the employer if a blackout 

notice is not provided as required under the Code.25 The excise tax is $100 per day for each 

applicable individual with respect to whom the failure occurred, until notice is provided or the 

failure is otherwise corrected. If the employer exercises reasonable diligence to meet the notice 

requirements, the total excise tax imposed during a taxable year will not exceed $500,000. No 

tax will be imposed with respect to a failure if the employer does not know that the failure 

existed and exercises reasonable diligence to comply with the notice requirement. In addition, 

no tax will be imposed if the employer exercises reasonable diligence to comply and provides the 

required notice as soon as reasonably practicable after learning of the failure. In the case of a 

failure due to reasonable cause and not to willful neglect, the Secretary of the Treasury is 

authorized to waive the excise tax to the extent that the payment of the tax would be excessive or 

otherwise inequitable relative to the failure involved. 

Effective Date

The amendments to the Code apply to failures to provide the required notice after the 

date of enactment. The amendments to ERISA made by the proposal are effective as if included 

in section 306 of the Sarbanes-Oxley Act of 2002. 

 25 In the case of a multiemployer plan, the excise tax is imposed on the plan. In the case of a taxsheltered annuity (sec. 403(b)) that is not a plan established or maintained by the employer, the excise tax 

generally is imposed on the issuer of the annuity contract.
19 

E. Additional IRA Contributions for Certain Employees 

Present Law

Under present law, favored tax treatment applies to qualified retirement plans maintained 

by employers and to individual retirement arrangements (“IRAs”). 

Qualified defined contribution plans may permit both employees and employers to make 

contributions to the plan. Under a qualified cash or deferred arrangement (commonly referred to 

as a “section 401(k) plan”), employees may elect to make pretax contributions to a plan, referred 

to as elective deferrals. Employees may also be permitted to make after-tax contributions to a 

plan. In addition, a plan may provide for employer nonelective contributions or matching 

contributions. Nonelective contributions are employer contributions that are made without 

regard to whether the employee makes elective deferrals or after-tax contributions. Matching 

contributions are employer contributions that are made only if the employee makes elective 

deferrals or after-tax contributions. Matching contributions are sometimes made in the form of 

employer stock. 

Under present law, an individual may generally make contributions to an IRA for a 

taxable year up to the lesser of a certain dollar amount or the individual’s compensation. The 

maximum annual dollar limit on IRA contributions to IRAs is $4,000 for 2005-2007 and $5,000 

for 2008, with indexing thereafter. Individuals who have attained age 50 may make additional 

“catch-up” contributions to an IRA for a taxable year of up to $500 in 2005 and $1,000 in 2006 

and thereafter. 

Present law provides a temporary nonrefundable tax credit for eligible taxpayers for 

qualified retirement savings contributions (“saver’s” credit). The maximum annual contribution 

eligible for the credit is $2,000. The credit rate depends on the adjusted gross income (“AGI”) of 

the taxpayer. Taxpayers filing joint returns with AGI of $50,000 or less, head of household 

returns of $37,500 or less, and single returns of $25,000 or less are eligible for the credit. The 

AGI limits applicable to single taxpayers apply to married taxpayers filing separate returns. The 

credit is in addition to any deduction or exclusion that would otherwise apply with respect to the 

contribution. The credit offsets minimum tax liability as well as regular tax liability. The credit 

is available to individuals who are 18 or over, other than individuals who are full-time students 

or claimed as a dependent on another taxpayer’s return. The credit is available with respect to 

contributions to various types of retirement savings arrangements, including contributions to a 

traditional or Roth IRA. 

Description of Proposal

Under the proposal, an eligible individual would be permitted to make additional 

contributions to an IRA up to $1,500 per year in 2005, and $3,000 per year in 2006-2009. To be 

eligible to make these additional contributions, an individual must have been a participant in a 

section 401(k) plan under which the employer matched at least 50 percent of the employee’s 

contribution to the plan with stock of the employer. In addition, (1) the employer must have 

filed for bankruptcy, (2) the employer or any other person must have been subject to an 

indictment or conviction resulting from business transactions related to the bankruptcy, and 
20 

(3) the individual was a participant in the section 401(k) plan on the date six months before the 

employer filed for bankruptcy. An individual eligible to make these additional contributions is 

not permitted to make IRA catch-up contributions that apply to individuals age 50 and older. 

Under the proposal, the saver’s credit applies, with modifications, to an additional IRA 

contribution made by an eligible individual in a taxable year beginning before January 1, 2008. 

The modified credit is equal to 50 percent of the additional IRA contribution and is available 

without regard to the individual’s adjusted gross income. 

Effective Date

The ability to make additional IRA contributions is effective for taxable years beginning 

after December 31, 2004, and before January 1, 2010. The modified saver’s credit applies with 

respect to additional IRA contributions made for taxable years beginning after December 31, 

2004, and before January 1, 2008.
21

II. PROVIDING INVESTMENT ADVICE AND 

INVESTMENT EDUCATION TO PLAN PARTICIPANTS 

A. Investment Education Requirements for Defined Contribution Plan Participants 

Present Law

In general

Under ERISA, a plan administrator is required to furnish participants with certain notices 

and information about the plan.26 If a plan administrator fails or refuses to furnish to a 

participant information required to be provided to the participant within 30 days of the 

participant’s written request, the participant generally may bring a civil action to recover from 

the plan administrator $100 a day, within the court’s discretion, or other relief that the court 

deems proper. 

The Code contains a variety of notice requirements with respect to qualified plans. Such 

requirements are generally enforced by an excise tax. For example, in case of a failure to 

provide notice of a significant reduction in benefit accruals, an excise tax of $100 a day is 

generally imposed on the employer. If the employer exercised reasonable diligence in meeting 

the requirements, the excise tax with respect to a taxable year is limited to no more than 

$500,000. 

Pension benefit statements

ERISA provides that a plan administrator must furnish a benefit statement to any 

participant or beneficiary who makes a written request for such a statement. The benefit 

statement must indicate, on the basis of the latest available information: (1) the participant’s or 

beneficiary’s total accrued benefit; and (2) the participant’s or beneficiary’s vested accrued 

benefit or the earliest date on which the accrued benefit will become vested. A participant or 

beneficiary is not entitled to receive more than one benefit statement during any 12-month 

period. 

Statements to participants on separation from service 

A plan administrator must furnish a statement to each participant who: (1) separates from 

service during the year; (2) is entitled to a deferred vested benefit under the plan as of the end of 

the plan year; and (3) whose benefits were not paid during the year. The statement must set forth 

the nature, amount, and form of the deferred vested benefit to which the participant is entitled. 

The plan administrator generally must provide the statement no later than 180 days after the end 

of the plan year in which the separation from service occurs. 

 26 Governmental plans and church plans are exempt from ERISA, including requirements to 

provide notices or information to participants. 
22

Investment guidelines

Present law does not require that participants be given investment guidelines relating to 

retirement savings. 

Description of Proposal

In general

Under the proposal, the administrator of a defined contribution plan (other than a oneparticipant retirement plan) is required under the Code and ERISA to provide at least once a year 

a model form relating to basic investment guidelines to each participant or beneficiary who has 

the right to direct the investment of the assets in his or her account under the plan.27

Model form

Under the proposal, the Secretary of the Treasury is directed, in consultation with the 

Secretary of Labor, to develop and make available a model form containing basic guidelines for 

investing for retirement. The guidelines in the model form are to include: (1) information on the 

benefits of diversification of investments; (2) information on the essential differences, in terms of 

risk and return, of pension plan investments, including stocks, bonds, mutual funds and money 

market investments; (3) information on how an individual’s investment allocations under the 

plan may differ depending on the individual’s age and years to retirement, as well as other 

factors determined by the Secretary; (4) sources of information where individuals may learn 

more about pension rights, individual investing, and investment advice; and (5) such other 

information related to individual investing as the Secretary determines appropriate. For example, 

information on how investment fees may affect the return on an investment is appropriate other 

information that the Secretary may determine must be included in the investment guidelines. 

The model form must also include addresses for Internet sites, and a worksheet, that a 

participant or beneficiary may use to calculate: (1) the retirement age value of the individual’s 

vested benefits under the plan (expressed as an annuity amount and determined by reference to 

varied historical annual rates of return and annuity interest rates); and (2) other important 

amounts relating to retirement savings, including the amount that an individual must save 

annually in order to provide a retirement income equal to various percentages of his or her 

current salary (adjusted for expected growth prior to retirement). The Secretary of the Treasury 

is directed to provide at least 90 days for public comment before publishing final notice of the 

model form and to update the model form at least annually. In addition, the Secretary of Labor is 

required to develop an Internet site to be used by an individual in making these calculations, the 

address of which will be included in the model form. 

 27 In the case of a tax-sheltered annuity (sec. 403(b)) that is not a plan established or maintained 

by the employer, the model form generally must be provided by the issuer of the annuity contract. 
23

The model form must be written in a manner calculated to be understood by the average 

plan participant and may be delivered in written, electronic, or other appropriate form to the 

extent that such form is reasonably accessible to the recipient. 

Sanctions for failure to provide information

Excise tax

Under the proposal, an excise tax generally applies in the case of a failure to provide an 

investment guideline model form as required under the Code. The excise tax is generally 

imposed on the employer if a required benefit statement or model form is not provided.28 The 

excise tax is $100 per day for each participant or beneficiary with respect to whom the failure 

occurs, until the model form is provided or the failure is otherwise corrected. If the employer 

exercises reasonable diligence to meet the model form requirement, the total excise tax imposed 

during a taxable year will not exceed $500,000. 

No tax will be imposed with respect to a failure if the employer does not know that the 

failure existed and exercises reasonable diligence to comply with the model form requirement. 

In addition, no tax will be imposed if the employer exercises reasonable diligence to comply and 

provides the required model form within 30 days of learning of the failure. In the case of a 

failure due to reasonable cause and not to willful neglect, the Secretary of the Treasury is 

authorized to waive the excise tax to the extent that the payment of the tax would be excessive or 

otherwise inequitable relative to the failure involved. 

ERISA enforcement

The Secretary of Labor may assess a civil penalty against the plan administrator of up to 

$100 a day from the date of the failure. For this purpose, each violation with respect to any 

single participant or beneficiary is treated as a separate violation. 

Exception for governmental and church plans

The proposal contains an exception from the investment notice requirements under the 

Code for a governmental plan or a church plan. In addition, such plans are generally exempt 

from ERISA. Accordingly, the benefit statement and investment notice requirements do not 

apply to a governmental plan or a church plan. 

Effective Date

The proposal is generally effective for plan years beginning after December 31, 2006. In 

the case of a plan maintained pursuant to one or more collective bargaining agreements, the 

proposal is effective for plan years beginning after the earlier of (1) the later of December 31, 

 28 In the case of a multiemployer plan, the excise tax is imposed on the plan. In the case of a taxsheltered annuity (sec. 403(b)) that is not a plan established or maintained by the employer, the tax is 

generally imposed on the issuer of the annuity contract. 
24

2007, or the date on which the last of such collective bargaining agreements terminates 

(determined without regard to any extension thereof after the date of enactment), or 

(2) December 31, 2008. 
25

B. Information Relating to Investment in Employer Securities 

Present Law

The Code and ERISA require that certain information be provided to participants and 

beneficiaries under employer-sponsored retirement plans. Present law does not specifically 

require that participants in defined contribution plans which permit participants to direct the 

investment of the assets in their accounts in employer securities be provided with the reports, 

statements, and communications which are required to be provided to investors in connection 

with investing in securities under applicable securities laws. 

The Code contains a variety of notice requirements with respect to qualified plans. Such 

requirements are generally enforced by an excise tax. For example, in case of a failure to 

provide notice of a significant reduction in benefit accruals, an excise tax of $100 a day is 

generally imposed on the employer. If the employer exercised reasonable diligence in meeting 

the requirements, the excise tax with respect to a taxable year is limited to no more than 

$500,000. 

Under ERISA, if a plan administrator fails or refuses to furnish to a participant 

information required to be provided to the participant within 30 days of the participant’s written 

request, the participant generally may bring a civil action to recover from the plan administrator 

$100 a day, within the court’s discretion, or other relief that the court deems proper. 

Description of Proposal

In general

The proposal creates a new requirement in connection with defined contribution plans 

which permit participants to direct the investment of the assets in their accounts in employer 

securities. The proposal amends the Code and ERISA to require administrators of such plans to 

provide participants with all reports, proxy statements, and other communications regarding 

investment of such assets in employer securities to the extent that such reports, statements, and 

communications are required to be provided by the plan sponsor to investors in connection with 

investment employer securities under applicable securities laws. Any such information which is 

maintained by the plan sponsor must be provided to the plan administrator. 

The reports, statements, and communications may be delivered in written, electronic, or 

other appropriate form to the extent that such form is reasonably accessible to participants. 

Sanctions for failure to provide information

Excise tax

Under the proposal, an excise tax generally applies in the case of a failure to provide the 

information as required under the Code. The excise tax is generally imposed on the employer if 
26

notice is not provided.29 The excise tax is $100 per day for each participant or beneficiary with 

respect to whom the failure occurs, until the information is provided or the failure is otherwise 

corrected. If the employer exercises reasonable diligence to meet the requirement, the total 

excise tax imposed during a taxable year will not exceed $500,000. 

No tax will be imposed with respect to a failure if the employer does not know that the 

failure existed and exercises reasonable diligence to comply with the requirement. In addition, 

no tax is imposed if the employer exercises reasonable diligence to comply and provides the 

required information within 30 days of learning of the failure. In the case of a failure due to 

reasonable cause and not to willful neglect, the Secretary of the Treasury is authorized to waive 

the excise tax to the extent that the payment of the tax would be excessive or otherwise 

inequitable relative to the failure involved. 

ERISA civil penalty

In the case of a failure or refusal to provide the information as required under the 

proposal, the Secretary of Labor may assess a civil penalty against the plan administrator of up to 

$1,000 a day from the date of the failure or refusal until it is corrected. 

Effective Date

The proposal is generally effective for plan years beginning after December 31, 2005. In 

the case of a plan maintained pursuant to one or more collective bargaining agreements, the 

proposal is effective for plan years beginning after the earlier of (1) the later of December 31, 

2006, or the date on which the last of such collective bargaining agreements terminates 

(determined without regard to any extension thereof after the date of enactment), or 

(2) December 31, 2007. 

 29 In the case of a multiemployer plan, the excise tax is imposed on the plan. 
27

C. Safe Harbor for Independent Investment Advice Provided to Plan Participants 

Present Law

ERISA requires an employee benefit plan to provide for one or more named fiduciaries 

who jointly or severally have the authority to control and manage the operation and 

administration of the plan. In addition to fiduciaries named in the plan, or identified pursuant to 

a procedure specified in the plan, a person is a plan fiduciary under ERISA to the extent the 

fiduciary exercises any discretionary authority or control over management of the plan or 

exercises authority or control over management or disposition of its assets, renders investment 

advice for a fee or other compensation, or has any discretionary authority or responsibility in the 

administration of the plan. In certain circumstances, a fiduciary under ERISA may be liable for a 

breach of responsibility by a co-fiduciary. 

Description of Proposal

In general

The proposal amends ERISA by adding specific rules dealing with the provision of 

investment advice to plan participants by a qualified investment adviser. The proposal applies to 

an individual account plan30 that permits a participant or beneficiary to direct the investment of 

the assets in his or her account. Under the proposal, if certain requirements are met, an employer 

or other plan fiduciary will not be liable for investment advice provided by a qualified 

investment adviser. 

Qualified investment adviser

Under the proposal, a “qualified investment adviser” is defined as a person who is a plan 

fiduciary by reason of providing investment advice and who is also (1) a registered investment 

adviser under the Investment Advisers Act of 1940 or registered as an investment adviser under 

the laws of the State (consistent with section 203A of the Investment Advisers Act31) in which 

the adviser maintains its principal office, (2) a bank or similar financial institution, (3) an 

insurance company qualified to do business under State law, or (4) a comparably qualified entity 

under criteria to be established by the Secretary of Labor. In addition, any individual who 

provides investment advice to participants on behalf of the investment adviser (such as an 

employee thereof) is required to be (1) a registered investment adviser under Federal or State law 

as described above,32 (2) a registered broker or dealer under the Securities Exchange Act, (3) a 

 30 An “individual account plan” is the term generally used under ERISA for a defined 

contribution plan. 

31 See 15 U.S.C. 80b-3a. Nothing in the provision is intended to restrict the authority under 

present law of any State to assert jurisdiction over investment advisers and investment adviser 

representatives based on their presence in the State or the fact that they have clients in the State. 

32 An individual who is registered as an investment adviser under the laws of a State is a 

qualified investment adviser only if the State has an examination requirement to qualify for such 

registration. 
28

registered representative under the Securities Exchange Act or the Investment Advisers Act, or 

(4) any comparably qualified individual under criteria to be established by the Secretary of 

Labor. 

A qualified investment adviser is required to provide the following documents to the 

employer or plan fiduciary: (1) the contract for investment advice services, (2) a disclosure of 

any fees or other compensation to be received by the investment adviser for the provision of 

investment advice and any fees or other compensation to be received as a result of a participant’s 

investment choices, and (3) its registration with the Securities and Exchange Commission or 

other documentation of its status as a qualified investment adviser. A qualified investment 

adviser that acknowledges its fiduciary status will be a fiduciary under ERISA with respect to 

investment advice provided to a participant or beneficiary. 

Requirements for employer or other fiduciary

Before designating the investment adviser and at least annually thereafter, the employer 

or other fiduciary is required to obtain written verification that the investment adviser (1) is a 

qualified investment adviser, (2) acknowledges its status as a plan fiduciary that is solely 

responsible for the investment advice it provides, (3) has reviewed the plan document (including 

investment options) and determined that its relationship with the plan and the investment advice 

provided to any participant or beneficiary, including the receipt of fees or compensation, will not 

violate the prohibited transaction rules, (4) will consider any employer securities or employer 

real property allocated to the participant’s or beneficiary’s account in providing investment 

advice, and (5) has the necessary insurance coverage (as determined by the Secretary of Labor) 

for any claim by a participant or beneficiary. 

In designating an investment adviser, the employer or other fiduciary is required to 

review the documents provided by the qualified investment adviser. The employer or other 

fiduciary is also required to make a determination that there is no material reason not to engage 

the investment adviser. 

In the case of (1) information that the investment adviser is no longer qualified or 

(2) concerns about the investment adviser’s services raised by a substantial number of 

participants or beneficiaries, the employer or other fiduciary is required within 30 days to 

investigate and to determine whether to continue the investment adviser’s services. 

An employer or other fiduciary that complies with the requirements for designating and 

monitoring an investment adviser will be deemed to have satisfied its fiduciary duty in the 

prudent selection and periodic review of an investment adviser and does not bear liability as a 

fiduciary or co-fiduciary for any loss or breach resulting from the investment advice. 

Effective Date

The proposal applies to investment advisers designated after the date of enactment of the 

proposal. 
29

D. Treatment of Employer-Provided Qualified Retirement Planning Services 

Present Law

Under present law, certain employer-provided fringe benefits are excludable from gross 

income and wages for employment tax purposes.33 These excludable fringe benefits include 

qualified retirement planning services provided to an employee and his or her spouse by an 

employer maintaining a qualified employer plan. A qualified employer plan includes a qualified 

retirement plan or annuity, a tax-sheltered annuity, a simplified employee pension, a SIMPLE 

retirement account, or a governmental plan, including an eligible deferred compensation plan 

maintained by a governmental employer. 

Qualified retirement planning services are retirement planning advice and information. 

The exclusion is not limited to information regarding the qualified employer plan, and, thus, for 

example, applies to advice and information regarding retirement income planning for an 

individual and his or her spouse and how the employer’s plan fits into the individual’s overall 

retirement income plan. On the other hand, the exclusion does not apply to services that may be 

related to retirement planning, such as tax preparation, accounting, legal or brokerage services. 

The exclusion does not apply with respect to highly compensated employees unless the 

services are available on substantially the same terms to each member of the group of employees 

normally provided education and information regarding the employer’s qualified plan. 

Description of Proposal

The proposal permits employers to offer employees a choice between cash compensation 

and eligible qualified retirement planning services. The maximum amount for which such a 

choice can be provided is limited to $1,000 per individual, per year. The proposal only applies to 

qualified retirement planning services provided by an eligible investment adviser. 

Under the proposal, an “eligible investment adviser” is defined as a person who is (1) a 

registered investment adviser under the Investment Advisers Act of 1940 or registered as an 

investment adviser under the laws of the State (consistent with section 203A of the Investment 

Advisers Act34) in which the adviser maintains its principal office, (2) a bank or similar financial 

institution, (3) an insurance company qualified to do business under State law, or (4) a 

comparably qualified entity under criteria to be established by the Secretary of Treasury. In 

addition, any individual who provides investment advice to participants on behalf of the 

investment adviser (such as an employee thereof) is required to be (1) a registered investment 

adviser under Federal or State law as described above,35 (2) a registered broker or dealer under 

the Securities Exchange Act, (3) a registered representative under the Securities Exchange Act or 

 33 Secs. 132 and 3121(a)(20). 

34 See 15 U.S.C. 80b-3a. 

35 An individual who is registered as an investment adviser under the laws of a State is an eligible 

investment adviser only if the State has an examination requirement to qualify for such registration. 
30

the Investment Advisers Act, or (4) any comparably qualified individual under criteria to be 

established by the Secretary of Treasury. 

As under present law, the proposal applies only to amounts for retirement planning 

advice and information and does not apply to services that may be related to retirement planning, 

such as tax preparation, accounting, legal or brokerage services. 

Under the proposal, no amount is includible in gross income or wages merely because the 

employee is offered the choice of cash in lieu of eligible qualified retirement planning services. 

Also, no amount is includible in income or wages merely because the employee is offered a 

choice among eligible qualified retirement planning services. The amount of cash offered is 

includible in income and wages only to the extent the employee elects cash. The exclusion does 

not apply to highly compensated employees unless the salary reduction option is available on 

substantially the same terms to all employees normally provided education and information 

about the plan. 

Under the proposal, salary reduction amounts used to provide eligible qualified 

retirement planning services are generally treated for pension plan purposes the same as other 

salary reduction contributions. Thus, such amounts are included in compensation for purposes of 

applying the limits on contributions and benefits, and an employer is able to elect whether or not 

to include such amounts in compensation for nondiscrimination testing. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2005, and 

before January 1, 2011.
31 

III. IMPROVEMENTS IN FUNDING RULES FOR SINGLE-EMPLOYER 

DEFINED BENEFIT PENSION PLANS AND RELATED PROVISIONS 

A. Minimum Funding Rules for Single-Employer 

Defined Benefit Pension Plans 

Present Law

In general

Single-employer defined benefit pension plans are subject to minimum funding 

requirements under the Employee Retirement Income Security Act of 1974 (“ERISA”) and the 

Internal Revenue Code (the “Code”).36 The amount of contributions required for a plan year 

under the minimum funding rules is generally the amount needed to fund benefits earned during 

that year plus that year’s portion of other liabilities that are amortized over a period of years, 

such as benefits resulting from a grant of past service credit. The amount of required annual 

contributions is determined under one of a number of acceptable actuarial cost methods. 

Additional contributions are required under the deficit reduction contribution rules in the case of 

certain underfunded plans. No contribution is required under the minimum funding rules in 

excess of the full funding limit (described below). 

General minimum funding rules

Funding standard account

As an administrative aid in the application of the funding requirements, a defined benefit 

pension plan is required to maintain a special account called a “funding standard account” to 

which specified charges and credits are made for each plan year, including a charge for normal 

cost and credits for contributions to the plan. Other credits or charges or credits may apply as a 

result of decreases or increases in past service liability as a result of plan amendments, 

experience gains or losses, gains or losses resulting from a change in actuarial assumptions, or a 

waiver of minimum required contributions. 

In determining plan funding under an actuarial cost method, a plan’s actuary generally 

makes certain assumptions regarding the future experience of a plan. These assumptions 

typically involve rates of interest, mortality, disability, salary increases, and other factors 

affecting the value of assets and liabilities. If the plan’s actual unfunded liabilities are less than 

those anticipated by the actuary on the basis of these assumptions, then the excess is an 

 36 Code sec. 412. The minimum funding rules also apply to multiemployer plans, but the rules 

for multiemployer plans differ in various respects from the rules applicable to single-employer plans. The 

minimum funding rules do not apply to governmental plans or to church plans, except church plans with 

respect to which an election has been made to have various ERISA and Code requirements, including the 

funding requirements, apply to the plan. In addition, special rules apply to certain plans funded 

exclusively by the purchase of individual insurance contracts (referred to as “insurance contract” plans). 
32 

experience gain. If the actual unfunded liabilities are greater than those anticipated, then the 

difference is an experience loss. Experience gains and losses for a year are generally amortized 

as credits or charges to the funding standard account over five years. 

If the actuarial assumptions used for funding a plan are revised and, under the new 

assumptions, the accrued liability of a plan is less than the accrued liability computed under the 

previous assumptions, the decrease is a gain from changes in actuarial assumptions. If the new 

assumptions result in an increase in the accrued liability, the plan has a loss from changes in 

actuarial assumptions. The accrued liability of a plan is the actuarial present value of projected 

pension benefits under the plan that will not be funded by future contributions to meet normal 

cost or future employee contributions. The gain or loss for a year from changes in actuarial 

assumptions is amortized as credits or charges to the funding standard account over ten years. 

If minimum required contributions are waived (as discussed below), the waived amount 

(referred to as a “waived funding deficiency) is credited to the funding standard account. The 

waived funding deficiency is then amortized over a period of five years, beginning with the year 

following the year in which the waiver is granted. Each year, the funding standard account is 

charged with the amortization amount for that year unless the plan becomes fully funded. 

If, as of the close of a plan year, the funding standard account reflects credits at least 

equal to charges, the plan is generally treated as meeting the minimum funding standard for the 

year. If, as of the close of the plan year, charges to the funding standard account exceed credits 

to the account, then the excess is referred to as an “accumulated funding deficiency.” Thus, as a 

general rule, the minimum contribution for a plan year is determined as the amount by which the 

charges to the funding standard account would exceed credits to the account if no contribution 

were made to the plan. For example, if the balance of charges to the funding standard account of 

a plan for a year would be $200,000 without any contributions, then a minimum contribution 

equal to that amount would be required to meet the minimum funding standard for the year to 

prevent an accumulated funding deficiency. 

Credit balances

If credits to the funding standard account exceed charges, a “credit balance” results. A 

credit balance results, for example, if contributions in excess of minimum required contributions 

are made. Similarly, a credit balance may result from large net experience gains. The amount of 

the credit balance, increased with interest at the rate used under the plan to determine costs, can 

be used to reduce future required contributions. 

Funding methods and general concepts

A defined benefit pension plan is required to use an acceptable actuarial cost method to 

determine the elements included in its funding standard account for a year. Generally, an 

actuarial cost method breaks up the cost of benefits under the plan into annual charges consisting 

of two elements for each plan year. These elements are referred to as: (1) normal cost; and 

(2) supplemental cost. 

The plan’s normal cost for a plan year generally represents the cost of future benefits 

allocated to the year by the funding method used by the plan for current employees and, under 
33 

some funding methods, for separated employees. Specifically, it is the amount actuarially 

determined that would be required as a contribution by the employer for the plan year in order to 

maintain the plan if the plan had been in effect from the beginning of service of the included 

employees and if the costs for prior years had been paid, and all assumptions as to interest, 

mortality, time of payment, etc., had been fulfilled. The normal cost will be funded by future 

contributions to the plan: (1) in level dollar amounts; (2) as a uniform percentage of payroll; 

(3) as a uniform amount per unit of service (e.g., $1 per hour); or (4) on the basis of the actuarial 

present values of benefits considered accruing in particular plan years. 

The supplemental cost for a plan year is the cost of future benefits that would not be met 

by future normal costs, future employee contributions, or plan assets. The most common 

supplemental cost is that attributable to past service liability, which represents the cost of future 

benefits under the plan: (1) on the date the plan is first effective; or (2) on the date a plan 

amendment increasing plan benefits is first effective. Other supplemental costs may be 

attributable to net experience losses, changes in actuarial assumptions, and amounts necessary to 

make up funding deficiencies for which a waiver was obtained. Supplemental costs must be 

amortized (i.e., recognized for funding purposes) over a specified number of years, depending on 

the source. For example, the cost attributable to a past service liability is generally amortized 

over 30 years. 

Normal costs and supplemental costs under a plan are computed on the basis of an 

actuarial valuation of the assets and liabilities of a plan. An actuarial valuation is generally 

required annually and is made as of a date within the plan year or within one month before the 

beginning of the plan year. However, a valuation date within the preceding plan year may be 

used if, as of that date, the value of the plan’s assets is at least 100 percent of the plan’s current 

liability (i.e., the present value of benefit liabilities under the plan, as described below). 

For funding purposes, the actuarial value of plan assets may be used, rather than fair 

market value. The actuarial value of plan assets is the value determined under a reasonable 

actuarial valuation method that takes into account fair market value and is permitted under 

Treasury regulations. Any actuarial valuation method used must result in a value of plan assets 

that is not less than 80 percent of the fair market value of the assets and not more than 120 

percent of the fair market value. In addition, if the valuation method uses average value of the 

plan assets, values may be used for a stated period not to exceed the five most recent plan years, 

including the current year. 

In applying the funding rules, all costs, liabilities, interest rates, and other factors are 

required to be determined on the basis of actuarial assumptions and methods, each of which is 

reasonable (taking into account the experience of the plan and reasonable expectations), or 

which, in the aggregate, result in a total plan contribution equivalent to a contribution that would 

be obtained if each assumption and method were reasonable. In addition, the assumptions are 

required to offer the actuary’s best estimate of anticipated experience under the plan.37

 37 Under present law, certain changes in actuarial assumptions that decrease the liabilities of an 

underfunded single-employer plan must be approved by the Secretary of the Treasury. 
34 

Additional contributions for underfunded plans

In general

Under special funding rules (referred to as the “deficit reduction contribution” rules),38 an 

additional charge to a plan's funding standard account is generally required for a plan year if the 

plan’s funded current liability percentage for the plan year is less than 90 percent.39 A plan’s 

“funded current liability percentage” is generally the actuarial value of plan assets as a 

percentage of the plan’s current liability.40 In general, a plan’s current liability means all 

liabilities to employees and their beneficiaries under the plan, determined on a present-value 

basis. 

The amount of the additional charge required under the deficit reduction contribution 

rules is the sum of two amounts: (1) the excess, if any, of (a) the deficit reduction contribution 

(as described below), over (b) the contribution required under the normal funding rules; and 

(2) the amount (if any) required with respect to unpredictable contingent event benefits. The 

amount of the additional charge cannot exceed the amount needed to increase the plan’s funded 

current liability percentage to 100 percent (taking into account any expected increase in current 

liability due to benefits accruing during the plan year). 

The deficit reduction contribution is the sum of (1) the “unfunded old liability amount,” 

(2) the “unfunded new liability amount,” and (3) the expected increase in current liability due to 

benefits accruing during the plan year.41 The “unfunded old liability amount” is the amount 

needed to amortize certain unfunded liabilities under 1987 and 1994 transition rules. The 

“unfunded new liability amount” is the applicable percentage of the plan’s unfunded new 

liability. Unfunded new liability generally means the unfunded current liability of the plan (i.e., 

the amount by which the plan’s current liability exceeds the actuarial value of plan assets), but 

determined without regard to certain liabilities (such as the plan’s unfunded old liability and 

 38 The deficit reduction contribution rules apply to single-employer plans, other than singleemployer plans with no more than 100 participants on any day in the preceding plan year. Singleemployer plans with more than 100 but not more than 150 participants are generally subject to lower 

contribution requirements under these rules. 

39 Under an alternative test, a plan is not subject to the deficit reduction contribution rules for a 

plan year if (1) the plan’s funded current liability percentage for the plan year is at least 80 percent, and 

(2) the plan’s funded current liability percentage was at least 90 percent for each of the two immediately 

preceding plan years or each of the second and third immediately preceding plan years. 

40 In determining a plan's funded current liability percentage for a plan year, the value of the 

plan's assets is generally reduced by the amount of any credit balance under the plan's funding standard 

account. However, this reduction does not apply in determining the plan's funded current liability 

percentage for purposes of whether an additional charge is required under the deficit reduction 

contribution rules. 

41 If the Secretary of the Treasury prescribes a new mortality table to be used in determining 

current liability, as described below, the deficit reduction contribution may include an additional amount. 
35 

unpredictable contingent event benefits). The applicable percentage is generally 30 percent, but 

decreases by .40 of one percentage point for each percentage point by which the plan’s funded 

current liability percentage exceeds 60 percent. For example, if a plan’s funded current liability 

percentage is 85 percent (i.e., it exceeds 60 percent by 25 percentage points), the applicable 

percentage is 20 percent (30 percent minus 10 percentage points (25 multiplied by .4)).42

A plan may provide for unpredictable contingent event benefits, which are benefits that 

depend on contingencies that are not reliably and reasonably predictable, such as facility 

shutdowns or reductions in workforce. The value of any unpredictable contingent event benefit 

is not considered in determining additional contributions until the event has occurred. The event 

on which an unpredictable contingent event benefit is contingent is generally not considered to 

have occurred until all events on which the benefit is contingent have occurred. 

Required interest rate and mortality table

Specific interest rate and mortality assumptions must be used in determining a plan’s 

current liability for purposes of the special funding rule. For plans years beginning before 

January 1, 2004, the interest rate used to determine a plan’s current liability must be within a 

permissible range of the weighted average43 of the interest rates on 30-year Treasury securities 

for the four-year period ending on the last day before the plan year begins. The permissible 

range is generally from 90 percent to 105 percent (120 percent for plan years beginning in 2002 

or 2003).44 The interest rate used under the plan generally must be consistent with the 

assumptions which reflect the purchase rates which would be used by insurance companies to 

satisfy the liabilities under the plan.45

Under the Pension Funding Equity Act of 2004 (“PFEA 2004”),46 a special interest rate 

applies in determining current liability for plan years beginning in 2004 or 2005.47 For these 

 42 In making these computations, the value of the plan's assets is reduced by the amount of any 

credit balance under the plan's funding standard account. 

43 The weighting used for this purpose is 40 percent, 30 percent, 20 percent and 10 percent, 

starting with the most recent year in the four-year period. Notice 88-73, 1988-2 C.B. 383. 

44 If the Secretary of the Treasury determines that the lowest permissible interest rate in this 

range is unreasonably high, the Secretary may prescribe a lower rate, but not less than 80 percent of the 

weighted average of the 30-year Treasury rate. 

45 Code sec. 412(b)(5)(B)(iii)(II). Under Notice 90-11, 1990-1 C.B. 319, the interest rates in the 

permissible range are deemed to be consistent with the assumptions reflecting the purchase rates that 

would be used by insurance companies to satisfy the liabilities under the plan. 

46 Pub. L. No. 108-218 (2004). 

47 In addition, under PFEA 2004, if certain requirements are met, reduced contributions under the 

deficit reduction contribution rules apply for plan years beginning after December 27, 2003, and before 

December 28, 2005, in the case of plans maintained by commercial passenger airlines, employers 
36 

years, the interest rate used must be within a permissible range of the weighted average of the 

rates of interest on amounts invested conservatively in long-term investment-grade corporate 

bonds during the four-year period ending on the last day before the plan year begins. The 

permissible range for these years is from 90 percent to 100 percent. The interest rate is to be 

determined by the Secretary of the Treasury on the basis of two or more indices that are selected 

periodically by the Secretary and are in the top three quality levels available. 

The Secretary of the Treasury is required to prescribe mortality tables and to periodically 

review (at least every five years) and update such tables to reflect the actuarial experience of 

pension plans and projected trends in such experience.48 The Secretary of the Treasury has 

required the use of the 1983 Group Annuity Mortality Table.49

Other rules

Full funding limitation

No contributions are required under the minimum funding rules in excess of the full 

funding limitation. The full funding limitation is the excess, if any, of (1) the accrued liability 

under the plan (including normal cost), over (2) the lesser of (a) the market value of plan assets 

or (b) the actuarial value of plan assets.50 However, the full funding limitation may not be less 

than the excess, if any, of 90 percent of the plan’s current liability (including the current liability 

normal cost) over the actuarial value of plan assets. In general, current liability is all liabilities to 

plan participants and beneficiaries accrued to date, whereas the accrued liability under the full 

funding limitation may be based on projected future benefits, including future salary increases. 

 

primarily engaged in the production or manufacture of a steel mill product or in the processing of iron ore 

pellets, or a certain labor organization. 

48 Code sec. 412(l)(7)(C)(ii). 

49 Rev. Rul. 95-28, 1995-1 C.B. 74. The IRS and the Treasury Department have announced that 

they are undertaking a review of the applicable mortality table and have requested comments on related 

issues, such as how mortality trends should be reflected. Notice 2003-62, 2003-38 I.R.B. 576; 

Announcement 2000-7, 2000-1 C.B. 586. 

50 For plan years beginning before 2004, the full funding limitation was generally defined as the 

excess, if any, of (1) the lesser of (a) the accrued liability under the plan (including normal cost) or (b) a 

percentage (170 percent for 2003) of the plan’s current liability (including the current liability normal 

cost), over (2) the lesser of (a) the market value of plan assets or (b) the actuarial value of plan assets, but 

in no case less than the excess, if any, of 90 percent of the plan’s current liability over the actuarial value 

of plan assets. Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”), the 

full funding limitation based on 170 percent of current liability is repealed for plan years beginning in 

2004 and thereafter. The provisions of EGTRRA generally do not apply for years beginning after 

December 31, 2010. 
37 

Timing of plan contributions

In general, plan contributions required to satisfy the funding rules must be made within 

81⁄2 months after the end of the plan year. If the contribution is made by such due date, the 

contribution is treated as if it were made on the last day of the plan year. 

In the case of a plan with a funded current liability percentage of less than 100 percent for 

the preceding plan year, estimated contributions for the current plan year must be made in 

quarterly installments during the current plan year.51 The amount of each required installment is 

25 percent of the lesser of (1) 90 percent of the amount required to be contributed for the current 

plan year or (2) 100 percent of the amount required to be contributed for the preceding plan 

year.52

Funding waivers

Within limits, the Secretary of the Treasury is permitted to waive all or a portion of the 

contributions required under the minimum funding standard for a plan year (a “waived funding 

deficiency”).53 A waiver may be granted if the employer (or employers) responsible for the 

contribution could not make the required contribution without temporary substantial business 

hardship and if requiring the contribution would be adverse to the interests of plan participants in 

the aggregate. Generally, no more than three waivers may be granted within any period of 15 

consecutive plan years. 

The IRS is authorized to require security to be granted as a condition of granting a waiver 

of the minimum funding standard if the sum of the plan's accumulated funding deficiency and 

the balance of any outstanding waived funding deficiencies exceeds $1 million. 

Failure to make required contributions 

An employer is generally subject to an excise tax if it fails to make minimum required 

contributions and fails to obtain a waiver from the IRS.54 The excise tax is 10 percent of the 

amount of the funding deficiency. In addition, a tax of 100 percent may be imposed if the 

funding deficiency is not corrected within a certain period. 

 51 Code sec. 412(m). 

52 If quarterly contributions are required with respect to a plan, the amount of a quarterly 

installment must also be sufficient to cover any shortfall in the plan’s liquid assets (a “liquidity 

shortfall”). 

53 Code sec. 412(d). Under similar rules, the amortization period applicable to net experience 

losses may also be extended. 

54 Code sec. 4971. An excise tax applies also if a quarterly installment is less than the amount 

required to cover the plan’s liquidity shortfall. 
38 

If the total of the contributions the employer fails to make (plus interest) exceeds $1 

million and the plan’s funded current liability percentage is less than 100 percent, a lien arises in 

favor of the plan with respect to all property of the employer and the members of the employer’s 

controlled group. The amount of the lien is the total amount of the missed contributions (plus 

interest). 

Description of Proposal

Interest rate required for plan years beginning in 2006

For plan years beginning after December 31, 2005, and before January 1, 2007, the 

proposal generally applies the present-law funding rules.55 For such year, the proposal extends 

the use of the rate of interest on amounts invested conservatively in long-term investment-grade 

corporate bonds in determining current liability for funding purposes. As under present law, the 

interest rate used must be within the permissible range of the weighted average of the rates of 

interest on amounts invested conservatively in long-term investment-grade corporate bonds 

during the four-year period ending on the last day before the plan year begins. 

General funding rules for plan years beginning after 2006

For plan years beginning after December 31, 2006, in the case of single-employer defined 

benefit pension plans, the proposal repeals the present-law funding rules (including the 

requirement that a funding standard account be maintained) and provides a new set of rules for 

determining minimum required contributions.56 Under the proposal, the minimum required 

contribution to a single-employer defined benefit pension plan for a plan year generally depends 

on a comparison of the value of the plan’s assets with the plan’s target liability. 

The minimum required contribution for a plan year is the sum of (1) the target normal 

cost of the plan for the plan year; (2) the target liability amortization payment for the plan year; 

and (3) the waiver amortization payment for the plan year. The sum of the amortization 

payments for the plan year cannot exceed the unfunded target liability for the plan year. For plan 

years beginning after 2007, a limit applies on the amount that required contributions can increase 

or decrease from the contribution required for the prior year. 

A plan’s target normal cost for a plan year is the present value of benefits that accrue or 

are earned during the plan year. A plan’s unfunded target liability is the excess of the target 

liability for the plan year, over the value of the assets of the plan as of the valuation date. Under 

 55 The interest rate used under the proposal for PBGC premiums, and other proposals relating to 

such premiums, is discussed in Part VI, below. 

56 The proposal does not change the funding rules applicable to insurance contract plans. 

Governmental plans and church plans continue to be exempt from the funding rules to the extent provided 

under present law. The proposal generally does not change the funding rules for multiemployer plans, 

except to repeal the alternative minimum funding standard account rules and extend controlled-group 

liability for required contributions to multiemployer plans. 
39 

the proposal, a plan’s target liability is the present value of all liabilities under the plan 

attributable to benefits accrued or earned as of the beginning of the plan year. As discussed 

below, if a plan sponsor is a financially-weak employer, the target normal cost is the at-risk 

normal cost and the target liability is the at-risk target liability. 

The proposal specifies the interest rates and mortality table that must be used in 

determining a plan's target normal cost and target liability, as well as certain other actuarial 

assumptions that must be used. 

As described in more detail below, under the proposal, credit balances generated under 

present law are carried over to a new “prefunding balance.” In addition, as described more fully 

below, contributions in excess of the minimum contributions required under the proposal 

generally increase the prefunding balance. Prefunding balances may be credited against the 

minimum required contribution. In determining the required contribution for a plan year, the 

value of plan assets is reduced by any prefunding balance. 

Target normal cost

Under the proposal, the minimum required contribution for a plan year generally includes 

the plan’s target normal cost for the plan year. A plan’s target normal cost is the present value of 

all benefits which accrue or are earned under the plan during the plan year (the “current” year). 

For this purpose, an increase in any benefit attributable to services performed in a preceding year 

by reason of a compensation increase during the current year is treated as accruing in the current 

year. 

As discussed below, if a plan sponsor is a financially-weak employer, the plan’s target 

normal cost is the at-risk target normal cost. 

Target liability amortization payment

In general

The minimum required contribution includes the target liability amortization payment (if 

any) for the plan. 

Target liability

A plan’s target liability is the present value of all liabilities to participants and 

beneficiaries under the plan attributable to benefits accrued or earned as of the beginning of the 

plan year. 

As discussed below, if a plan sponsor is financially weak, the target liability is the at-risk 

target liability. 
40 

Unfunded target liability

A plan’s unfunded target liability with respect to a plan year is the excess of the target 

liability for the plan year over the value of the assets of the plan as of the valuation date (reduced 

by any prefunding balance). 

A transition rule applies in determining a plan’s unfunded target liability for plan years 

beginning in 2007 and 2008. In the case of plan years beginning in 2007, the unfunded target 

liability is the excess of 93 percent of the target liability for the plan year over the assets of the 

plan as of the valuation date (reduced by any prefunding balance). For plan years beginning in 

2008, the percentage is 96 percent. 

A five-year transition rule applies in the case of plans with 100 or fewer participants. 

Under such rule, for plan years beginning in 2007, the unfunded target liability is the excess of 

92 percent of the target liability for the plan year over the assets of the plan as of the valuation 

date (reduced by any prefunding balance). The percentage is 94 percent for 2008, 96 percent for 

2009, and 98 percent for 2010. 

Target liability amortization payment 

The target liability amortization payment is the aggregate amount of the target liability 

amortization installments determined for the plan year with respect to amortizable unfunded 

target liability for the plan year and each of the six preceding plan years. 

Amortizable unfunded target liability is the difference between (1) the unfunded target 

liability for the plan year, and (2) the present value of all target liability amortization installments 

and waiver amortization installments which were determined for the current year or any 

succeeding plan year with respect to any amortizable unfunded target liability or amortizable 

waived funding deficiency for any plan year preceding the current plan year. The proposal also 

allows amortization of gains. 

If the plan has an amortizable unfunded target liability, the liability must be amortized 

over the seven year period beginning with the current plan year. Each amortization installment is 

a fixed amount equal to the amount necessary to amortize the liability in seven level amortization 

payments. 

In determining the present value of any amortization installment or the amount of any 

amortization installment, the plan must assume that each amortization installment will be paid on 

the valuation date for the plan year for which the installment was determined. The plan must 

also use the interest rate determined under the applicable yield curve method (discussed below) 

for the current plan year. 

Waiver amortization payment 

The proposal retains the present-law rules under which the Secretary of the Treasury may 

waive all or a portion of the contributions required under the minimum funding standard for a 
41 

plan year (referred to as a “waived funding deficiency”).57 If a plan has a waived funding 

deficiency for a plan year or any of the four preceding plan years, the minimum required 

contribution for the plan year includes the waiver amortization payment for the plan year. 

The waiver amortization payment for a plan year is the aggregate amount of the waiver 

amortization installments determined for the plan year with respect to any amortizable waived 

funding deficiency for the five preceding plan years. The waiver amortization installments with 

respect to an amortizable waived funding deficiency for a plan year are annual installments 

determined as the amount needed to amortize the waiver amortization base in level annual 

installments over the over the five-year period beginning with the following plan year. The 

waiver amortization installments for a plan year are determined as of the valuation date for the 

plan year, using the interest rate determined under the applicable yield curve method for the plan 

year in which the amortizable waived funding deficiency to which the installment relates arose. 

Limitation on annual increases and decreases

For plan years beginning after 2007, the proposal includes a limitation on the amount that 

required contributions can increase or decease from one plan year to the next. The limit is the 

greater of (1) 30 percent of the plan's normal cost for the preceding plan year or (2) two percent 

of the plan's target liability for the preceding plan year. The minimum required contribution for 

the current plan year cannot be greater than the minimum required contribution for the preceding 

plan year plus the limit and cannot be less than the minimum required contribution for the 

preceding plan year minus the limit. 

For purposes of this rule, the minimum required contribution for the preceding year is 

determined (1) before interest is determined in the case of contributions made after the valuation 

date (as discussed below) and (2) after the application of the limit on the annual increase or 

decrease in minimum required contributions for that year. In addition, for purposes of this rule, 

the minimum required contribution for the preceding year is reduced by any amortization 

installment that was the last scheduled payment of a series of amortization installments. 

The limit does not apply to costs attributable to benefit improvements for the current year 

(i.e., the minimum required contribution taking into account the limit would be determined and 

then costs attributable to benefit improvements would be taken into account). 

Special rule for plans that reach funding target 

If the value of the plan’s assets (reduced by any prefunding balance) equals or exceeds 

the target liability for the plan year (1) the minimum required contribution otherwise determined 

is equal to normal cost, reduced (but not below zero) by the amount of such excess, and 

(2) amortization installments determined with respect to unfunded target liability and waived 

funding deficiencies allocable to the current plan year or any succeeding plan year are not 

required to be made, or taken into account for any other purpose, in any succeeding plan year. 

 57 In the case of single-employer plans, the proposal repeals the present-law rules under which 

the amortization period applicable to losses may be extended. 
42 

Actuarial assumptions used in determining a plan's target normal cost and target liability 

Interest rates

The proposal requires that the determination of present value or other computation 

requiring any interest rate assumption be made using the yield curve method. For plan years 

beginning in 2007 and 2008, a phase-in yield curve method applies. 

The yield curve method is a method under which present value or other amounts 

requiring interest rate assumptions are determined: (1) using interest rates drawn from a yield 

curve prescribed by the Secretary of the Treasury that reflects interest rates on high-quality 

corporate bonds of varying maturities; and (2) by matching the timing of the expected benefit 

payments under the plan to the interest rates on the yield curve (i.e., for bonds with maturity 

dates comparable to the times when benefits are expected to be paid). Each month, the Secretary 

of the Treasury is required to publish any yield curve which shall apply to plan years beginning 

in such month and such yield curve must be based on average interest rates for business days 

occurring during the three preceding months. 

Under the phase-in yield curve method applicable for plan years beginning in 2007 and 

2008, present value or any other amount requiring the use of interest rate assumptions is equal to 

the sum of two amounts: (1) the applicable percentage of such amount determined under the 

yield curve method; and (2) such amount determined using the interest rate rules in effect for 

plan years beginning in 2005 under present law and 2006 under the proposal (i.e., an interest rate 

in the permissible range of the weighted four-year average of conservative long-term corporate 

bond rates), multiplied by a percentage equal to 100 percent minus the applicable percentage for 

the plan year. For this purpose, the applicable percentage is 33 percent for plan years beginning 

in 2007 and 67 percent for plan years beginning in 2008. 

 Under the proposal, certain amounts are determined using the plan's “applicable 

effective interest rate” for a plan year. The applicable effective interest rate with respect to a 

plan for a plan year is the single rate of interest which, if used to determine the present value of 

the expected benefit payments under the plan, would result in an amount equal to the plan's 

target liability for the plan year. 

Mortality table

As under present law, the proposal requires that the Secretary of the Treasury prescribe 

by regulation mortality tables to be used in calculating funding requirements. Such tables must 

be based on the actual experience of pension plans and projected trends in such experience. It is 

expected that the Secretary will take into account projections of future improvements in 

mortality. In prescribing the mortality tables, the Secretary is required to take into account 

results of available independent studies of mortality of individuals covered by pension plans. 

As under present law, the proposal requires the Secretary of the Treasury to issue 

separate mortality tables that may be used for individuals who are entitled to benefits under the 

plan on account of disability. 
43 

The proposal requires that the Secretary periodically (at least every five years) review the 

mortality tables and, to the extent determined necessary, update the tables to reflect the actual 

experience in pension plans and projected trends in such experience. 

Value of plan assets

The proposal provides that the value of plan assets is to be determined on the basis of fair 

market value. The proposal allows the value of plan assets to be determined by averaging fair 

market values over not more than the period beginning on the last day of the fourth month 

preceding the valuation date and ending on the valuation date in accordance with regulations 

prescribed by the Secretary.58 

Other assumptions

Under the proposal, in determining the target liability or target normal cost, the 

probability that future benefits will be paid in optional forms of benefit provided under the plan 

must be taken into account (including lump-sum distributions). In addition, there must be taken 

into account any difference in the present value of such optional form of benefit resulting from 

the use, in determining optional forms of benefits, of actuarial assumptions different from those 

required to be used under the proposal. 

The proposal generally does not require other specified assumptions to be used in 

determining the plan's target normal cost and funding target except in the case of plans 

maintained by financially-weak plan sponsors (discussed below). However, similar to present 

law, the determination of present value or other computation must be made on the basis of 

actuarial assumptions and methods, each of which is reasonable (taking into account the 

experience of the plan and reasonable expectations), and which, in combination, offer the 

actuary’s best estimate of anticipated experience under the plan.59 

Special rules for plans maintained by financially-weak employers

The proposal applies special rules in determining the target liability and target normal 

cost in the case of plans maintained by financially-weak employers. If, as of the valuation date, a 

plan sponsor is a financially-weak employer, the plan's target liability is the at-risk target liability 

and the plan's target normal cost is the at-risk target normal cost. 

In general, a plan sponsor is a financially-weak employer if, as of the valuation date for 

each of the three consecutive plan years ending with the current plan year, the plan sponsor is 

 58 The 80 to 120 percent corridor under present law does not apply. 

59 The proposal retains the present-law rule under which certain changes in actuarial assumptions 

that decrease the liabilities of an underfunded single-employer plan must be approved by the Secretary of 

the Treasury. 
44 

rated as below investment grade.60 A sponsor is rated as below investment grade if (1) it has an 

outstanding senior unsecured debt instrument which is rated lower than investment grade by each 

of the nationally recognized statistical rating organizations for corporate bonds that has issued a 

credit rating for such instrument, or (2) if no outstanding senior unsecured debt instrument has 

been rated by such an organization, but one or more organizations has made an issuer credit 

rating for the employer, all such organizations that have so rated the employer have rated the 

employer lower than investment grade. 

In determining if a plan sponsor is a financially-weak employer, a special rule applies in 

the case of a plan sponsor that, as of the current year valuation date, continues to be rated as 

below investment grade, but receives a higher credit rating by any rating organization than that 

received by such organization as of the valuation date for the preceding plan year (an 

“improvement period”).61 Under such rule, the improvement period is not taken into account in 

determining if the plan sponsor is financially weak and plan years immediately before and after 

the improvement period are treated as consecutive plan years. The rule applies even if the credit 

rating by another rating organization is lowered for such period. For example, suppose that as of 

the valuation date for 2007, the employer is rated by all of the nationally recognized statistical 

rating organizations as below investment grade, including a rating by Moody's of Ca. Suppose 

that the ratings for the employer remain the same as of the valuation date for 2008. If, as of the 

valuation date for 2009, the rating by Moody's is improved to B, plan year 2009 is an 

improvement period and such year is disregarded in determining if the employer is financially 

weak. This result applies even if the rating from another rating agency is lowered as of the 

valuation date for 2009. If, as of the valuation date for 2010, there is no additional improvement 

(i.e., ratings by all of the rating organizations are either lowered or remain the same as those for 

2009), the employer is treated as below investment grade for three consecutive plan years (2007, 

2008 and 2010) and is financially-weak beginning in 2010. 

A phase-in rule applies in the case of plan sponsors that are financially weak for less than 

five consecutive years. If a plan sponsor was not financially weak on the valuation date of the 

four immediately preceding plan years, the at-risk target liability or at-risk target normal cost is 

equal to the sum of (1) the applicable percentage of the at-risk target liability or the at-risk target 

normal cost (whichever is applicable, determined without regard to the phase-in), and (2) a 

percentage equal to 100 percent minus the applicable percentage of the target liability or target 

normal cost (whichever is applicable, determined without regard to the rules for financially-weak 

employers). The applicable percentage of at-risk target liability or at-risk normal cost that is 

used is based on the number of years that the plan sponsor is financially weak. The applicable 

percentage is 20 percent for the first year that the plan sponsor is financially weak and increases 

 60 Plan years beginning on or before the date of enactment are not taken into account in 

determining whether an employer is financially weak. 

61 If a plan sponsor receives a rating of investment grade or higher from any of the nationally 

recognized statistical rating organizations for any plan year, the plan sponsor is not treated as below 

investment grade for such year. Thus, the earliest that the plan sponsor could be determined to be a 

financially-weak employer is the third year following such year. 
45 

by 20 percent per year until the fifth year when 100 percent of the at-risk target liability or at-risk 

normal cost is used. 

The proposal applies a special rule to the 20-percent phase-in in the case of an 

improvement period. In the case of an improvement period, the applicable percentage is the 

applicable percentage in effect for the preceding plan year. The rule applies even if the credit 

rating by another rating organization is lowered for such period. If, as of the valuation date for 

any succeeding plan year, the credit rating has not been raised, the applicable percentage is 

increased by 20 percent for such succeeding plan year. 

If an employer is a member of a controlled group, the employer is not treated as 

financially weak if a significant member (as determined under regulations prescribed by the 

Secretary) of such group has an outstanding senior unsecured debt instrument that is rated as 

being investment grade by one of the nationally recognized statistical rating organizations. In 

the case of plans with fewer than 500 participants, the employer is not treated as financially 

weak. In the case of a plan which on any day during the preceding plan year had at least 500 

participants, if an employer has no outstanding senior unsecured debt instrument which is rated 

by a nationally recognized statistical rating organization and no such organization has made an 

issuer credit rating for the employer, the Secretary is required to prescribe regulations for 

determining whether the employer is to be treated as a financially-weak employer. 

A plan’s at-risk target liability and at-risk normal cost are determined in the same manner 

as target liability and target normal cost, except that the plan is required to use certain additional 

actuarial assumptions. Under those assumptions, the plan is required to assume that all 

employees who are not otherwise assumed to retire as of the valuation date will retire at the 

earliest retirement age under the plan, but not before the end of the plan year for which the atrisk target liability and at-risk target normal cost are being determined. The plan is also required 

to assume that all employees will elect the retirement benefit available under the plan at the 

assumed age that would result in the highest present value of liabilities. In no event, however, 

can at-risk target liability or at-risk normal cost be less than target liability or target normal cost 

determined without regard to the at-risk rules. 

Use of prefunding balance to satisfy minimum required contributions

The proposal allows a plan sponsor to use any amount of a plan's prefunding balance to 

satisfy all or a portion of the minimum required contribution for the plan year. The prefunding 

balance consists of a beginning balance, increased and decreased (as described below) and 

adjusted to reflect the rate of net gain or loss on plan assets. 

In the case of a single-employer plan that was in effect for a plan year beginning in 2006 

and, as of the end of the 2006 plan year, had a positive balance in the funding standard account 

maintained under the funding rules as in effect for 2006, the beginning balance for the 

prefunding balance is such positive balance. In other cases, the beginning balance of the 

prefunding balance is zero. 

 As of the valuation date for each plan year beginning after 2007, the prefunding balance 

of a plan is increased by the amount of the excess (if any) of (1) the aggregate total employer 
46 

contributions for the preceding plan year, over (2) the minimum required contribution for the 

preceding plan year. As of the valuation date for each plan year beginning after 2007, the 

prefunding balance of a plan is decreased (but not below zero) by the amount credited against the 

minimum required contribution for the preceding plan year. 

In determining the prefunding balance as of the valuation date for a plan year (before 

applying any increase or decrease as described above), the plan sponsor must adjust the balance 

in accordance with regulations prescribed by the Secretary of the Treasury, to reflect the rate of 

net gain or loss on plan assets. The rate of net gain or loss is determined on the basis of the fair 

market value of the plan assets and the gain or loss experienced by all plan assets for the period 

beginning with the valuation date for the preceding plan year and ending with the date preceding 

the valuation date for the current plan year, properly taking into account, in accordance with 

regulations, all contributions, distributions, and other plan payments made during the period. 

The value of assets must be reduced by the prefunding balance in determining the plan’s 

minimum required contribution. 

Other rules and definitions

Valuation date

Under the proposal, all determinations made with respect to minimum required 

contributions for a plan year (such as the value of plan assets and liabilities) must be made as of 

the plan's valuation date for the plan year. In general, the valuation date for a plan year must be 

the first day of the plan year. However, any day in the plan year may be designated as the plan's 

valuation date if, on each day during the preceding plan year, the plan had 100 or fewer 

participants.62 For this purpose, all defined benefit pension plans (other than multiemployer 

plans) maintained by the same employer (or a predecessor employer), or by any member of such 

employer's controlled group, are treated as a single plan, but, in the case of multiple employer 

plans, only participants with respect to such employer or controlled group member are taken into 

account. 

Treatment of contributions after valuation date

If an employer makes any contribution to the plan after the valuation date for the plan 

year in which the contribution is made and the contribution is for a preceding plan year, the 

contribution is taken into account as an asset of the plan as of the valuation date. In the case of 

any plan year beginning after 2007, only the present value of such contribution is be taken into 

account. The present value is determined using the applicable effective interest rate for the 

 62 In the case of a plan's first plan year, the ability to use a valuation date other than the first day 

of the plan year is determined by taking into account the number of participants the plan is reasonably 

expected to have on each day during that first plan year. As under present law, a change in valuation date 

is a change in funding method requiring IRS approval. Thus, IRS approval is required to change the 

valuation date used by a smaller plan. However, the valuation date is automatically changed to the first 

day of the plan year if a plan is no longer eligible for the special rule. 
47 

preceding plan year to which the contribution is properly allocable. If contributions for the plan 

year are made during the plan year, but before the valuation date for the plan year, such 

contributions and interest on such contributions between the date of the contributions and the 

valuation date (determined by using the applicable effective interest rate for the plan year) are 

not included in the plan assets. 

Timing rules for contributions

As under present law, the due date for the payment of a minimum required contribution 

for a plan year is 8-1/2 months after the end of the plan year. Any payment made on a date other 

than the valuation date for the plan year must be adjusted by interest at the plan’s applicable 

effective rate of interest for the plan year for the period between the valuation date and the 

payment date. Such interest is included in the minimum required contribution. 

Similar to present-law rules, except in the case of plans covering 100 or fewer 

participants during the preceding year and plans that had an unfunded target liability of $1 

million or less for the preceding year, quarterly contributions must be made during a plan year if 

the plan had a funded target liability percentage of less than 100 percent for the preceding plan 

year.63 If a plan fails to pay the full amount of a required installment for the plan year, the 

amount of interest charged on the underpayments is determined using a rate of interest equal to 

the applicable effective rate of interest for the plan, plus five percentage points. 

Excise tax on failure to make minimum required contributions

The proposal retains the present-law rules under which an employer is generally subject 

to an excise tax if it fails to make minimum required contributions and fails to obtain a waiver 

from the IRS.64 The excise tax is 10 percent of the aggregate unpaid minimum required 

contributions for all plan years remaining unpaid as of the end of any plan year. In addition, a 

tax of 100 percent may be imposed if any unpaid minimum required contributions remain unpaid 

after a certain period. 

Regulations

Under the proposal, the Secretary of the Treasury is to prescribe such regulations as are 

necessary to carry out the proposal, including regulations (1) for the proper treatment of 

increases in liabilities of any plan pursuant to plan amendments that are adopted, or which take 

effect, on a date during the plan year other than the valuation date; (2) for the application of the 

small plan valuation date exception in the case of mergers and acquisitions; and (3) for the 

application of the funding rules for multiple employer plans. In general, it is intended that for 

 63 The proposal also retains the present-law rules under which the amount of any quarterly 

installment must be sufficient to cover any liquidity shortfall. 

64 The proposal retains the present-law rules under which a lien in favor of the plan with respect 

to property of the employer (and members of the employer's controlled group) arises in certain 

circumstances in which the employer fails to make required contributions. 
48 

purposes of the minimum funding requirements, multiple employer plans will be treated as 

separate plans. 

Conforming changes

The proposal makes various technical and conforming changes to reflect the new funding 

requirements. 

Effective Date

The extension of the present-law interest rate is effective for plan years beginning after 

December 31, 2005, and before January 1, 2007. The modifications to the single-employer plan 

funding rules are generally effective for plan years beginning after December 31, 2006. 
49 

B. Benefit Limitations Under Single-Employer 

Defined Benefit Pension Plans 

Present Law

In general

Under present law, various restrictions may apply to benefit increases and distributions 

from a defined benefit pension plan, depending on the funding status of the plan. 

Limitation on certain benefit increases while funding waivers in effect

Within limits, the IRS is permitted to waive all or a portion of the contributions required 

under the minimum funding standard for a plan year.65 A waiver may be granted if the employer 

responsible for the contribution could not make the required contribution without temporary 

substantial business hardship for the employer (and members of the employer’s controlled group) 

and if requiring the contribution would be adverse to the interests of plan participants in the 

aggregate. 

If a funding waiver is in effect for a plan, subject to certain exceptions, no plan 

amendment may be adopted that increases the liabilities of the plan by reason of any increase in 

benefits, any change in the accrual of benefits, or any change in the rate at which benefits vest 

under the plan.66

Security for certain plan amendments

In the case of a single-employer defined benefit pension plan, if a plan amendment 

increasing current liability is adopted and the plan’s funded current liability percentage is less 

than 60 percent (taking into account the effect of the amendment, but disregarding any 

unamortized unfunded old liability), the employer and members of the employer’s controlled 

group must provide security in favor of the plan.67 The amount of security required is the excess 

of: (1) the lesser of (a) the amount by which the plan’s assets are less than 60 percent of current 

liability, taking into account the benefit increase, or (b) the amount of the benefit increase and 

prior benefit increases after December 22, 1987, over (2) $10 million. The amendment is not 

effective until the security is provided. 

The security must be in the form of a bond, cash, certain U.S. government obligations, or 

such other form as is satisfactory to the Secretary of the Treasury and the parties involved. The 

security is released after the funded liability of the plan reaches 60 percent. 

 65 Code sec. 412(d). 

66 Code sec. 412(f). 

67 Code sec. 401(a)(29). 
50 

Prohibition on benefit increases during bankruptcy

Subject to certain exceptions, if an employer maintaining a single-employer defined 

benefit pension plans is involved in bankruptcy proceedings, no plan amendment may be adopted 

that increases the liabilities of the plan by reason of any increase in benefits, any change in the 

accrual of benefits, or any change in the rate at which benefits vest under the plan.68

Restrictions on benefit payments due to liquidity shortfalls

In the case of a single-employer plan with a funded current liability percentage of less 

than 100 percent for the preceding plan year, estimated contributions for the current plan year 

must be made in quarterly installments during the current plan year. If quarterly contributions 

are required with respect to a plan, the amount of a quarterly installment must also be sufficient 

to cover any shortfall in the plan’s liquid assets (a “liquidity shortfall”). In general, a plan has a 

liquidity shortfall for a quarter if the plan’s liquid assets (such as cash and marketable securities) 

are less than a certain amount (generally determined by reference to disbursements from the plan 

in the preceding 12 months). 

If a quarterly installment is less than the amount required to cover the plan’s liquidity 

shortfall, limits apply to the benefits that can be paid from a plan during the period of 

underpayment. During that period, the plan may not make: (1) any payment in excess of the 

monthly amount paid under a single life annuity (plus any social security supplement provided 

under the plan) in the case of a participant or beneficiary whose annuity starting date occurs 

during the period; (2) any payment for the purchase of an irrevocable commitment from an 

insurer to pay benefits (e.g., an annuity contract); or (3) any other payment specified by the 

Secretary of the Treasury by regulations.69

Prohibition on reductions in accrued benefits

An amendment of a qualified retirement plan may not decrease the accrued benefit of a 

plan participant.70 This restriction is sometimes referred to as the “anticutback” rule and applies 

to benefits that have already accrued. In general, an amendment may reduce the amount of 

future benefit accruals, provided that, in the case of a significant reduction in the rate of future 

benefit accrual, certain notice requirements are met. 

For purposes of the anticutback rule, an amendment is also treated as reducing an accrued 

benefit if, with respect to benefits accrued before the amendment is adopted, the amendment has 

the effect of either (1) eliminating or reducing an early retirement benefit or a retirement-type 

subsidy, or (2) except as provided by Treasury regulations, eliminating an optional form of 

benefit. 

 68 Code sec. 401(a)(33). 

69 Code sec. 401(a)(32). 

70 Code sec. 411(d)(6). 
51 

Description of Proposal

In general

Under the proposal, in the case of an underfunded single-employer defined benefit 

pension plan, limitations may apply with respect to: (1) benefit increases; (2) certain forms of 

distribution; and (3) benefit accruals. 

Limitations on benefit increases for plans less than 80 percent funded

If a plan's funded target liability percentage for the preceding plan year is less than 80 

percent, then no applicable benefit increase may take effect in the current plan year unless the 

funded target liability percentage for the current year, including any additional employer 

contributions made to satisfy this requirement, is at least 80 percent. 

An applicable benefit increase generally is any increase in liabilities of the plan (whether 

by plan amendment or otherwise) which would occur by reason of: (1) any increase in benefits; 

(2) any change in the accrual of benefits; or (3) any change in the rate at which benefits become 

nonforfeitable under the plan. 

An applicable benefit increase does not include any increase in liabilities under a plan: 

(1) by reason of a plan amendment if such amendment is required as a condition of qualification 

of the plan; or (2) which is specified in Treasury regulations. Two additional exceptions apply in 

the case of a plan maintained pursuant to a collective bargaining agreement.71 In the case of such 

a plan, an applicable benefit increase does not include an increase in liabilities of the plan by 

reason of any increase in benefits under a formula which is not based on a participant's 

compensation, if the rate of increase is not in excess of the contemporaneous rate of increase in 

average wages of participants covered by the plan. In addition, in the case of increases in 

liabilities by reason of a plan provision pursuant to a collective bargaining agreement ratified 

before the limitation would otherwise apply and when the plan had a funded target liability 

percentage of at least 80 percent, the restriction does not apply for years beginning before the 

earlier of: (1) the date on which such collective bargaining agreement terminates (determined 

without regard to any extensions); and (2) the date which is three years after the date the 

limitation would otherwise apply. 

The limitation ceases to apply with respect to any plan year, effective as of the first day 

of the plan year (or, if later, the effective date of the amendment), if the plan sponsor makes a 

contribution (in addition to any minimum required contribution for the plan year), equal to the 

amount sufficient to result in a funding target attainment percentage of 80 percent. 

 71 The special rules for plans maintained pursuant to a collective bargaining agreement apply 

with respect to individuals covered by such agreement. 
52 

The limitation does not apply to a plan for the first five years the plan (or a predecessor 

plan) is in effect.72

Limitation on certain forms of distribution for plans less than 60 percent funded and plans 

of employers in bankruptcy 

In general

Under the proposal, the restrictions on distributions apply if (1) a plan is less than 60 

percent funded or (2) the employer is in bankruptcy and the plan is less than 100 percent 

funded.73 

Restrictions on plans less than 60 percent funded

If a plan’s funded target liability percentage is less than 60 percent for the prior plan year, 

then prohibited payments may not be made in the current plan year until the plan actuary certifies 

that the plan has a funded target liability percentage of at least 60 percent or the employer makes 

sufficient contributions (or provides security as provided below) so that the plan’s funded target 

liability percentage for the current year is at least 60 percent. 

If the plan’s funded target liability percentage is not at least 60 percent by the end of the 

plan year, the prohibition on payments continues until the plan's funded target liability 

percentage has been at least 60 percent for two consecutive plan years. If contributions (or 

security) are required in order for the funded target liability percentage to be 60 percent by the 

end of the current plan year, and the employer fails to make the contributions (or provide 

security), such failure is treated as the failure to make a minimum required contribution for 

purposes of the quarterly contribution rules, the excise tax on failure to make required 

contributions, and the lien with respect to failures to make certain required contributions. 

The timing of the provision is illustrated by the following example. Suppose that the 

valuation date for a plan (and the beginning of the plan year) is January 1 and that the plan’s 

funded target liability percentage is less than 60 percent as of January 1, 2008. If the plan’s 

funded target liability percentage is less than 60 percent as of January 1, 2009, then no prohibited 

payments can be made until the plan actuary certifies that such percentage is at least 60 percent 

or the employer makes sufficient contributions to the plan (or provides security) so that such 

percentage is at least 60 by the end of the plan year. 

As described above, the requirement to make contributions under the provision may be 

satisfied by providing security in lieu of contributions.74 The security must meet the present-law 

 72 The present-law restrictions on benefit increases in the case of bankruptcy of the employer 

continue to apply under the proposal. 

73 The present-law restrictions on distributions during a period of liquidity shortfall continue to 

apply under the proposal. 

74 The security may not be used to offset minimum required contributions.
53 

requirements applicable to security required for certain plan amendments. The security is 

released at the end of the prohibited period for the failure to which the security relates. The plan 

may foreclose on the security if (1) the employer fails to meet any minimum funding 

requirement (other than the requirement for which the security was provided), (2) after seven 

years, or (3) if the plan terminates. 

The prohibited payments for a plan that is less than 60-percent funded are generally the 

same as those that are prohibited under present law during a period of a liquidity shortfall. Thus, 

during a prohibited period, a plan generally may not make: (1) any payment in excess of the 

monthly amount paid under a single life annuity (plus any social security supplement provided 

under the plan) in the case of a participant or beneficiary whose annuity starting date occurs 

during the period; (2) any payment for the purchase of an irrevocable commitment from an 

insurer to pay benefits (e.g., an annuity contract); or (3) any other payment specified by the 

Secretary of the Treasury by regulations. However, an otherwise prohibited payment may be 

made if the payment does not exceed the lesser of: (1) 50 percent of the amount of the payment 

that would be made in the absence of the prohibition; and (2) the present value (as determined 

under section 417(e)) of the maximum amount of any benefit guaranteed by the PBGC. The 

PBGC is directed to publish such present value. 

Restrictions on plans in bankruptcy 

Under the proposal, no prohibited payments (regardless of amount) may be made during 

any period the plan sponsor is in bankruptcy. This prohibition does not apply to any portion of a 

plan year which occurs on or after the date the plan's actuary certifies that, as of the valuation 

date for the plan year, the plan's funded target liability percentage is at least 100 percent. 

Additional limitation on benefit accruals for plans less than 60-percent funded and plans of 

employers in bankruptcy

In general

If a plan is less than 60 percent funded or the employer is in bankruptcy, then accruals are 

frozen and certain benefits are eliminated. These limitations do not apply for the first five plan 

years a plan (or a predecessor plan) is in effect. 

Plans less than 60 percent funded

If a plan’s funded target liability percentage is less than 60 percent for the prior plan year, 

then benefit accruals are suspended in the current plan year until the plan actuary certifies that 

the plan has a funded target liability percentage of at least 60 percent or the employer makes 

sufficient contributions (or provides security as provided below) so that the plan’s funded target 

liability percentage for the current year is at least 60 percent. 

If the plan’s funded target liability percentage is not at least 60 percent by the end of the 

plan year, the freeze continues until the plan's funded target liability percentage has been at least 

60 percent for two consecutive plan years. If contributions (or security) are required in order for 

the funded target liability percentage to be 60 percent by the end of the current plan year, and the 

employer fails to make the contributions (or provide security), such failure is treated as the 
54 

failure to make a minimum required contribution for purposes of the quarterly contribution rules, 

the excise tax on failure to make required contributions, and the lien with respect to failures to 

make certain required contributions. 

A special rule applies in the case of a plan maintained pursuant to a collective bargaining 

agreement ratified before the freeze period would otherwise apply and when the plan had a 

funded target liability percentage of at least 60 percent. In the case of benefits pursuant to and 

individuals covered by such an agreement, the freeze does not apply for years beginning before 

the earlier of: (1) the date on which such collective bargaining agreement terminates 

(determined without regard to any extensions); and (2) the date which is three years after the date 

the freeze would otherwise apply. 

During a freeze period, the accrued benefit, any death or disability benefit, and any social 

security supplement (as described in sec. 411(a)(9)) of each participant are frozen at the amount 

of such benefit or supplement immediately before the freeze period and all other benefits 

provided under the plan are eliminated to the extent that such freezing or elimination would be 

permitted under the anti-cutback rules if they had been implemented by a plan amendment. 

The same rules relating to providing security in lieu of contributions that apply with 

respect to restrictions on distributions apply with respect to a freeze period. 

Restrictions on plans in bankruptcy 

Under the proposal, a freeze period includes any period the plan sponsor is in bankruptcy. 

A freeze period does not include any portion of a plan year which occurs on or after the date the 

plan’s actuary certifies that, as of the valuation date for the plan year, the plan’s funded target 

liability percentage is at least 100 percent. 

Determining funding levels and other rules

For purposes of the restrictions on benefits, accruals, and payments, the funded target 

liability percentage for any plan year is a percentage equal to a fraction, the numerator of which 

is the value of plan assets (determined as under the funding rules) and the denominator of which 

is the target liability for the plan year. In determining funded target liability percentage, certain 

distributions for the immediately preceding two plan years are added back in to the numerator 

and denominator of the fraction. The distributions added back in are the sum of purchases of 

annuities, payments of single sums, and such other disbursements as the Secretary provides in 

regulations. In determining the funded target liability percentage, plan assets are not reduced by 

any prefunding balance. Contributions required under the provisions relating to benefit 

limitations, prohibited payments and freeze periods do not give rise to a prefunding balance (and 

such contribution requirements cannot be satisfied with a prefunding balance). 

Notice to participants

The proposal amends the Code and ERISA to require that the plan administrator provide 

written notice to participants and beneficiaries of a limitation applicable to a plan within a 

reasonable period of time before the limitation takes effect. Similarly, the plan administrator is 

to provide written notice to participants and beneficiaries of the date a limitation will cease to 
55 

apply to a plan within a reasonable period of time before such cessation. The Secretary may 

provide that a notice be provided at a later time if it is not practicable to provide the notice in 

advance. 

Under the proposal, an excise tax generally applies in the case of a failure to provide the 

information as required under the Code. The excise tax is generally imposed on the employer if 

notice is not provided. The excise tax is $100 per day for each participant or beneficiary with 

respect to whom the failure occurs, until the information is provided or the failure is otherwise 

corrected. If the employer exercises reasonable diligence to meet the requirement, the total 

excise tax imposed during a taxable year will not exceed $500,000. The $500,000 limit is 

applied separately with respect to each type of notice required. 

No tax will be imposed with respect to a failure if the employer does not know that the 

failure existed and exercises reasonable diligence to comply with the requirement. In addition, 

no tax is imposed if the employer uses reasonable diligence to comply and provides the required 

information within 30 days of learning of the failure. In the case of a failure due to reasonable 

cause and not to willful neglect, the Secretary of the Treasury is authorized to waive the excise 

tax to the extent that the payment of the tax would be excessive or otherwise inequitable relative 

to the failure involved. 

In addition to the excise tax, if the required notice is not provided, the Secretary of Labor 

may impose a civil penalty of up to $100 a day from the time of the failure. Each violation with 

respect to any single participant or beneficiary is treated as a separate violation. 

Coordination with other requirements

Under the proposal, a plan does not fail to meet the qualification requirements solely by 

reason of complying with the requirements of the proposal. 

Restoration of benefits

If limitations on distributions or accruals apply with respect to plan for a plan year, unless 

the plan provides otherwise, a plan is treated as having adopted an amendment (including for 

purposes of the PBGC guarantee phase in) which provides for the resumption of distributions or 

accruals as of the day following the prohibited or freeze period. This rule is not to be construed 

as affecting the plans’ treatment of benefits prohibited, frozen, or eliminated during the 

prohibited or freeze period. 

Effective Date

The proposal generally applies with respect to plan years beginning after December 31, 

2006. 

In the case of a plan maintained pursuant to one or more collective bargaining agreements 

between employee representatives and one or more employers ratified before the date of 

enactment of the proposal, the proposal does not apply to plan years beginning before the earlier 

of: (1) the later of (a) the date on which the last collective bargaining agreement relating to the 

plan terminates (determined without regard to any extension thereof agreed to after the date of 
56 

enactment, or (b) the first day of the first plan year to which the proposal would otherwise apply; 

or (2) January 1, 2009. For this purpose, any plan amendment made pursuant to a collective 

bargaining agreement relating to the plan that amends the plan solely to conform to any 

requirement under the proposal is not to be treated as a termination of the collective bargaining 

agreement. 

Only plan years after the effective date are taken into account in determining whether a 

limitation applies to a plan. Thus, in the case of a plan that is not maintained pursuant to a 

collective bargaining agreement, the first year that a limitation could apply to a plan based on its 

funding status is a plan year beginning in 2008. 
57 

C. Increase in Deduction Limits 

Present Law

Employer contributions to qualified retirement plans are deductible subject to certain 

limits.75 In general, the deduction limit depends on the kind of plan. 

In the case of a defined benefit pension plan, the employer generally may deduct the 

greater of: (1) the amount necessary to satisfy the minimum funding requirement of the plan for 

the year; or (2) the amount of the plan’s normal cost for the year plus the amount necessary to 

amortize certain unfunded liabilities over 10 years, but limited to the full funding limitation for 

the year.76 The maximum amount otherwise deductible generally is not less than the plan’s 

unfunded current liability.77 In the case of a single-employer plan covered by the PBGC that 

terminates during the year, the maximum deductible amount is generally not less than the 

amount needed to make the plan assets sufficient to fund benefit liabilities as defined for 

purposes of the PBGC termination insurance program. 

In the case of a defined contribution plan, the employer generally may deduct 

contributions in an amount up to 25 percent of compensation paid or accrued during the 

employer’s taxable year. 

If an employer sponsors one or more defined benefit pension plans and one or more 

defined contribution plans that cover at least one of the same employees, an overall deduction 

limit applies to the total contributions to all plans for a plan year. The overall deduction limit 

generally is the greater of (1) 25 percent of compensation, or (2) the amount necessary to meet 

the minimum funding requirements of the defined benefit plan for the year, but not less than the 

amount of the plan’s unfunded current liability. 

Subject to certain exceptions, an employer that makes nondeductible contributions to a 

plan is subject to an excise tax equal to 10 percent of the amount of the nondeductible 

contributions for the year. Certain contributions to a defined contribution plan that are 

nondeductible solely because of the overall deduction limit are disregarded in determining the 

amount of nondeductible contributions for purposes of the excise tax. Contributions that are 

disregarded are the greater of (1) the amount of contributions not in excess of six percent of the 

 75 Code sec. 404. 

76 The full funding limitation is the excess, if any, of (1) the accrued liability of the plan 

(including normal cost), over (2) the lesser of (a) the market value of plan assets or (b) the actuarial value 

of plan assets. However, the full funding limit is not less than the excess, if any, of 90 percent of the 

plan’s current liability (including the current liability normal cost) over the actuarial value of plan assets. 

77 In the case of a plan with 100 or fewer participants, current liability for this purpose does not 

include the liability attributable to benefit increases for highly compensated individuals resulting from an 

amendment that is made or becomes effective, whichever is later, within the last two years. 
58 

compensation of the employees covered by the defined contribution plan, or (2) the amount of 

matching contributions. 

Description of Proposal

Deduction limits for contributions to defined benefit pension plans

Under the proposal, for 2006, the maximum amount deductible for contributions to a 

single-employer defined benefit pension plan is not less than the excess (if any) of (1) 180 

percent of the plan’s current liability, over (2) the value of plan assets.78 

For years after 2006, the maximum deductible amount for a single-employer defined 

benefit pension plan is not less than the greater of: (1) the excess (if any) of the sum of the 

plan’s target liability, the plan's target normal cost, and a cushion amount for a plan year, over 

the value of plan assets; and (2) the minimum required contribution for the plan year. However, 

in the case of a plan to which at-risk target liability and at-risk target normal cost do not apply, 

the amount in (1) is not less than the excess (if any) of the sum of the plan's at-risk target liability 

and at-risk target normal cost (determined as if they did apply), over the value of plan assets. 

 The cushion amount for a plan year is the sum of (1) 80 percent of the plan's target 

liability for the plan year; and (2) the amount by which the plan’s target liability would increase 

if determined by taking into account increases in participants' compensation for future years or, if 

the plan does not base benefits attributable to past service on compensation, increases in benefits 

that are expected to occur in succeeding plans year (determined on the basis of average annual 

benefit increases over the previous six years).79 For this purpose, the dollar limits on benefits 

and on compensation apply, but, in the case of a plan that is covered by the PBGC insurance 

program, increases in the limits that are expected to occur in succeeding plan years may be taken 

into account. 

The proposal retains the present-law rule, that, in the case of a single-employer plan 

covered by the PBGC that terminates during the year, the maximum deductible amount is 

generally not less than the amount needed to make the plan assets sufficient to fund benefit 

liabilities as defined for purposes of the PBGC termination insurance program. 

 78 Under the proposal relating to funding requirements for single-employer plans, the interest 

rate used to determine current liability for plan years beginning in 2006 must be within the permissible 

range of the weighted average of the rates of interest on amounts invested conservatively in long-term 

investment-grade corporate bonds during the four-year period ending on the last day before the plan year 

begins. Current liability as determined for funding purposes in 2006 applies also in determining the 

deduction limits for 2006. 

79 In determining the cushion amount for a plan with 100 or fewer participants, target liability 

does not include the liability attributable to benefit increases for highly compensated individuals resulting 

from an amendment that is made or becomes effective, whichever is later, within the last two years. 
59 

Overall deduction limit for combinations of plans

For 2006, in the case of a single-employer plan, the overall limit on deductions for 

contributions to combinations of defined benefit and defined contribution plans applies to 

contributions to one or more defined contribution plans only to the extent that such contributions 

exceed six percent of compensation otherwise paid or accrued during the taxable year to the 

beneficiaries under the plans. For purposes of determining the excise tax on nondeductible 

contributions, matching contributions to a defined contribution plan that are nondeductible solely 

because of the overall deduction limit are disregarded. 

Under the proposal, for years after 2006, single-employer defined benefit plans that are 

covered by the PBGC insurance program are not taken into account in applying the overall limit 

on deductions for contributions to combinations of defined benefit and defined contribution 

plans. Thus, the deduction for contributions to a defined benefit pension plan or a defined 

contribution plan is not affected by the overall deduction limit merely because employees are 

covered by both plans if the defined benefit plan is covered by the PBGC insurance program 

(i.e., the separate deduction limits for contributions to defined contribution plans and defined 

benefit pension plans apply). 

For years after 2006, in applying the overall limit to the contributions made to one or 

more single-employer defined benefit plans that are not covered by the PBGC insurance program 

and one or more defined contribution plans, the overall limit on deductions applies to 

contributions to the defined contribution plans only to the extent that such contributions exceed 

six percent of compensation otherwise paid or accrued during the taxable year to the 

beneficiaries under the plans. For purposes of determining the excise tax on nondeductible 

contributions, matching contributions to a defined contribution plan that are nondeductible solely 

because of the overall deduction limit are disregarded. 

Effective Date

The proposal is effective for contributions for taxable years beginning after December 31, 

2005. 
60 

D. Interest Rate Assumption for Determination of Lump-Sum Distributions 

Present law

Accrued benefits under a defined benefit pension plan generally must be paid in the form 

of an annuity for the life of the participant unless the participant consents to a distribution in 

another form. Defined benefit pension plans generally provide that a participant may choose 

among other forms of benefit offered under the plan, such as a lump-sum distribution. These 

optional forms of benefit generally must be actuarially equivalent to the life annuity benefit 

payable to the participant. 

A defined benefit pension plan must specify the actuarial assumptions that will be used in 

determining optional forms of benefit under the plan in a manner that precludes employer 

discretion in the assumptions to be used. For example, a plan may specify that a variable interest 

rate will be used in determining actuarial equivalent forms of benefit, but may not give the 

employer discretion to choose the interest rate. 

Statutory assumptions must be used in determining the minimum present value of certain 

optional forms of benefit, such as a lump sum.80 That is, the lump sum payable under the plan 

may not be less than the amount of the lump sum that is actuarially equivalent to the life annuity 

payable to the participant, determined using the statutory assumptions. The statutory 

assumptions consist of an applicable mortality table (as published by the IRS) and an applicable 

interest rate. 

The applicable interest rate is the annual interest rate on 30-year Treasury securities, 

determined as of the time that is permitted under regulations. The regulations provide various 

options for determining the interest rate to be used under the plan, such as the period for which 

the interest rate will remain constant (“stability period”) and the use of averaging. 

Under the anticutback rule, an amendment of a qualified retirement plan generally may 

not eliminate an optional form of benefit.81 For this purpose, a change in the interest rate used to 

determine an optional form of benefit is generally treated as the elimination of one optional form 

of benefit and the addition of a new optional form of benefit. 

Description of Proposal

The proposal replaces the applicable interest rate used in determining the minimum 

present value of certain optional forms of benefit, such as a lump sum, with the phase-in yield 

curve method (for plan years beginning in 2007-2010) and the yield curve method (for plan years 

beginning after 2010), which are used to determine the present value of plan liabilities under the 

proposal relating to the funding requirements for single-employer defined benefit pension plans. 

 80 Code sec. 417(e)(3). 

81 Code sec. 411(d)(6). 
61 

Under the yield curve method, present value is determined: (1) using interest rates drawn 

from a yield curve prescribed by the Secretary of the Treasury that reflects interest rates on highquality corporate bonds of varying maturities; and (2) by matching the timing of the expected 

benefit payments under the plan to the interest rates on the yield curve (i.e., for bonds with 

maturity dates comparable to the times when benefits are expected to be paid). 

Under the phase-in yield curve method, present value is the sum of two amounts: (1) the 

applicable percentage of present value determined under the yield curve method; and (2) present 

value determined using the annual rate of interest on 30-year Treasury securities, multiplied by a 

percentage equal to 100 percent minus the applicable percentage for the plan year.82 For this 

purpose, the applicable percentage for a plan year is determined in accordance with the following 

table. 

Table 2.–Applicable Percentage for Plan Years Beginning in 2007-2010 

Plan years beginning in: Applicable percentage: 

2007 20 percent 

2008 40 percent 

2009 60 percent 

2010 80 percent 

Thus, for example, for plan years beginning in 2008, a lump-sum benefit payable under a 

plan may not be less than the sum of: (1) 40 percent of the minimum lump-sum benefit 

determined under the yield curve method, and (2) 60 percent of the minimum lump-sum benefit 

determined using the annual rate of interest on 30-year Treasury securities. 

Under the proposal relating to plan amendments, a plan amendment made pursuant to the 

proposal generally will not violate the anticutback rule if certain requirements are met (e.g., the 

plan amendment is made on or before the last day of the first plan year beginning on or after 

January 1, 2007). Thus, subject to those requirements, a plan amendment will not violate the 

anticutback rule merely because it provides for the use of the phase-in yield curve method and 

the yield curve method, rather than the interest rate on 30-year Treasury securities, in 

determining benefits subject to the minimum value rules. 

The proposal provides a special rule that allows a plan amendment to change the interest 

rate used to determine certain optional forms of benefit. Under the special rule, a plan 

amendment will not violate the anticutback rule if: (1) for the last plan year beginning in 2003, 

the plan provides that the annual rate of interest on 30 year Treasury securities is used in 

determining the amount of a benefit (other than the accrued benefit) that is not subject to the 

 82 In applying the phase-in yield curve method for purposes of the proposal relating to the 

funding requirements for single-employer defined benefit pension plans, an interest rate based on a 

weighted four-year average of conservative long term corporate bond rates applies, rather than the annual 

rate of interest on 30-year Treasury securities. 
62 

minimum value rules; (2) the plan is amended to provide that a different rate of interest is used in 

determining the amount of such benefit; and (3) the first plan year for which such amendment is 

effective begins no later than January 1, 2007. The proposal relating to plan amendments applies 

to a plan amendment made pursuant to the special rule. 

Effective Date

The proposal is effective for plan years beginning after December 31, 2006.
63 

E. Interest Rate Assumption for Applying Benefit Limitations 

to Lump-Sum Distributions 

Present Law

Annual benefits payable under a defined benefit pension plan generally may not exceed 

the lesser of (1) 100 percent of average compensation, or (2) $170,000 (for 2005).83 The dollar 

limit generally applies to a benefit payable in the form of a straight life annuity. If the benefit is 

not in the form of a straight life annuity (e.g., a lump sum), the benefit generally is adjusted to an 

equivalent straight life annuity. For purposes of adjusting a benefit in a form that is subject to 

the minimum present value rules, such as a lump-sum benefit, the interest rate used generally 

must be not less than the greater of: (1) the rate applicable in determining minimum lump sums, 

i.e., the interest rate on 30-year Treasury securities; or (2) the interest rate specified in the plan. 

For 2004 and 2005, the interest rate used must be not less than the greater of: (1) 5.5 percent; or 

(2) the interest rate specified in the plan. 

Under the anticutback rule, an amendment of a qualified retirement plan generally may 

not eliminate an optional form of benefit.84 For this purpose, a change in the interest rate used to 

determine an optional form of benefit is generally treated as the elimination of one optional form 

of benefit and the addition of a new optional form of benefit. 

Description of Proposal

Under the proposal, for purposes of adjusting a benefit in a form that is subject to the 

minimum present value rules, such as a lump-sum benefit, the interest rate used generally must 

be not less than the greater of: (1) 5.5 percent; or (2) the interest rate specified in the plan.85 

Thus, the rule that applies for 2004 and 2005 is made permanent. 

Under the proposal relating to plan amendments, a plan amendment made pursuant to the 

proposal generally will not violate the anticutback rule if certain requirements are met (e.g., the 

plan amendment is made on or before the last day of the first plan year beginning on or after 

January 1, 2007). Thus, subject to those requirements, a plan amendment that changes made 

pursuant to the proposal to change the interest rate used to apply the benefit limits to benefits that 

are subject to the minimum present value rules will not violate the anticutback rule. 

 83 Code sec. 415(b). 

84 Code sec. 411(d)(6). 

85 In the case of a plan under which lump-sum benefits are determined solely as required under 

the minimum value rules (rather than using an interest rate that results in larger lump-sum benefits), the 

interest rate specified in the plan is the interest rate applicable under the minimum value rules. Thus, for 

purposes of applying the benefit limits to lump-sum benefits under the plan, the interest rate used must be 

not less than the greater of: (1) 5.5 percent; (2) the rate that provides a benefit of not more than 105 

percent of the benefit that would be provided if the rate applicable in determining minimum lump sums 

were used; or (3) the interest rate applicable under the minimum value rules. 
64 

Effective Date

The proposal is effective for distributions made in years beginning after 2005.
65

F. Restrictions on Funding of Nonqualified Deferred Compensation Plan when Employer’s 

Defined Benefit Pension Plan is Underfunded 

Present Law

In general

Present law does not include any prohibition on the funding of nonqualified deferred 

compensation in connection with the funded status of a defined benefit pension plan of the same 

plan sponsor. 

Income tax treatment of nonqualified deferred compensation

Amounts deferred under a nonqualified deferred compensation plan for all taxable years 

are currently includible in gross income to the extent not subject to a substantial risk of forfeiture 

and not previously included in gross income, unless certain requirements are satisfied.86 For 

example, distributions from a nonqualified deferred compensation plan may be allowed only 

upon certain times and events. Rules also apply for the timing of elections. If the requirements 

are not satisfied, in addition to current income inclusion, interest at the underpayment rate plus 

one percentage point is imposed on the underpayments that would have occurred had the 

compensation been includible in income when first deferred, or if later, when not subject to a 

substantial risk of forfeiture. The amount required to be included in income is also subject to a 

20-percent additional tax. 

In the case of assets set aside in a trust (or other arrangement) for purposes of paying 

nonqualified deferred compensation, such assets are treated as property transferred in connection 

with the performance of services under Code section 83 at the time set aside if such assets (or 

trust or other arrangement) are located outside of the United States or at the time transferred if 

such assets (or trust or other arrangement) are subsequently transferred outside of the United 

States. A transfer of property in connection with the performance of services under Code section 

83 also occurs with respect to compensation deferred under a nonqualified deferred 

compensation plan if the plan provides that upon a change in the employer’s financial health, 

assets will be restricted to the payment of nonqualified deferred compensation. 

Description of Proposal

The proposal provides that during any restricted period, a plan sponsor of a singleemployer defined benefit pension plan (and any member of its controlled group) may not directly 

or indirectly transfer assets, and may not directly or indirectly otherwise reserve assets, in a trust 

(or other arrangement) for purposes of paying deferred compensation of an applicable covered 

employee under a nonqualified deferred compensation plan of such plan sponsor or member. 

 86 Code section 409A. 
66

With respect to any single-employer defined benefit pension plan, the restricted period is 

(1) the portion of the plan year on or after the date on which the plan’s enrolled actuary certifies 

that, as of the valuation date for the plan year, the plan sponsor is financially weak and the 

funded target liability percentage of the plan is 60 percent or less; (2) any period that the plan 

sponsor is in bankruptcy; and (3) the 12-month period beginning on the date which is six months 

before the termination date of the plan if, as of the termination date, the plan is not sufficient for 

benefit limitations. 

In general, covered employees include the chief executive officer (or individual acting in 

such capacity) and the four highest compensated officers for the taxable year (other than the 

chief executive officer). An applicable covered employee includes any (1) covered employee of 

a plan sponsor; (2) covered employee of a member of a controlled group which includes the plan 

sponsor; and (3) former employee who was a covered employee at the time of termination of 

employment with the plan sponsor or a member of a controlled group which includes the plan 

sponsor. 

The proposal requires that the plan administrator of the single-employer defined benefit 

pension plan must notify the plan sponsor within a reasonable time after the occurrence of an 

event which results in a restricted period with respect to the plan. The notice must include the 

duration of the restricted period and the restrictions that apply during such period. Within 30 

days of receipt of the notice, the plan sponsor must notify the plan administrator (of the singleemployer defined benefit pension plan) of nonqualified deferred compensation plans maintained 

by the plan sponsor (or members of the controlled group) and the amount of asset transferred or 

otherwise reserved by the plan sponsor (or member) in violation of the prohibition on transfers 

during any portion of the restricted period occurring on or before the date the plan sponsor 

provided such notice. If, subsequent to this notice, and during any portion of the remaining 

restricted period, the plan sponsor (or member of controlled group) (1) transfers or reserves 

assets in violation of the prohibition, or (2) establishes a new nonqualified deferred 

compensation plan, the plan sponsor must notify the plan administrator (of the single-employer 

defined benefit pension plan) within three days of such action. An excise tax of $1,000 per day 

applies in the case of a failure to provide a notice as required by the proposal. 

The proposal provides that any fiduciary of the plan may have access to the financial 

records of a plan sponsor (or member of the controlled group) to determine if assets were 

transferred or otherwise reserved in violation of the proposal. 

The proposal also creates a right of action by the Secretary of Labor or a fiduciary of a 

single-employer defined benefit pension plan against (1) a plan sponsor, member of a controlled 

group which includes the plan sponsor, an applicable covered employee, or a person holding 

assets which are part of a nonqualified deferred compensation plan, to recover on behalf of the 

plan (A) assets which were set aside or transferred in violation of the proposal (and earnings 

thereon), or (B) amounts equivalent to such assets and earnings; or (2) a plan sponsor, or member 

of a controlled group which includes the plan sponsor, to compel the production of records the 

fiduciary is entitled to under the proposal. The proposal also provides for the recovery of 

attorney’s fees and costs of the action. 
67

Under the proposal, if during any restricted period, a plan sponsor of a single-employer 

defined benefit pension plan (or any member of the controlled group) directly or indirectly 

transfers assets, or directly or indirectly otherwise reserves assets, in a trust (or other 

arrangement as determined by the Secretary of the Treasury) for purposes of paying deferred 

compensation of an applicable covered employee under a nonqualified deferred compensation 

plan, such assets are treated as property transferred in connection with the performance of 

services (whether or not such assets are available to satisfy the claims of general creditors) under 

Code section 83. Thus, there is current income inclusion to the extent of assets transferred or 

otherwise reserved. 

Any subsequent increases in the value of, or any earnings with respect to, transferred or 

restricted assets are treated as additional transfers of property. Interest at the underpayment rate 

plus one percentage point is imposed on the underpayments that would have occurred had the 

amounts been includible in income for the taxable year in which first deferred or, if later, the first 

taxable year not subject to a substantial risk of forfeiture. The amount required to be included in 

income is also subject to an additional 20-percent tax. 

A nonqualified deferred compensation plan is any plan that provides for the deferral of 

compensation other than a qualified employer plan or any bona fide vacation leave, sick leave, 

compensatory time, disability pay, or death benefit plan. A qualified employer plan means a 

qualified retirement plan, tax-deferred annuity, simplified employee pension, and SIMPLE.87 A 

qualified governmental excess benefit arrangement (sec. 415(m)) is a qualified employer plan. 

An eligible deferred compensation plan (sec. 457(b)) is also a qualified employer plan under the 

provision. The term plan includes any agreement or arrangement, including an agreement or 

arrangement that includes one person. 

Effective Date

The proposal is effective for transfers and other reservations of assets after December 31, 

2006. 

 87 A qualified employer plan also includes a section 501(c)(18) trust. 
68

G. Defined Benefit Pension Plan Benefits Provided in Combination with a 

Qualified Cash-or-Deferred Arrangement 

Present Law

In general

Under present law, most defined contribution plans may include a qualified cash or 

deferred arrangement (commonly referred to as a “section 401(k)” or “401(k)” plan),88 under 

which employees may elect to make pretax contributions to a plan (“elective deferrals”).89 Some 

section 401(k) plans are designed to provide for automatic enrollment, a design under which 

elective deferrals are withheld from a participant's compensation at a specified rate unless the 

participant elects a different rate (including no elective deferrals). A section 401(k) plan may 

also provide for: (1) matching contributions, which are employer contributions that are made 

only if an employee makes elective deferrals; and (2) nonelective contributions, which are 

employer contributions that are made without regard to whether an employee makes elective 

deferrals. 

Under a section 401(k) plan, no benefit other than matching contributions can be 

contingent on whether an employee makes elective deferrals. Thus, an employee's eligibility for 

benefits under a defined benefit pension plan cannot be contingent on whether the employee 

makes elective deferrals. 

The assets of a qualified retirement plan (either a defined contribution plan or a defined 

benefit plan) must be held in trust for the exclusive benefit of participants and beneficiaries. 

Defined benefit plans are subject to funding rules, which require employers to make 

contributions at specified minimum levels.90 In addition, limits apply on the extent to which 

defined benefit plan assets may be invested in employer securities or real property. The 

minimum funding rules and limits on investments in employer securities or real property 

generally do not apply to defined contribution plans. 

 88 Legally, a section 401(k) plan is not a separate type of plan, but is a profit-sharing, stock 

bonus, or pre-ERISA money purchase plan that contains a qualified cash or deferred arrangement. The 

terms “section 401(k) plan” and “401(k) plan” are used here for convenience. 

89 The maximum annual amount of elective deferrals that can be made by an individual is subject 

to a limit ($14,000 for 2005). An individual who has attained age 50 before the end of the taxable year 

may also make catch-up contributions to a section 401(k) plan, subject to a limit ($4,000 for 2005).

90 The Pension Benefit Guaranty Corporation generally guarantees a minimum level of benefits 

under a defined benefit plan. 
69

Nondiscrimination requirements

Under a general nondiscrimination requirement, the contributions or benefits provided 

under a qualified retirement plan must not discriminate in favor of highly compensated 

employees. Treasury regulations provide detailed and exclusive rules for determining whether a 

plan satisfies the general nondiscrimination rules. Under the regulations, the amount of 

contributions or benefits provided under the plan and the benefits, rights and features offered 

under the plan must be tested. 

A special nondiscrimination test applies to elective deferrals under a section 401(k) plan, 

called the actual deferral percentage test or the “ADP” test. The ADP test compares the actual 

deferral percentages (“ADPs”) of the highly compensated employee group and the nonhighly 

compensated employee group. The ADP for each group generally is the average of the deferral 

percentages separately calculated for the employees in the group who are eligible to make 

elective deferrals for all or a portion of the relevant plan year. Each eligible employee’s deferral 

percentage generally is the employee’s elective deferrals for the year divided by the employee’s 

compensation for the year. 

The plan generally satisfies the ADP test if the ADP of the highly compensated employee 

group for the current plan year is either (1) not more than 125 percent of the ADP of the 

nonhighly compensated employee group for the prior plan year, or (2) not more than 200 percent 

of the ADP of the nonhighly compensated employee group for the prior plan year and not more 

than two percentage points greater than the ADP of the nonhighly compensated employee group 

for the prior plan year. 

Under a safe harbor, a section 401(k) plan is deemed to satisfy the special 

nondiscrimination test if the plan satisfies one of two contribution requirements and satisfies a 

notice requirement (a “safe harbor section 401(k) plan”). A plan satisfies the contribution 

requirement under the safe harbor rule if the employer either (1) satisfies a matching contribution 

requirement or (2) makes a nonelective contribution to a defined contribution plan of at least 

three percent of an employee’s compensation on behalf of each nonhighly compensated 

employee who is eligible to participate in the arrangement. A plan generally satisfies the 

matching contribution requirement if, under the arrangement: (1) the employer makes a 

matching contribution on behalf of each nonhighly compensated employee that is equal to 

(a) 100 percent of the employee’s elective deferrals up to three percent of compensation and 

(b) 50 percent of the employee’s elective deferrals from three to five percent of compensation; 

and (2) the rate of match with respect to any elective deferrals for highly compensated 

employees is not greater than the rate of match for nonhighly compensated employees. In 

addition, the rate of matching contribution with respect to any rate of elective deferral of a highly 

compensated employee cannot be greater than the rate of matching contribution with respect to 

the same rate of elective deferral of a nonhighly compensated employee. 

Employer matching contributions are also subject to a special nondiscrimination test, the 

“ACP test,” which compares the average actual contribution percentages (“ACPs”) of matching 

contributions for the highly compensated employee group and the nonhighly compensated 

employee group. The plan generally satisfies the ACP test if the ACP of the highly compensated 

employee group for the current plan year is either (1) not more than 125 percent of the ACP of 
70

the nonhighly compensated employee group for the prior plan year, or (2) not more than 200 

percent of the ACP of the nonhighly compensated employee group for the prior plan year and not 

more than two percentage points greater than the ACP of the nonhighly compensated employee 

group for the prior plan year. 

A safe harbor section 401(k) plan that provides for matching contributions must satisfy 

the ACP test. Alternatively, it is deemed to satisfy the ACP test if it satisfies a matching 

contribution safe harbor, under which (1) matching contributions are not provided with respect to 

elective deferrals in excess of six percent of compensation, (2) the rate of matching contribution 

does not increase as the rate of an employee’s elective deferrals increases, and (3) the rate of 

matching contribution with respect to any rate of elective deferral of a highly compensated 

employee is no greater than the rate of matching contribution with respect to the same rate of 

deferral of a nonhighly compensated employee. 

Vesting rules

A qualified retirement plan generally must satisfy one of two alternative minimum 

vesting schedules. A plan satisfies the first schedule if a participant acquires a nonforfeitable 

right to 100 percent of the participant’s accrued benefit derived from employer contributions 

upon the completion of five years of service. A plan satisfies the second schedule if a participant 

has a nonforfeitable right to at least 20 percent of the participant’s accrued benefit derived from 

employer contributions after three years of service, 40 percent after four years of service, 60 

percent after five years of service, 80 percent after six years of service, and 100 percent after 

seven years of service. 

Special vesting rules apply to elective deferrals and matching contributions. Elective 

deferrals must be immediately vested. Matching contributions generally must vest at least as 

rapidly as under one of two alternative minimum vesting schedules. A plan satisfies the first 

schedule if a participant acquires a nonforfeitable right to 100 percent of matching contributions 

upon the completion of three years of service. A plan satisfies the second schedule if a 

participant has a nonforfeitable right to 20 percent of matching contributions for each year of 

service beginning with the participant’s second year of service and ending with 100 percent after 

six years of service. However, matching contributions under a safe harbor section 401(k) plan 

must be immediately vested. 

Top-heavy rules

Under present law, a top-heavy plan is a qualified retirement plan under which 

cumulative benefits are provided primarily to key employees. An employee is considered a key 

employee if, during the prior year, the employee was (1) an officer with compensation in excess 

of a certain amount ($135,000 for 2005), (2) a five-percent owner, or (3) a one-percent owner 

with compensation in excess of $150,000. A plan that is top-heavy must provide (1) minimum 

employer contributions or benefits to employees who are not key employees and (2) more rapid 

vesting for plan participants who are not key employees (as discussed below). 

In the case of a defined contribution plan, the minimum contribution is the lesser of 

(1) three percent of compensation, or (2) the highest percentage of compensation at which 
71

contributions were made for any key employee. In the case of a defined benefit plan, the 

minimum benefit is the lesser of (1) two percent of compensation multiplied by the employee's 

years of service, or (2) 20 percent of compensation. 

Top-heavy plans must satisfy one of two alternative minimum vesting schedules. A plan 

satisfies the first schedule if a participant acquires a nonforfeitable right to 100 percent of 

contributions or benefits upon the completion of three years of service. A plan satisfies the 

second schedule if a participant has a nonforfeitable right to 20 percent of contributions or 

benefits for each year of service beginning with the participant’s second year of service and 

ending with 100 percent after six years of service.91

A safe harbor section 401(k) plan is not subject to the top-heavy rules, provided that, if 

the provides for matching contributions, it must also satisfy the matching contribution safe 

harbor. 

Other qualified retirement plan requirements

Qualified retirement plans are subject to various other requirements, some of which 

depend on whether the plan is a defined contribution plan or a defined benefit plan. Such 

requirements include limits on contributions and benefits and spousal protections. 

In the case of a defined contribution plan, annual additions with respect to each plan 

participant cannot exceed the lesser of: (1) 100 percent of the participant’s compensation; or 

(2) a dollar amount, indexed for inflation ($42,000 for 2005). Annual additions are the sum of 

employer contributions, employee contributions, and forfeitures with respect to an individual 

under all defined contribution plans of the same employer. In the case of a defined benefit plan, 

annual benefits payable under the plan generally may not exceed the lesser of: (1) 100 percent of 

average compensation; or (2) $170,000 (for 2005). 

Defined benefit pension plans are required to provide benefits in the form of annuity 

unless the participant (and his or her spouse, in the case of a married participant) consents to 

another form of benefit. In addition, in the case of a married participant, benefits generally must 

be paid in the form of a qualified joint and survivor annuity (“QJSA”) unless the participant and 

his or her spouse consent to a distribution in another form. A QJSA is an annuity for the life of 

the participant, with a survivor annuity for the life of the spouse which is not less than 50 percent 

(and not more than 100 percent) of the amount of the annuity payable during the joint lives of the 

participant and his or her spouse. These spousal protection requirements generally do not apply 

to a defined contribution plan that does not offer annuity distributions. 

Annual reporting by qualified retirement plans

The plan administrator of a qualified retirement plan generally must file an annual return 

with the Secretary of the Treasury and an annual report with the Secretary of Labor. In addition, 

 91 The top-heavy vesting schedules are the same as the vesting schedules that apply to matching 

contributions. 
72

in the case of a defined benefit plan, certain information is generally required to be filed with the 

Pension Benefit Guaranty Corporation (“PBGC”). Form 5500, which consists of a primary form 

and various schedules, includes the information required to be filed with all three agencies. The 

plan administrator satisfies the reporting requirement with respect to each agency by filing the 

Form 5500 with the Department of Labor. 

The Form 5500 is due by the last day of the seventh month following the close of the plan 

year. The due date may be extended up to two and one-half months. Copies of filed Form 5500s 

are available for public examination at the U.S. Department of Labor. 

A plan administrator must automatically provide participants with a summary of the 

annual report within two months after the due date of the annual report (i.e., by the end of the 

ninth month after the end of the plan year unless an extension applies). In addition, a copy of the 

full annual report must be provided to participants on written request. 

Description of Proposal

In general

The proposal provides rules for “DB/K” plans, which are a combination of a defined 

benefit plan and a section 401(k) plan. A minimum benefit is required to be provided under the 

defined benefit component of the plan and a reduced safe harbor matching contribution applies 

under the 401(k) component of the plan. 

Both the defined contribution and defined benefit components of a DB/K plan can be 

included in a single plan document. However, except as otherwise provided, each part of the 

DB/K plan continues to be subject to the present-law rules for defined benefit plans or 401(k) 

plans, as applicable. Thus, for example, the present-law limits on contributions and benefits 

apply separately to benefits under the defined benefit component of the DB/K plan and 

contributions under the section 401(k) component of the plan. In addition, the spousal protection 

rules apply to the defined benefit component of the plan, but not to the section 401(k) component 

of the plan except to the extent provided under present law. 

The assets of both components of the DB/K plan can be held in a trust covered by a 

single trust instrument. However, the assets of the defined benefit component of the plan and the 

assets of the 401(k) component of the plan must be clearly identified and allocated to the 

appropriate part of the trust. Any present-law rules relating to plan assets would continue to 

apply to the assets of each component of the plan. For example, the funding rules apply to the 

defined benefit component of the plan on the basis of the assets of the defined benefit component 

of the plan, and the limits on investing defined benefit plan assets in employer securities or real 

property apply to such assets. Similarly, separate participant accounts are required to be 

maintained under the 401(k) component of the plan, and earnings on participants’ account are 

based on the earnings (or losses) with respect to the assets of the section 401(k) component of 

the plan. 
73

Defined benefit component of the plan

The defined benefit plan component of a DB/K plan is required to provide each 

participant with a minimum benefit of one percent of final average compensation per year of 

service up to 20 years, without regard to whether the participant makes elective deferrals to the 

section 401(k) plan. Benefits under the defined benefit plan must be fully vested after three 

years of service. The defined benefit component of the plan is not subject to the top-heavy rules. 

The defined benefit component of the plan may provide benefits in addition to the 

required minimum benefits. Any additional benefits are subject to the normally applicable 

nondiscrimination rules. 

Section 401(k) component of the plan

The section 401(k) plan component of a DB/K plan must provide for automatic 

enrollment of all eligible participants, under which elective deferrals at a rate of four percent are 

withheld from a participant's compensation unless the participant elects otherwise. The section 

401(k) component must also provide for matching contributions at a rate of at least 50 percent of 

the employee’s elective deferrals up to four percent of compensation and is deemed to satisfy the 

ADP test on a safe-harbor basis. As under present law, matching contributions used to satisfy 

the safe harbor (as well as elective deferrals) must be immediately vested. 

If the section 401(k) component of the plan provides for matching contributions in 

addition to the safe harbor contributions, the additional matching contributions must also be 

immediately vested. Additional matching contributions are subject to the ACP test unless they 

meet the present-law section 401(m) safe harbor (e.g., matching contributions cannot exceed six 

percent of compensation). 

The section 401(k) component of the plan may provide for nonelective contributions. 

Any nonelective contributions cannot be used to meet the safe harbor. Any nonelective 

contributions must be fully vested after three years of service and are subject to the normally 

applicable nondiscrimination rules. 

Annual reporting

A DB/K plan is treated as a single plan for purposes of annual reporting. Thus, only a 

single Form 5500 is required. All of the information required under present law with respect to a 

defined benefit plan or a defined contribution plan must be provided in the Form 5500 for the 

DB/K plan. In addition, only a single summary annual report must be provided to participants. 

Effective Date

The proposal is effective for plan years beginning after December 31, 2006. 
74

H. Studies 

1. Study on revitalizing the defined benefit plans 

Present Law

Qualified retirement plans are broadly classified into two categories under the Code, 

defined benefit plans and defined contribution plans, based on the nature of the benefits 

provided. Under a defined benefit plan, benefits are determined under a plan formula, such as a 

formula based on the participant’s compensation and years of service. Subject to certain limits, 

benefits under a defined benefit plan are guaranteed by the PBGC. 

Under a defined contribution plan, benefits are based solely on contributions allocated to 

separate accounts for each plan participant (as adjusted by gains, losses, and expenses). Benefits 

under defined contribution plans are not insured by the PBGC. 

Description of Proposal

The Department of Treasury, the Department of Labor, and the PBGC are directed to 

jointly undertake a study on ways to revitalize employer interest in defined benefit plans. In 

conducting the study, the Treasury and Labor Departments and the PBGC are to consider: 

(1) ways to encourage the establishment of defined benefit plans by small and mid-sized 

employers; (2) ways to encourage the continued maintenance of defined benefit plans by larger 

employers; and (3) legislative proposals to accomplish these objectives. 

Within two years after the date of enactment, the results of the study, together with any 

recommendations for legislative changes, are to be reported to the Senate Committees on 

Finance and Health, Education, Labor, and Pensions and to the House Committees on Ways and 

Means and Education and the Workforce. 

Effective Date

The proposal is effective on the date of enactment. 

2. Study on floor-offset ESOPs 

Present Law

Qualified retirement plans are broadly classified into two categories under the Code, 

defined benefit plans and defined contribution plans, based on the nature of the benefits 

provided. Under a defined benefit plan, benefits are determined under a plan formula, such as a 

formula based on the participant’s compensation and years of service. Subject to certain limits, 

benefits under a defined benefit plan are guaranteed by the PBGC. 

Under a defined contribution plan, benefits are based solely on contributions allocated to 

separate accounts for each plan participant (as adjusted by gains, losses, and expenses). Benefits 

under defined contribution plans are not insured by the PBGC. 
75

Under ERISA, defined contribution plans are referred to as “individual account plans.” 

Individual account plans may provide that plan participants may direct the investment of assets 

allocated to their accounts. If certain requirements are satisfied, ERISA fiduciary liability does 

not apply to investment decisions made by plan participants under an individual account plan.92

ERISA generally prohibits qualified retirement plans from acquiring employer securities 

if, after the acquisition, more than 10 percent of the assets of the plan would be invested in 

employer securities.93 This 10-percent limitation does not apply to eligible individual account 

plans. 

A floor-offset arrangement is an arrangement under which benefits payable to a 

participant under a defined benefit plan are reduced by benefits under an individual account plan. 

The 10-percent limitation on the acquisition of employer securities applies to an individual 

account plan that is part of a floor-offset arrangement, unless the floor-offset arrangement was 

established on or before December 17, 1987. 

An employee stock ownership plan (an “ESOP”) is an individual account plan that is 

designed to invest primarily in employer securities and which meets certain other requirements. 

ESOPs are not subject to the 10-percent limit on the acquisition of employer securities, unless 

the ESOP is part of a floor-offset arrangement (as described above). 

Description of Proposal

The Department of the Treasury and the PBGC are directed to undertake a study to 

determine the number of floor-offset ESOPs still in existence and the extent to which such plans 

pose a risk to plan participants or beneficiaries or the PBGC. The study is to consider legislative 

proposals to address the risks posed by floor-offset ESOPs. 

Within one year after the date of enactment, the Department of Treasury and the PBGC 

are to report the results of the study, together with any recommendations for legislative changes, 

to the Senate Committees on Finance and Health, Education, Labor, and Pensions and the House 

Committees on Ways and Means and Education and the Workforce. 

Effective Date

The proposal is effective on the date of enactment. 

 92 ERISA sec. 404(c). 

93 ERISA sec. 407. The 10-percent limitation also applies to employer real property. 
76

IV. DISCLOSURE AND BENEFIT STATEMENT REQUIREMENTS FOR 

SINGLE-EMPLOYER DEFINED BENEFIT PENSION PLANS94

A. Actuarial Reports and Summary Annual Reports 

Present Law

The plan administrator of a qualified retirement plan generally must file an annual return 

with the Secretary of the Treasury, an annual report with the Secretary of Labor, and certain 

information with the Pension Benefit Guaranty Corporation (“PBGC”).95 Form 5500, which 

consists of a primary form and various schedules, includes the information required to be filed 

with all three agencies. The plan administrator satisfies the reporting requirement with respect to 

each agency by filing the Form 5500 with the Department of Labor. 

In the case of a defined benefit pension plan, the annual report must include an actuarial 

report (filed on Schedule B of the Form 5500).96 The actuarial report must include, for example, 

information as to the value of plan assets, the plan’s accrued and current liabilities, expected 

disbursements from the plan for the year, plan contributions, the plan’s actuarial cost method and 

actuarial assumptions, and amortization bases established in the year. The report must be signed 

by an actuary enrolled to practice before the IRS, Department of Labor and the PBGC. 

The Form 5500 is due by the last day of the seventh month following the close of the plan 

year. The due date may be extended up to two and one-half months. Copies of filed Form 5500s 

are available for public examination at the U.S. Department of Labor. 

A participant must be provided with a copy of the full annual report on written request. 

In addition, the plan administrator must automatically provide participants with a summary of the 

annual report within two months after the due date of the annual report (i.e., by the end of the 

ninth month after the end of the plan year unless an extension applies). The summary annual 

report must include a statement whether contributions were made to keep the plan funded in 

 94 Notice requirements that apply with respect to the following proposals are described with 

those proposals: benefit limitations under single-employer defined benefit pension plans and rules 

relating to bankruptcy of an employer. 

95 Code secs. 6058 and 6059; ERISA secs. 103 and 4065. In addition, under ERISA section 

4010, certain financial information with respect to the members of a controlled group and actuarial 

information with respect to plans maintained by members of the controlled group (“section 4010 

information”) must be reported annually to the PBGC if: (1) the aggregate unfunded vested benefits 

under all plans maintained by controlled-group members exceed $50 million; (2) required contributions 

totaling more than $1 million have not been made with respect to an underfunded plan maintained by a 

controlled-group member; or (3) any portion of a waived funding deficiency exceeding $1 million is 

outstanding with respect to a plan maintained by a controlled-group member. Section 4010 information 

provided to the PBGC is not available to the public. 

96 Code sec. 6059; ERISA sec. 103(d).
77

accordance with minimum funding requirements, or whether contributions were not made and 

the amount of the deficit. The current value of plan assets is also required to be disclosed. If an 

extension applies for the Form 5500, the summary annual report must be provided within two 

months after the extended due date. A plan administrator who fails to provide a summary annual 

report to a participant within 30 days of the participant making a request for the report may be 

liable to the participant for a civil penalty of up to $100 a day from the date of the failure. 

Certain notices must be provided to participants in a single-employer defined benefit 

pension plan relating to the funding status of the plan. In the case of an underfunded plan for 

which variable rate PBGC premiums are required, the plan administrator generally must notify 

plan participants of the plan’s funding status and the limits on the PBGC benefit guarantee if the 

plan terminates while underfunded.97

Description of Proposal

Actuarial report and summary annual report

The proposal requires certain information to be provided in an actuarial report and 

summary annual description of an annual return with respect to a single-employer plan. The 

proposal also accelerates the time by which the actuarial report and summary annual report are 

required.98 In addition, the proposal adds a new Code requirement under which participants must 

be provided with a summary of the actuarial report. 

An actuarial report with respect to a single-employer plan must include the fair market 

value of the plan’s assets, the plan’s target liability and target normal cost, and the plan’s at-risk 

target liability and at-risk normal cost (determined as if the employer has been financially weak 

for at least five consecutive years).99 This information must also be included in the summary 

annual report provided to participants. In addition, the summary annual report must include: (1) 

a statement of the plan’s funded target liability percentage (i.e., the value of the plan’s assets as a 

percentage of the plan’s target liability) for the plan year and the two preceding plan years; (2) a 

statement of whether the plan sponsor was financially weak for the plan year and the two 

preceding plan years; and (3) the limits on benefits guaranteed by the PBGC if the plan is 

terminated while underfunded.100

 97 ERISA sec. 4011. 

98 The proposal also provides that section 4010 information provided to the PBGC is available to 

the public. 

99 Target liability, target normal cost, at-risk target liability, at-risk normal cost, and financially 

weak status are determined as under the proposal relating to funding requirements for single-employer 

plans. 

100 This information replaces the present-law requirement that plan participants be notified of the 

plan’s funding status and the limits on the PBGC benefit guarantee. 
78

Under the proposal, if quarterly contributions are required with respect to a singleemployer plan, the deadline for the actuarial report is accelerated. The actuarial report is due on 

the 15th day of the second month following the close of the plan year (e.g., February 15 for 

calendar year plans). If any contribution is subsequently made for the plan year, the additional 

contribution is required to be reflected in an amended actuarial report with the Form 5500. 

Under the proposal, the summary annual report must be provided to participants and 

beneficiaries within 15 business days after the due date for filing the Form 5500. 

Summary actuarial report

The proposal amends the Code to require that the plan administrator of a single-employer 

defined benefit pension plan must provide participants and beneficiaries with a summary of the 

actuarial report filed for the plan year. The summary actuarial report must include: (1) a 

statement of the fair market value of the plan assets, the plan’s target liability and target normal 

cost, and the plan’s at-risk target liability and at-risk normal cost (determined as if the employer 

has been financially weak for at least five consecutive years); (2) a statement of the plan’s 

funded target liability percentage for the plan year and the two preceding plan years; (3) a 

statement whether contributions were made to keep the plan funded in accordance with 

minimum funding requirements, or whether contributions were not made and the amount of the 

deficit; (4) a statement of whether the plan sponsor was financially weak for the plan year and 

the two preceding plan years; (5) the limits on benefits guaranteed by the PBGC if the plan is 

terminated while underfunded; and (6) such other relevant information as determined by the 

Secretary of Treasury. 

The summary actuarial report must be provided to participants and beneficiaries within 

15 business days after the due date for filing the Form 5500. 

Under the proposal, an excise tax is generally imposed on the employer in the case of a 

failure to provide the summary actuarial report. The excise tax is $100 per day for each 

participant or beneficiary with respect to whom the failure occurs, until the summary actuarial 

report is provided or the failure is otherwise corrected. If the employer exercises reasonable 

diligence to meet the requirement, the total excise tax imposed during a taxable year will not 

exceed $500,000. The $500,000 limit is applied separately with respect to each type of notice 

required. 

No tax will be imposed with respect to a failure if the employer does not know that the 

failure existed and exercises reasonable diligence to comply with the requirement. In addition, 

no tax is imposed if the employer uses reasonable diligence to comply and provides the summary 

actuarial report within 30 days of learning of the failure. In the case of a failure due to 

reasonable cause and not to willful neglect, the Secretary of the Treasury is authorized to waive 

the excise tax to the extent that the payment of the tax would be excessive or otherwise 

inequitable relative to the failure involved. 

Effective Date

The proposal is effective for plan years beginning after December 31, 2006. 
79

B. Periodic Pension Benefit Statements for Defined Benefit Pension Plans 

Present Law

In general

Under ERISA, a plan administrator is required to furnish participants with certain notices 

and information about the plan.101 If a plan administrator fails or refuses to furnish to a 

participant information required to be provided to the participant within 30 days of the 

participant’s written request, the participant generally may bring a civil action to recover from 

the plan administrator $100 a day, within the court’s discretion, or other relief that the court 

deems proper. 

The Code contains a variety of notice requirements with respect to qualified plans. Such 

requirements are generally enforced by an excise tax. For example, in case of a failure to 

provide notice of a significant reduction in benefit accruals, an excise tax of $100 a day is 

generally imposed on the employer. If the employer exercised reasonable diligence in meeting 

the requirements, the excise tax with respect to a taxable year is limited to no more than 

$500,000. 

Pension benefit statements

ERISA provides that a plan administrator must furnish a benefit statement to any 

participant or beneficiary who makes a written request for such a statement. The benefit 

statement must indicate, on the basis of the latest available information: (1) the participant’s or 

beneficiary’s total accrued benefit; and (2) the participant’s or beneficiary’s vested accrued 

benefit or the earliest date on which the accrued benefit will become vested. A participant or 

beneficiary is not entitled to receive more than one benefit statement during any 12-month 

period. 

Statements to participants on separation from service 

A plan administrator must furnish a statement to each participant who: (1) separates from 

service during the year; (2) is entitled to a deferred vested benefit under the plan as of the end of 

the plan year; and (3) whose benefits were not paid during the year. The statement must set forth 

the nature, amount, and form of the deferred vested benefit to which the participant is entitled. 

The plan administrator generally must provide the statement no later than 180 days after the end 

of the plan year in which the separation from service occurs. 

 101 Governmental plans and church plans are exempt from ERISA, including requirements to 

provide notices or information to participants.
80

Description of Proposal

Requirements for benefit statements

Under the proposal, the administrator of a defined benefit pension plan is required under 

the Code and ERISA either: (1) to furnish a benefit statement at least once every three years to 

each participant who has a vested accrued benefit and who is employed by the employer at the 

time the benefit statements are furnished to participants; or (2) to furnish at least annually to each 

such participant notice of the availability of a benefit statement and the manner in which the 

participant can obtain it. The Secretary of Labor is authorized to provide that years in which no 

employee or former employee benefits under the plan need not be taken into account in 

determining the three-year period. It is intended that the annual notice of the availability of a 

benefit statement may be included with other communications to the participant if done in a 

manner reasonably designed to attract the attention of the participant. 

The administrator of a defined benefit pension plan is also required to furnish a benefit 

statement to a participant or beneficiary upon written request, limited to one request during any 

12-month period. 

The benefit statement is required to indicate, on the basis of the latest available 

information: (1) the total benefits accrued; (2) the vested accrued benefit or the earliest date on 

which the accrued benefit will become vested; and (3) an explanation of any offset that may be 

applied in determining accrued benefits under a plan that provides for permitted disparity or that 

is part of a floor-offset arrangement (i.e., an arrangement under which benefits payable to a 

participant under a defined benefit pension plan are reduced by benefits under a defined 

contribution plan). With respect to information on vested benefits, the Secretary of Labor is 

required to provide that the requirements of the proposal are met if, at least annually, the plan: 

(1) updates the information on vested benefits that is provided in the benefit statement; or 

provides in a separate statement information as is necessary to enable participants and 

beneficiaries to determine their vested benefits. In the case of a statement provided to a 

participant (other than at the participant’s request), information may be based on reasonable 

estimates determined under regulations prescribed by the Secretary of Labor in consultation with 

the Pension Benefit Guaranty Corporation. 

Form of benefit statement

The benefit statement must be written in a manner calculated to be understood by the 

average plan participant. It may be delivered in written, electronic, or other appropriate form to 

the extent that such form is reasonably accessible to the recipient. For example, regulations 

could permit current benefit statements to be provided on a continuous basis through a secure 

plan website for a participant or beneficiary who has access to the website. 

The Secretary of Labor is directed, within 180 days after the date of enactment of the 

proposal, to develop one or more model benefit statements, written in a manner calculated to be 

understood by the average plan participant, that may be used by plan administrators in 

complying with the requirements of ERISA and the Code. The use of the model statement is 

optional. It is intended that the model statement include items such as the amount of 
81

nonforfeitable accrued benefits as of the statement date that are payable at normal retirement age 

under the plan, the amount of accrued benefits that are forfeitable but that may become 

nonforfeitable under the terms of the plan, information on how to contact the Social Security 

Administration to obtain a participant’s personal earnings and benefit estimate statement, and 

other information that may be important to understanding benefits earned under the plan. 

Sanctions for failure to provide information

Excise tax

Under the proposal, an excise tax generally applies in the case of a failure to provide a 

benefit statement as required under the Code. The excise tax is generally imposed on the 

employer if a required benefit statement or model form is not provided.102 The excise tax is $100 

per day for each participant or beneficiary with respect to whom the failure occurs, until the 

benefit statement or model form is provided or the failure is otherwise corrected. If the employer 

exercises reasonable diligence to meet the benefit statement, the total excise tax imposed during 

a taxable year will not exceed $500,000. 

No tax will be imposed with respect to a failure if the employer does not know that the 

failure existed and exercises reasonable diligence to comply with the benefit statement 

requirement. In addition, no tax will be imposed if the employer exercises reasonable diligence 

to comply and provides the required benefit statement within 30 days of learning of the failure. 

In the case of a failure due to reasonable cause and not to willful neglect, the Secretary of the 

Treasury is authorized to waive the excise tax to the extent that the payment of the tax would be 

excessive or otherwise inequitable relative to the failure involved. 

ERISA enforcement

The ERISA remedies that apply in the case of a failure or refusal to provide a participant 

with information under present law apply if the plan administrator fails to furnish a benefit 

statement required under the proposal. That is, the participant or beneficiary is entitled to bring a 

civil action to recover from the plan administrator $100 a day, within the court’s discretion, or 

such other relief that the court deems proper. 

Exception for governmental and church plans

The proposal contains an exception from the benefit statement under the Code for a 

governmental plan or a church plan. In addition, such plans are generally exempt from ERISA. 

Accordingly, the benefit statement and investment notice requirements do not apply to a 

governmental plan or a church plan. 

 102 In the case of a multiemployer plan, the excise tax is imposed on the plan.
82

Effective Date

The proposal is generally effective for plan years beginning after December 31, 2006. In 

the case of a plan maintained pursuant to one or more collective bargaining agreements, the 

proposal is effective for plan years beginning after the earlier of (1) the later of December 31, 

2007, or the date on which the last of such collective bargaining agreements terminates 

(determined without regard to any extension thereof after the date of enactment), or 

(2) December 31, 2008. 
83

V. IMPROVEMENTS IN FUNDING RULES FOR MULTIEMPLOYER 

DEFINED BENEFIT PLANS 

A. Increase in Deduction Limits 

Present Law

Employer contributions to qualified retirement plans are deductible subject to certain 

limits.103 In general, the deduction limit depends on the kind of plan. 

In the case of a defined benefit pension plan, the employer generally may deduct the 

greater of: (1) the amount necessary to satisfy the minimum funding requirement of the plan for 

the year; or (2) the amount of the plan’s normal cost for the year plus the amount necessary to 

amortize certain unfunded liabilities over 10 years, but limited to the full funding limitation for 

the year.104 The maximum amount otherwise deductible generally is not less than the plan’s 

unfunded current liability.105 In the case of a single-employer plan covered by the PBGC that 

terminates during the year, the maximum deductible amount is generally not less than the 

amount needed to make the plan assets sufficient to fund benefit liabilities as defined for 

purposes of the PBGC termination insurance program. 

In the case of a defined contribution plan, the employer generally may deduct 

contributions in an amount up to 25 percent of compensation paid or accrued during the 

employer’s taxable year. 

If an employer sponsors one or more defined benefit pension plans and one or more 

defined contribution plans that cover at least one of the same employees, an overall deduction 

limit applies to the total contributions to all plans for a plan year. The overall deduction limit 

generally is the greater of (1) 25 percent of compensation, or (2) the amount necessary to meet 

the minimum funding requirements of the defined benefit plan for the year, but not less than the 

amount of the plan’s unfunded current liability. 

Subject to certain exceptions, an employer that makes nondeductible contributions to a 

plan is subject to an excise tax equal to 10 percent of the amount of the nondeductible 

contributions for the year. Certain contributions to a defined contribution plan that are 

nondeductible solely because of the overall deduction limit are disregarded in determining the 

amount of nondeductible contributions for purposes of the excise tax. Contributions that are 

 103 Code sec. 404. 

104 The full funding limitation is the excess, if any, of (1) the accrued liability of the plan 

(including normal cost), over (2) the lesser of (a) the market value of plan assets or (b) the actuarial value 

of plan assets. However, the full funding limit is not less than the excess, if any, of 90 percent of the 

plan’s current liability (including the current liability normal cost) over the actuarial value of plan assets. 

105 In the case of a plan with 100 or fewer participants, current liability for this purpose does not 

include the liability attributable to benefit increases for highly compensated individuals resulting from an 

amendment that is made or becomes effective, whichever is later, within the last two years. 
84

disregarded are the greater of (1) the amount of contributions not in excess of six percent of the 

compensation of the employees covered by the defined contribution plan, or (2) the amount of 

matching contributions. 

Description of Proposal

The proposal increases the limits on deductions for contributions to multiemployer plans. 

Under the proposal, the maximum amount otherwise deductible for contributions to a 

multiemployer defined benefit pension plan is not less than the excess (if any) of (1) 130 percent 

of the plan’s current liability, over (2) the value of plan assets. 

In addition, under the proposal, the overall limit on deductions for contributions to 

combinations of defined benefit and defined contribution plans applies to contributions to one or 

more defined contribution plans does not apply to multiemployer plans. 

Effective Date

The proposal is effective for contributions for taxable years beginning after December 31, 

2005. 
85

B. Multiemployer Plan Funding Notice 

Present Law

Under ERISA, effective for plan years beginning after December 31, 2004, the plan 

administrator of a multiemployer plan must provide an annual funding notice to: (1) each 

participant and beneficiary; (2) each labor organization representing such participants or 

beneficiaries; (3) each employer that has an obligation to contribute under the plan; and (4) the 

PBGC.106

Such a notice must include: (1) identifying information, including the name of the plan, 

the address and phone number of the plan administrator and the plan’s principal administrative 

officer, each plan sponsor’s employer identification number, and the plan identification number; 

(2) a statement as to whether the plan’s funded current liability percentage for the plan year to 

which the notice relates is at least 100 percent (and if not, a statement of the percentage); (3) a 

statement of the value of the plan’s assets, the amount of benefit payments, and the ratio of the 

assets to the payments for the plan year to which the notice relates; (4) a summary of the rules 

governing insolvent multiemployer plans, including the limitations on benefit payments and any 

potential benefit reductions and suspensions (and the potential effects of such limitations, 

reductions, and suspensions on the plan); (5) a general description of the benefits under the plan 

which are eligible to be guaranteed by the PBGC and the limitations of the guarantee and 

circumstances in which such limitations apply; and (6) any additional information which the plan 

administrator elects to include to the extent it is not inconsistent with regulations prescribed by 

the Secretary of Labor. 

The annual funding notice must be provided no later than two months after the deadline 

(including extensions) for filing the plan’s annual report for the plan year to which the notice 

relates (i.e., generally nine or eleven months after the end of the plan year). The funding notice 

must be provided in a form and manner prescribed in regulations by the Secretary of Labor. 

Additionally, it must be written so as to be understood by the average plan participant and may 

be provided in written, electronic, or some other appropriate form to the extent that it is 

reasonably accessible to persons to whom the notice is required to be provided. 

A plan administrator that fails to provide the required notice to a participant or 

beneficiary may be liable to the participant or beneficiary in the amount of up to $100 a day from 

the time of the failure and for such other relief as a court may deem proper. 

Description of Proposal

The proposal amends the Code to include a multiemployer plan funding notice 

requirement similar to the present-law ERISA requirement. 

Under the proposal, an excise tax is generally imposed on the plan if a funding notice is 

not provided as required under the Code. The excise tax is $100 per day for each person with 

 106 ERISA sec. 101(f). 
86

respect to whom the failure occurred, until notice is provided or the failure is otherwise 

corrected. If the plan administrator exercises reasonable diligence to meet the notice 

requirements, the total excise tax imposed during a taxable year will not exceed $500,000. No 

tax will be imposed with respect to a failure if the plan administrator does not know that the 

failure existed and exercises reasonable diligence to comply with the notice requirement. In 

addition, no tax will be imposed if the plan administrator exercises reasonable diligence to 

comply and provides the required notice as soon as reasonably practicable after learning of the 

failure. In the case of a failure due to reasonable cause and not to willful neglect, the Secretary 

of the Treasury is authorized to waive the excise tax to the extent that the payment of the tax 

would be excessive or otherwise inequitable relative to the failure involved. 

Effective Date

The proposal is effective for failures to provide the required notice after the date of 

enactment. 
87

C. Permit Qualified Transfers of Excess Pension Assets to 

Retiree Health Accounts by Multiemployer Plan 

Present Law

Defined benefit plan assets generally may not revert to an employer prior to termination 

of the plan and satisfaction of all plan liabilities. In addition, a reversion may occur only if the 

plan so provides. A reversion prior to plan termination may constitute a prohibited transaction 

and may result in plan disqualification. Any assets that revert to the employer upon plan 

termination are includible in the gross income of the employer and subject to an excise tax. The 

excise tax rate is 20 percent if the employer maintains a replacement plan or makes certain 

benefit increases in connection with the termination; if not, the excise tax rate is 50 percent. 

Upon plan termination, the accrued benefits of all plan participants are required to be 100-

percent vested. 

A pension plan may provide medical benefits to retired employees through a separate 

account that is part of such plan. A qualified transfer of excess assets of a defined benefit plan to 

such a separate account within the plan may be made in order to fund retiree health benefits.107 

A qualified transfer does not result in plan disqualification, is not a prohibited transaction, and is 

not treated as a reversion. Thus, transferred assets are not includible in the gross income of the 

employer and are not subject to the excise tax on reversions. No more than one qualified transfer 

may be made in any taxable year. A qualified transfer may not be made from a multiemployer 

plan. No qualified transfer may be made after December 31, 2013.108

Excess assets generally means the excess, if any, of the value of the plan’s assets109 over 

the greater of (1) the accrued liability under the plan (including normal cost) or (2) 125 percent 

of the plan’s current liability.110 In addition, excess assets transferred in a qualified transfer may 

not exceed the amount reasonably estimated to be the amount that the employer will pay out of 

such account during the taxable year of the transfer for qualified current retiree health liabilities. 

No deduction is allowed to the employer for (1) a qualified transfer or (2) the payment of 

qualified current retiree health liabilities out of transferred funds (and any income thereon). 

 107 Sec. 420. 

108 Under present law in effect on the dates of Committee action on the bill, no qualified transfer 

could be made after December 31, 2005. 

109 The value of plan assets for this purpose is the lesser of fair market value or actuarial value. 

110 In the case of plan years beginning before January 1, 2004, excess assets generally means the 

excess, if any, of the value of the plan’s assets over the greater of (1) the lesser of (a) the accrued liability 

under the plan (including normal cost) or (b) 170 percent of the plan’s current liability (for 2003), or 

(2) 125 percent of the plan’s current liability. The current liability full funding limit was repealed for 

years beginning after 2003. Under the general sunset provision of EGTRRA, the limit is reinstated for 

years after 2010. 
88

Transferred assets (and any income thereon) must be used to pay qualified current retiree 

health liabilities for the taxable year of the transfer. Transferred amounts generally must benefit 

pension plan participants, other than key employees, who are entitled upon retirement to receive 

retiree medical benefits through the separate account. Retiree health benefits of key employees 

may not be paid out of transferred assets. 

Amounts not used to pay qualified current retiree health liabilities for the taxable year of 

the transfer are to be returned to the general assets of the plan. These amounts are not includible 

in the gross income of the employer, but are treated as an employer reversion and are subject to a 

20-percent excise tax. 

In order for the transfer to be qualified, accrued retirement benefits under the pension 

plan generally must be 100-percent vested as if the plan terminated immediately before the 

transfer (or in the case of a participant who separated in the one-year period ending on the date of 

the transfer, immediately before the separation). 

In order to a transfer to be qualified, the employer generally must maintain retiree health 

benefits at the same level for the taxable year of the transfer and the following four years. 

In addition, the Employee Retirement Income Security Act of 1974 (“ERISA”) provides 

that, at least 60 days before the date of a qualified transfer, the employer must notify the 

Secretary of Labor, the Secretary of the Treasury, employee representatives, and the plan 

administrator of the transfer, and the plan administrator must notify each plan participant and 

beneficiary of the transfer.111

Under present law, special deduction rules apply to a multiemployer defined benefit plan 

established before January 1, 1954, under an agreement between the Federal government and 

employee representatives in a certain industry.112 

Description of Proposal

The proposal allows qualified transfers of excess defined benefit plan assets to be made 

by the multiemployer defined benefit plan to which special deduction rules apply (or a 

continuation or spin-off thereof) that primarily covers employees in the building and construction 

industry. 

Effective Date

The proposal is effective for transfers made in taxable years beginning after 

December 31, 2004. 

 111 ERISA sec. 101(e). ERISA also provides that a qualified transfer is not a prohibited 

transaction under ERISA or a prohibited reversion. 

112 Code sec. 404(c). 
89

VI. IMPROVEMENTS IN PBGC GUARANTEE PROVISIONS 

A. Increases in PBGC Premiums for Single-Employer Plans 

Present Law

The PBGC 

The minimum funding requirements permit an employer to fund defined benefit plan 

benefits over a period of time. Thus, it is possible that a plan may be terminated at a time when 

plan assets are not sufficient to provide all benefits accrued by employees under the plan. In 

order to protect plan participants from losing retirement benefits in such circumstances, the 

Pension Benefit Guaranty Corporation (“PBGC”), a corporation within the Department of Labor, 

was created in 1974 under ERISA to provide an insurance program for benefits under most 

defined benefit plans maintained by private employers. 

Termination of single-employer defined benefit plans

An employer may voluntarily terminate a single-employer plan only in a standard 

termination or a distress termination. The PBGC may also involuntarily terminate a plan (that 

is, the termination is not voluntary on the part of the employer). 

A standard termination is permitted only if plan assets are sufficient to cover benefit 

liabilities. If assets in a defined benefit plan are not sufficient to cover benefit liabilities, the 

employer may not terminate the plan unless the employer (and members of the employer’s 

controlled group) meets one of four criteria of financial distress.113 

The PBGC may institute proceedings to terminate a plan if it determines that the plan in 

question has not met the minimum funding standards, will be unable to pay benefits when due, 

has a substantial owner who has received a distribution greater than $10,000 (other than by 

reason of death) while the plan has unfunded nonforfeitable benefits, or may reasonably be 

expected to increase PBGC’s long-run loss unreasonably. The PBGC must institute proceedings 

to terminate a plan if the plan is unable to pay benefits that are currently due. 

Guaranteed benefits

When an underfunded plan terminates, the amount of benefits that the PBGC will pay 

depends on legal limits, asset allocation, and recovery on the PBGC’s employer liability claim. 

 113 The four criteria for a distress termination are: (1) the contributing sponsor, and every 

member of the controlled group of which the sponsor is a member, is being liquidated in bankruptcy or 

any similar Federal law or other similar State insolvency proceedings; (2) the contributing sponsor and 

every member of the sponsor’s controlled group is being reorganized in bankruptcy or similar State 

proceeding; (3) the PBGC determines that termination is necessary to allow the employer to pay its debts 

when due; or (4) the PBGC determines that termination is necessary to avoid unreasonably burdensome 

pension costs caused solely by a decline in the employer’s work force. 
90

The PBGC guarantee applies to “basic benefits.” Basic benefits generally are benefits accrued 

before a plan terminates, including (1) benefits at normal retirement age; (2) most early 

retirement benefits; (3) disability benefits for disabilities that occurred before the plan was 

terminated; and (4) certain benefits for survivors of plan participants. Generally only that part of 

the retirement benefit that is payable in monthly installments (rather than, for example, lumpsum benefits payable to encourage early retirement) is guaranteed.114

Retirement benefits that begin before normal retirement age are guaranteed, provided 

they meet the other conditions of guarantee (such as that before the date the plan terminates, the 

participant had satisfied the conditions of the plan necessary to establish the right to receive the 

benefit other than application for the benefit). Contingent benefits (for example, subsidized early 

retirement benefits) are guaranteed only if the triggering event occurs before plan termination. 

For plans terminating in 2005, the maximum guaranteed benefit for an individual retiring 

at age 65 is $3,698.86 per month or $44,386.32 per year.115 The dollar limit is indexed annually 

for inflation. The guaranteed amount is reduced for benefits starting before age 65. 

In the case of a plan or a plan amendment that has been in effect for less than five years 

before a plan termination, the amount guaranteed is phased in by 20 percent a year.116

PBGC premiums

In general

The PBGC is funded by assets in terminated plans, amounts recovered from employers 

who terminate underfunded plans, premiums paid with respect to covered plans, and investment 

earnings. All covered single-employer plans are required to pay a flat per-participant premium 

and underfunded plans are subject to an additional rate variable premium based on the level of 

underfunding. The amount of both the flat rate premium and the variable rate premium are set 

by statute; the premiums are not indexed for inflation. 

 114 ERISA sec. 4022(b) and (c). 

115 The PBGC generally pays the greater of the guaranteed benefit amount and the amount that 

was covered by plan assets when it terminated. Thus, depending on the amount of assets in the 

terminating plan, participants may receive more than the amount guaranteed by PBGC. 

Special rules limit the guaranteed benefits of individuals who are substantial owners covered by a 

plans whose benefits have not been increased by reason of any plan amendment. A substantial owner 

generally is an individual who: (1) owns the entire interest in an unincorporated trade or business; (2) in 

the case of a partnership, is a partner who owns, directly or indirectly, more than 10 percent of either the 

capital interest or the profits interest in the partnership; (3) in the case of a corporation, owns, directly or 

indirectly, more than 10 percent in value of either the voting stock of the corporation or all the stock of 

the corporation; or (4) at any time within the preceding 60 months was a substantial owner under the plan. 

ERISA sec. 4022(b)(5). 

116 The phase in does not apply if the benefit is less than $20 per month. 
91

Flat rate premiums

The annual flat rate per participant premium is $19 per participant. 

Variable rate premiums 

The variable rate premium is equal to $9 per $1,000 of unfunded vested benefits. 

“Unfunded vested benefits” is the amount which would be the unfunded current liability (as 

defined under the minimum funding rules) if only vested benefits were taken into account and if 

benefits were valued at the variable premium interest rate. No variable rate premium is imposed 

for a year if contributions to the plan for the prior year were at least equal to the full funding 

limit for that year. 

In determining the amount of unfunded vested benefits, the interest rate used is generally 

85 percent of the interest rate on 30 year Treasury securities for the month preceding the month 

in which the plan year begins (100 percent of the interest rate on 30 year Treasury securities for 

plan years beginning in 2002 and 2003). Under PFEA 2004, in determining the amount of 

unfunded vested benefits for PBGC variable rate premium purposes for plan years beginning 

after December 31, 2003, and before January 1, 2006, the interest rate used is 85 percent of the 

annual rate of interest determined by the Secretary of the Treasury on amounts invested 

conservatively in long term investment-grade corporate bonds for the month preceding the month 

in which the plan year begins. 

Description of Proposal

Flat rate premiums

The proposal increases the flat-rate premium to $30 per participant for years beginning 

after December 31, 2005. After 2006, the flat-rate premium is indexed for increases in the social 

security contribution and benefit base (rounded to the nearest dollar). 

Variable rate premium

Under the proposal, for years beginning in 2006, the variable rate premium is equal to 

$9.00 for each $1,000 of a plan's unfunded current liability as of the close of the preceding plan 

year. The interest rate used in determining current liability for plan years beginning in 2005 

continues to apply for plan years beginning in 2006. 

For years beginning after 2006, the variable rate premium is equal to $9.00 for each 

$1,000 of a plan’s unfunded target liability (determined as under the minimum funding rules) as 

of the close of the preceding plan year.117

 117 The rule providing that no variable rate premium is required if contributions for the prior plan 

year were at least equal to the full funding limit no longer applies under the proposal for years beginning 

after December 31, 2006. 
92

Effective Date

The proposal is effective for plan years beginning after December 31, 2005. 
93

B. Rules Relating to Bankruptcy of Employer 

Present Law

Guaranteed benefits

When an underfunded plan terminates, the amount of benefits that the PBGC will pay 

depends on legal limits, asset allocation, and recovery on the PBGC’s employer liability claim. 

The PBGC guarantee applies to “basic benefits.” Basic benefits generally are benefits accrued 

before a plan terminates, including (1) benefits at normal retirement age; (2) most early 

retirement benefits; (3) disability benefits for disabilities that occurred before the plan was 

terminated; and (4) certain benefits for survivors of plan participants. Generally only that part of 

the retirement benefit that is payable in monthly installments is guaranteed.118

Retirement benefits that begin before normal retirement age are guaranteed, provided 

they meet the other conditions of guarantee (such as that before the date the plan terminates, the 

participant had satisfied the conditions of the plan necessary to establish the right to receive the 

benefit other than application for the benefit). Contingent benefits (for example, subsidized early 

retirement benefits) are guaranteed only if the triggering event occurs before plan termination. 

For plans terminating in 2005, the maximum guaranteed benefit for an individual retiring 

at age 65 is $3,698.86 per month or $44,386.32 per year.119 The dollar limit is indexed annually 

for inflation. The guaranteed amount is reduced for benefits starting before age 65. 

In the case of a plan or a plan amendment that has been in effect for less than five years 

before a plan termination, the amount guaranteed is phased in by 20 percent a year.120

Asset allocation

ERISA contains rules for allocating the assets of a single-employer plan when the plan 

terminates. Plan assets available to pay for benefits under a terminating plan include all plan 

 118 ERISA sec. 4022(b) and (c). 

119 The PBGC generally pays the greater of the guaranteed benefit amount and the amount that 

was covered by plan assets when it terminated. Thus, depending on the amount of assets in the 

terminating plan, participants may receive more than the amount guaranteed by PBGC. 

Special rules limit the guaranteed benefits of individuals who are substantial owners covered by a 

plans whose benefits have not been increased by reason of any plan amendment. A substantial owner 

generally is an individual who: (1) owns the entire interest in an unincorporated trade or business; (2) in 

the case of a partnership, is a partner who owns, directly or indirectly, more than 10 percent of either the 

capital interest or the profits interest in the partnership; (3) in the case of a corporation, owns, directly or 

indirectly, more than 10 percent in value of either the voting stock of the corporation or all the stock of 

the corporation; or (4) at any time within the preceding 60 months was a substantial owner under the plan. 

ERISA sec. 4022(b)(5). 

120 The phase in does not apply if the benefit is less than $20 per month. 
94

assets remaining after subtracting all liabilities (other than liabilities for future benefit payments), 

paid or payable from plan assets under the provisions of the plan. On termination, the plan 

administrator must allocate plan assets available to pay for benefits under the plan in the manner 

prescribed by ERISA. In general, plan assets available to pay for benefits under the plan are 

allocated to six priority categories. If the plan has sufficient assets to pay for all benefits in a 

particular priority category, the remaining assets are allocated to the next lower priority category. 

This process is repeated until all benefits in the priority categories are provided or until all 

available plan assets have been allocated. 

Description of Proposal

Under the proposal, the amount of guaranteed benefits payable by the PBGC is frozen 

when a contributing sponsor enters bankruptcy or a similar proceeding.121 If the plan terminates 

during the contributing sponsor’s bankruptcy, the amount of guaranteed benefits payable by the 

PBGC is determined based on plan provisions, salary, service, and the guarantee in effect on the 

date the employer entered bankruptcy. 

The priority among participants for purposes of allocating plan assets and employer 

recoveries to non-guaranteed benefits in the event of plan termination is determined as of the 

date the sponsor enters bankruptcy or a similar proceeding. 

A contributing sponsor of a single-employer plan is required to notify the plan 

administrator when the sponsor enters bankruptcy or a similar proceeding. 

Within a reasonable time after a plan administrator knows or has reason to know that a 

contributing sponsor has entered bankruptcy (or similar proceeding), the administrator is 

required to notify plan participants and beneficiaries of the bankruptcy and the limitations on 

benefit guarantees while if the plan in terminated while underfunded, taking into account the 

bankruptcy. 

The Secretary of Labor is to prescribe the form and manner of the notices required under 

this provision. The notice is to be written in a manner calculated to be understood by the average 

plan participant and may be delivered in written, electronic, or other appropriate form to the 

extent that such form is reasonably accessible to the applicable individual. 

The Secretary of Labor may assess a civil penalty of up to $100 a day for each failure to 

provide the notices required by the proposal. Each violation with respect to any single 

participant or beneficiary is treated as a separate violation. 

Effective Date

 121 For purposes of the proposal, a contributing sponsor is considered to have entered bankruptcy 

if the sponsor files or has had filed against it a petition seeking liquidation or reorganization in a case 

under title 11 of the United States Code or under any similar Federal law or law of a State or political 

subdivision. 
95

The proposal is effective with respect to Federal bankruptcy or similar proceedings or 

arrangements for the benefit of creditors which are initiated on or after the date that is 30 days 

after enactment. 
96

C. Limitation on PBGC Guarantee of Shutdown and Other Benefits 

Present Law

A plan may provide for unpredictable contingent event benefits, which are benefits that 

depend on contingencies that are not reliably and reasonably predictable, such as facility 

shutdowns or reductions in workforce. Under present law, unpredictable contingent event 

benefits generally are not taken into account for funding purposes until the event has occurred. 

Under present law, defined benefit pension plans are not permitted to provide “layoff” 

benefits (i.e., severance benefits).122 However, defined benefit pension plans may provide 

subsidized early retirement benefits, including early retirement window benefits.123

Within certain limits, the PBGC guarantees any retirement benefit that was vested on the 

date of plan termination (other than benefits that vest solely on account of the termination), and 

any survivor or disability benefit that was owed or was in payment status at the date of plan 

termination.124 Generally only that part of the retirement benefit that is payable in monthly 

installments is guaranteed.125

Retirement benefits that begin before normal retirement age are guaranteed, provided 

they meet the other conditions of guarantee (such as that, before the date the plan terminates, the 

participant had satisfied the conditions of the plan necessary to establish the right to receive the 

benefit other than application for the benefit). Contingent benefits (for example, early retirement 

benefits provided only if a plant shuts down) are guaranteed only if the triggering event occurs 

before plan termination. 

In the case of a plan or a plan amendment that has been in effect for less than five years 

before a plan termination, the amount guaranteed is phased in by 20 percent a year. 

Description of Proposal

The proposal provides that the PBGC guarantee of certain benefits phases in under the 

rules relating to plan amendments. Under the proposal, if a benefit is payable by reason of (1) a 

plant shutdown or similar event, or (2) any event other than attainment of any age, performance 

of any service, receipt or derivation of any compensation, or the occurrence of death or 

disability, the PBGC guarantee provisions apply as if a plan amendment had been adopted on the 

date such event occurred that provides for the payment of such benefits. 

Effective Date

 122 Treas. Reg. sec. 1.401-1(b)(1)(i). 

123 Treas. Reg. secs. 1.401(a)(4)-3(f)(4) and 1.411(a)-7(c). 

124 ERISA sec. 4022(a). 

125 ERISA sec. 4022(b) and (c). 
97

The proposal is effective for benefits that become payable as a result of a plant shutdown 

or other covered event that occurs after July 21, 2005.
98

D. PBGC Premiums for Small and New Plans 

Present Law

Under present law, the Pension Benefit Guaranty Corporation (“PBGC”) provides 

insurance protection for participants and beneficiaries under certain defined benefit pension 

plans by guaranteeing certain basic benefits under the plan in the event the plan is terminated 

with insufficient assets to pay benefits promised under the plan. The guaranteed benefits are 

funded in part by premium payments from employers who sponsor defined benefit pension plans. 

The amount of the required annual PBGC premium for a single-employer plan is generally a flat 

rate premium of $19 per participant and an additional variable-rate premium based on a charge 

of $9 per $1,000 of unfunded vested benefits. Unfunded vested benefits under a plan generally 

means (1) the unfunded current liability for vested benefits under the plan, over (2) the value of 

the plan’s assets, reduced by any credit balance in the funding standard account. No variablerate premium is imposed for a year if contributions to the plan were at least equal to the full 

funding limit. 

The PBGC guarantee is phased in ratably in the case of plans that have been in effect for 

less than five years, and with respect to benefit increases from a plan amendment that was in 

effect for less than five years before termination of the plan. 

Description of Proposal

Reduced flat-rate premiums for new plans of small employers

Under the proposal, for the first five plan years of a new single-employer plan of a small 

employer, the flat-rate PBGC premium is $5 per plan participant. 

A small employer would be a contributing sponsor that, on the first day of the plan year, 

has 100 or fewer employees. For this purpose, all employees of the members of the controlled 

group of the contributing sponsor are to be taken into account. In the case of a plan to which 

more than one unrelated contributing sponsor contributes, employees of all contributing sponsors 

(and their controlled group members) are to be taken into account in determining whether the 

plan was a plan of a small employer. 

A new plan means a defined benefit pension plan maintained by a contributing sponsor if, 

during the 36-month period ending on the date of adoption of the plan, such contributing sponsor 

(or controlled group member or a predecessor of either) has not established or maintained a plan 

subject to PBGC coverage with respect to which benefits were accrued for substantially the same 

employees as in the new plan. 

Reduced variable-rate PBGC premium for new plans

The proposal provides that the variable-rate premium is phased in for new defined benefit 

pension plans over a six-year period starting with the plan’s first plan year. The amount of the 

variable-rate premium is a percentage of the variable premium otherwise due, as follows: zero 

percent of the otherwise applicable variable-rate premium in the first plan year; 20 percent in the 
99

second plan year; 40 percent in the third plan year; 60 percent in the fourth plan year; 80 percent 

in the fifth plan year; and 100 percent in the sixth plan year (and thereafter). 

A new defined benefit pension plan is defined as described above under the proposal 

relating to flat-rate premiums for new small employer plans. 

Reduced variable-rate PBGC premium for small plans

In the case of a plan of a small employer, the variable-rate premium is no more than $5 

multiplied by the number of plan participants in the plan at the end of the preceding plan year. 

For purposes of the proposal, a small employer is a contributing sponsor that, on the first day of 

the plan year, has 25 or fewer employees. For this purpose, all employees of the members of the 

controlled group of the contributing sponsor are to be taken into account. In the case of a plan to 

which more than one unrelated contributing sponsor contributed, employees of all contributing 

sponsors (and their controlled group members) are to be taken into account in determining 

whether the plan was a plan of a small employer. 

Effective Date

The reduction of the flat-rate premium for new plans of small employers and the 

reduction of the variable-rate premium for new plans apply to plans first effective after 

December 31, 2005. The reduction of the variable-rate premium for small plans applies to plan 

years beginning after December 31, 2005. 
100

E. Authorization for PBGC to Pay Interest on Premium Overpayment Refunds 

Present Law

The PBGC charges interest on underpayments of premiums, but is not authorized to pay 

interest on overpayments. 

Description of Proposal

The proposal allows the PBGC to pay interest on overpayments made by premium 

payors. Interest paid on overpayments is to be calculated at the same rate and in the same 

manner as interest charged on premium underpayments. 

Effective Date

The proposal is effective with respect to interest accruing for periods beginning not 

earlier than the date of enactment. 
101

F. Rules for Substantial Owner Benefits in Terminated Plans 

Present Law

Under present law, the Pension Benefit Guaranty Corporation (“PBGC”) provides 

participants and beneficiaries in a defined benefit pension plan with certain minimal guarantees 

as to the receipt of benefits under the plan in case of plan termination. The employer sponsoring 

the defined benefit pension plan is required to pay premiums to the PBGC to provide insurance 

for the guaranteed benefits. In general, the PBGC will guarantee all basic benefits which are 

payable in periodic installments for the life (or lives) of the participant and his or her 

beneficiaries and are non-forfeitable at the time of plan termination. The amount of the 

guaranteed benefit is subject to certain limitations. One limitation is that the plan (or an 

amendment to the plan which increases benefits) must be in effect for 60 months before 

termination for the PBGC to guarantee the full amount of basic benefits for a plan participant, 

other than a substantial owner. In the case of a substantial owner, the guaranteed basic benefit is 

phased in over 30 years beginning with participation in the plan. A substantial owner is one who 

owns, directly or indirectly, more than 10 percent of the voting stock of a corporation or all the 

stock of a corporation. Special rules restricting the amount of benefit guaranteed and the 

allocation of assets also apply to substantial owners. 

Description of Proposal

The proposal provides that the 60-month phase-in of guaranteed benefits applies to a 

substantial owner with less than 50 percent ownership interest. For a substantial owner with a 50 

percent or more ownership interest (“majority owner”), the phase-in occurs over a 10-year period 

and depends on the number of years the plan has been in effect. The majority owner’s 

guaranteed benefit is limited so that it cannot be more than the amount phased in over 60 months 

for other participants. The rules regarding allocation of assets apply to substantial owners, other 

than majority owners, in the same manner as other participants. 

Effective Date

The proposal is effective for plan terminations with respect to which notices of intent to 

terminate are provided, or for which proceedings for termination are instituted by the PBGC, 

after December 31, 2005. 
102

G. Acceleration of PBGC Computation of Benefits Attributable 

 to Recoveries from Employers 

Present Law

In general

The Pension Benefit Guaranty Corporation (“PBGC”) provides insurance protection for 

participants and beneficiaries under certain defined benefit pension plans by guaranteeing certain 

basic benefits under the plan in the event the plan is terminated with insufficient assets to pay 

promised benefits.126 The guaranteed benefits are funded in part by premium payments from 

employers who sponsor defined benefit plans. In general, the PBGC guarantees all basic benefits 

which are payable in periodic installments for the life (or lives) of the participant and his or her 

beneficiaries and are non-forfeitable at the time of plan termination. For plans terminating in 

2005, the maximum guaranteed benefit for an individual retiring at age 65 is $3,698.86 per 

month, or $44,386.32 per year. 

The PBGC pays plan benefits, subject to the guarantee limits, when it becomes trustee of 

a terminated plan. The PBGC also pays amounts in addition to the guarantee limits (“additional 

benefits”) if there are sufficient plan assets, including amounts recovered from the employer for 

unfunded benefit liabilities and contributions owed to the plan. The employer (including 

members of its controlled group) is statutorily liable for these amounts. 

Plan underfunding recoveries

The PBGC’s recoveries on its claims for unfunded benefit liabilities are shared between 

the PBGC and plan participants. The amounts recovered are allocated partly to the PBGC to 

help cover its losses for paying unfunded guaranteed benefits and partly to participants to help 

cover the loss of benefits that are above the PBGC’s guarantees and are not funded. In 

determining the portion of the recovered amounts that will be allocated to participants, present 

law specifies the use of an average recovery ratio, rather than the actual amount recovered for 

each specific plan. The average recovery ratio that applies to a plan includes the PBGC’s actual 

recovery experience for plan terminations in the five-year period immediately preceding the year 

the particular plan is terminated. 

The average recovery ratio is used for all but very large plans taken over by the PBGC. 

For a very large plan (i.e., a plan for which participants’ benefit losses exceed $20 million) actual 

recovery amounts with respect to the specific plan are used to determine the portion of the 

amounts recovered that will be allocated to participants. 

 126 The PBGC termination insurance program does not cover plans of professional service 

employers that have fewer than 25 participants.
103

Recoveries for due and unpaid employer contributions

Amounts recovered from an employer for contributions owed to the plan are treated as 

plan assets and are allocated to plan benefits in the same manner as other assets in the plan’s trust 

on the plan termination date. The amounts recovered are determined on a plan-specific basis 

rather than based on an historical average recovery ratio. 

Description of Proposal

The proposal makes two amendments to the PBGC insurance provisions of ERISA. 

First, it changes the five-year period used to determine the average recovery ratio for unfunded 

benefit liabilities so that the period begins two years earlier. 

In addition, the proposal creates an average recovery ratio for determining amounts 

recovered for contributions owed to the plan, based on the PBGC’s recovery experience over the 

same five-year period. 

The proposal does not apply to very large plans (i.e., plans for which participants’ benefit 

losses exceed $20 million). As under present law, in the case of a very large plan, actual 

amounts recovered for unfunded benefit liabilities and for contributions owed to the plan are 

used to determine the amount available to provide additional benefits to participants. 

Effective Date

The proposal is effective for any plan termination for which notices of intent to terminate 

are provided (or, in the case of a termination by the PBGC, a notice of determination that the 

plan must be terminated is issued) on or after the date that is 30 days after the date of enactment. 
104

VII. SPOUSAL PENSION PROTECTION 

A. Study of Spousal Consent for Distributions from Defined Contribution Plans 

Present Law

Qualified retirement plans are generally subject to requirements regarding the form in 

which benefits may be paid without spousal consent.127 The extent to which the requirements 

apply depends on the type of plan. 

Defined benefit pension plans and money purchase pension plans128 are generally 

required to provide benefits in the form of a qualified joint and survivor annuity (“QJSA”) unless 

the participant and his or her spouse consent to another form of benefit. A QJSA is an annuity 

for the life of the participant, with a survivor annuity for the life of the spouse that is not less 

than 50 percent (and not more than 100 percent) of the amount of the annuity payable during the 

joint lives of the participant and his or her spouse. In addition, if a married participant dies 

before the commencement of retirement benefits, the surviving spouse must be provided with a 

qualified preretirement survivor annuity (“QPSA”), which generally must provide the surviving 

spouse with a benefit that is not less than the benefit that would have been provided under the 

survivor portion of a QJSA.129

The participant and his or her spouse may waive the right to a QJSA and QPSA if certain 

requirements are satisfied. In general, these requirements include providing the participant with 

a written explanation of the terms and conditions of the survivor annuity, the right to make, and 

the effect of, a waiver of the annuity, the rights of the spouse to waive the survivor annuity, and 

the right of the participant to revoke the waiver. In addition, the spouse must provide a written 

consent to the waiver, witnessed by a plan representative or a notary public, which acknowledges 

the effect of the waiver. 

Defined contribution plans other than money purchase pension plans are generally not 

subject to the QJSA and QPSA rules unless the plan offers benefits in the form of an annuity and 

the participant elects an annuity. However, such defined contribution plans must provide that the 

participant’s surviving spouse is the beneficiary of the participant’s entire vested account balance 

under the plan, unless the spouse consents to designation of another beneficiary. In addition, the 

plan must not have received a transfer of assets from a plan to which the QJSA and QPSA 

requirements applied or must separately account for the transferred assets. 

 127 Code secs. 401(a)(11) and 417; ERISA sec. 205.

128 A money purchase pension plan is a type of defined contribution plan that provides for a set 

level of required employer contributions, generally as a specified percentage of participants’ 

compensation, and for the distribution of benefits in the form of an annuity. 

129 In the case of a money purchase pension plan, a QPSA means an annuity for the life of the 

surviving spouse that has an actuarial value of at least 50 percent of the participant’s vested account 

balance as of the date of death. 
105

Description of Proposal

The Secretary of Labor and the Secretary of Treasury are required to conduct a joint 

study of the feasibility and desirability of extending the spousal consent requirements to defined 

contribution plans to which the requirements do not apply under present law and to report the 

results thereof, with recommendations for legislative changes, within two years after the date of 

enactment, to the House Committees on Ways and Means and on Education and the Workforce 

and the Senate Committees on Finance and on Health, Education, Labor and Pensions. In 

conducting the study, the Secretary of Labor and the Secretary of Treasury are required to 

consider: (1) any modifications of the spousal consent requirements that are necessary to apply 

the requirements to defined contribution plans; and (2) the feasibility of providing notice and 

spousal consent in electronic form that are capable of authentication. 

Effective Date

The proposal is effective on the date of enactment. 
106

B. Division of Pension Benefits Upon Divorce 

Present Law

Benefits provided under a qualified retirement plan for a participant may not be assigned 

or alienated to creditors of the participant, except in very limited circumstances.130 One 

exception to the prohibition on assignment or alienation is a qualified domestic relations order 

(“QDRO”).131 A QDRO is a domestic relations order that creates or recognizes a right of an 

alternate payee, including a former spouse, to any plan benefit payable with respect to a 

participant and that meets certain procedural requirements. In addition, a QDRO generally may 

not require the plan to provide any type or form of benefit, or any option, not otherwise provided 

under the plan, or to provide increased benefits. 

Present law also provides that a QDRO may not require the payment of benefits to an 

alternate payee that are required to be paid to another alternate payee under a domestic relations 

order previously determined to be a QDRO. This rule implicitly recognizes that a domestic 

relations order issued after a QDRO may also qualify as a QDRO. However, present law does 

not otherwise provide specific rules for the treatment of a domestic relations order as a QDRO if 

the order is issued after another domestic relations order or a QDRO (including an order issued 

after a divorce decree) or revises another domestic relations order or a QDRO. 

Present law provides specific rules that apply during any period in which the status of a 

domestic relations order as a QDRO is being determined (by the plan administrator, by a court, 

or otherwise). During such a period, the plan administrator is required to account separately for 

the amounts that would have been payable to the alternate payee during the period if the order 

had been determined to be a QDRO (referred to as “segregated amounts”). If, within the 

18-month period beginning with the date on which the first payment would be required to be 

made under the order, the order (or modification thereof) is determined to be a QDRO, the plan 

administrator is required to pay the segregated amounts (including any interest thereon) to the 

person or persons entitled thereto. If, within the 18-month period, the order is determined not to 

be a QDRO, or its status as a QDRO is not resolved, the plan administrator is required to pay the 

segregated amounts (including any interest) to the person or persons who would be entitled to 

such amounts if there were no order. In such a case, any subsequent determination that the order 

is a QDRO is applied prospectively only. 

Description of Proposal

The Secretary of Labor is directed to issue, not later than one year after the date of 

enactment of the proposal, regulations to clarify the status of certain domestic relations orders. 

In particular, the regulations are to clarify that a domestic relations order otherwise meeting the 

QDRO requirements will not fail to be treated as a QDRO solely because of the time it is issued 

or because it is issued after or revises another domestic relations order or another QDRO. The 

 130 Code sec. 401(a)(13); ERISA sec. 206(d). 

131 Code secs. 401(a)(13)(B) and 414(p); ERISA sec. 206(d)(3). 
107

regulations are also to clarify that such a domestic relations order is in all respects subject to the 

same requirements and protections that apply to QDROs. For example, as under present law, 

such a domestic relations order may not require the payment of benefits to an alternate payee that 

are required to be paid to another alternate payee under an earlier QDRO. In addition, the 

present-law rules regarding segregated amounts that apply while the status of a domestic 

relations order as a QDRO is being determined continue to apply. 

Effective Date

The proposal is effective on the date of enactment. 
108

C. Protection of Rights of Former Spouses under the Railroad Retirement System 

Present Law

In general

The Railroad Retirement System has two main components. Tier I of the system is 

financed by taxes on employers and employees equal to the Social Security payroll tax and 

provides qualified railroad retirees (and their qualified spouses, dependents, widows, or 

widowers) with benefits that are roughly equal to Social Security. Covered railroad workers and 

their employers pay the Tier I tax instead of the Social Security payroll tax, and most railroad 

retirees collect Tier I benefits instead of Social Security. Tier II of the system replicates a private 

pension plan, with employers and employees contributing a certain percentage of pay toward the 

system to finance defined benefits to eligible railroad retirees (and qualified spouses, dependents, 

widows, or widowers) upon retirement; however, the Federal Government collects the Tier II 

payroll contribution and pays out the benefits. 

Former spouses of living railroad employees

Generally, a former spouse of a railroad employee who is otherwise eligible for any Tier I 

or Tier II benefit cannot receive either benefit until the railroad employee actually retires and 

begins receiving his or her retirement benefits. This is the case regardless of whether a State 

divorce court has awarded such railroad retirement benefits to the former spouse. 

Former spouses of deceased railroad employees

The former spouse of a railroad employee may be eligible for survivors benefits under 

Tier I of the Railroad Retirement System. However, a former spouse loses eligibility for any 

otherwise allowable Tier II benefits upon the death of the railroad employee. 

Description of Proposal

Former spouses of living railroad employees

The bill eliminates the requirement that a railroad employee actually receive railroad 

retirement benefits for the former spouse to be entitled to any Tier I benefit or Tier II benefit 

awarded under a State divorce court decision. 

Former spouses of deceased railroad employees

The bill provides that a former spouse of a railroad employee does not lose eligibility for 

otherwise allowable Tier II benefits upon the death of the railroad employee. 

Effective Date

The railroad retirement proposals are effective one year after the date of enactment.
109

D. Modifications of Joint and Survivor Annuity Requirements 

Present Law

Defined benefit pension plans and money purchase pension plans are required to provide 

benefits in the form of a qualified joint and survivor annuity (“QJSA”) unless the participant and 

his or her spouse consent to another form of benefit.132 A QJSA is an annuity for the life of the 

participant, with a survivor annuity for the life of the spouse which is not less than 50 percent 

(and not more than 100 percent) of the amount of the annuity payable during the joint lives of the 

participant and his or her spouse.133 In the case of a married participant who dies before the 

commencement of retirement benefits, the surviving spouse must be provided with a qualified 

preretirement survivor annuity (“QPSA”), which must provide the surviving spouse with a 

benefit that is not less than the benefit that would have been provided under the survivor portion 

of a QJSA. 

The participant and his or her spouse may waive the right to a QJSA and QPSA provided 

certain requirements are satisfied. In general, these conditions include providing the participant 

with a written explanation of the terms and conditions of the survivor annuity, the right to make, 

and the effect of, a waiver of the annuity, the rights of the spouse to waive the survivor annuity, 

and the right of the participant to revoke the waiver. In addition, the spouse must provide a 

written consent to the waiver, witnessed by a plan representative or a notary public, which 

acknowledges the effect of the waiver. 

Defined contribution plans other than money purchase pension plans are not required to 

provide a QJSA or QPSA if the participant does not elect an annuity as the form of payment, the 

surviving spouse is the beneficiary of the participant’s entire vested account balance under the 

plan (unless the spouse consents to designation of another beneficiary),134 and, with respect to 

the participant, the plan has not received a transfer from a plan to which the QJSA and QPSA 

requirements applied (or separately accounts for the transferred assets). In the case of a defined 

contribution plan subject to the QJSA and QPSA requirements, a QPSA means an annuity for the 

life of the surviving spouse that has an actuarial value of at least 50 percent of the participant’s 

vested account balance as of the date of death. 

Description of Proposal

The proposal revises the minimum survivor annuity requirements to require that, at the 

election of the participant, benefits will be paid in the form of a “qualified optional survivor 

 132 Code secs. 401(a)(11) and 417; ERISA sec. 205. 

133 Thus, a plan could provide an annuity for the life of the participant, with a survivor annuity 

for the life of the spouse equal to 75 percent of the amount of the annuity payable during the joint lives of 

the participant and his or her spouse. 

134 Waiver and election rules apply to the waiver of the right of the spouse to be the beneficiary 

under a defined contribution plan that is not required to provide a QJSA. 
110

annuity.” A qualified optional survivor annuity means an annuity for the life of the participant 

with a survivor annuity for the life of the spouse which is equal to the applicable percentage of 

the amount of the annuity which is payable during the joint lives of the participant and the 

spouse and which is the actuarial equivalent of a single annuity for the life of the participant. 

If the survivor annuity under plan’s qualified joint and survivor annuity is less than 75 

percent of the annuity payable during the joint lives of the participant and spouse, the applicable 

percentage is 75 percent. If the survivor annuity under plan’s qualified joint and survivor 

annuity is greater than or equal to 75 percent of the annuity payable during the joint lives of the 

participant and spouse, the applicable percentage is 50 percent. Thus, for example, if the 

survivor annuity under the plan’s qualified joint and survivor annuity is 50 percent, the survivor 

annuity under the qualified optional survivor annuity must be 75 percent. 

The written explanation required to be provided to participants explaining the terms and 

conditions of the qualified joint and survivor annuity must also include the terms and conditions 

of the qualified optional survivor annuity. 

Under the proposal relating to plan amendments, a plan amendment made pursuant to a 

proposal under the bill generally will not violate the anticutback rule if certain requirements are 

met (e.g., the plan amendment is made on or before the last day of the first plan year beginning 

on or after January 1, 2006). Thus, a plan is not treated as having decreased the accrued benefit 

of a participant solely by reason of the adoption of a plan amendment pursuant to the proposal 

requiring that the plan offer a qualified optional survivor annuity. The elimination of a 

subsidized qualified joint and survivor annuity is not protected by the anticutback proposal in the 

bill unless an equivalent or greater subsidy is retained in one of the forms offered under the plan 

as amended. For example, if a plan that offers a subsidized 50 percent qualified joint and 

survivor annuity is amended to provide an unsubsidized 50 percent qualified joint and survivor 

annuity and an unsubsidized 75 percent joint and survivor annuity as its qualified optional 

survivor annuity, the replacement of the subsidized 50 percent qualified joint and survivor 

annuity with the unsubsidized 50 percent qualified joint and survivor annuity is not protected by 

the anticutback protection. 

Effective Date

The proposal applies generally to plan years beginning after December 31, 2005. In the 

case of a plan maintained pursuant to one or more collective bargaining agreements, the proposal 

applies to plan years beginning on or after the earlier of (1) the later of January 1, 2006, and the 

last date on which an applicable collective bargaining agreement terminates (without regard to 

extensions), and (2) January 1, 2007. 
111

VIII. IMPROVEMENTS IN PORTABILITY AND DISTRIBUTION RULES 

FOR DEFINED CONTRIBUTION PLANS 

A. Purchase of Permissive Service Credit 

Present Law

In general

Present law imposes limits on contributions and benefits under qualified plans.135 The 

limits on contributions and benefits under qualified plans are based on the type of plan. Under a 

defined benefit plan, the maximum annual benefit payable at retirement is generally the lesser of 

(1) a certain dollar amount ($170,000 for 2005) or (2) 100 percent of the participant’s average 

compensation for his or her high three years. 

A qualified retirement plan maintained by a State or local government employer may 

provide that a participant may make after-tax employee contributions in order to purchase 

permissive service credit, subject to certain limits.136 

In the case of any repayment of contributions and earnings to a governmental plan with 

respect to an amount previously refunded upon a forfeiture of service credit under the plan (or 

another plan maintained by a State or local government employer within the same State), any 

such repayment is not taken into account for purposes of the section 415 limits on contributions 

and benefits. Also, service credit obtained as a result of such a repayment is not considered 

permissive service credit for purposes of the section 415 limits. 

Permissive service credit

Definition of permissive service credit

Permissive service credit means credit for a period of service recognized by the 

governmental plan which the participant has not received under the plan and which the employee 

receives only if the employee voluntarily contributes to the plan an amount (as determined by the 

plan) that does not exceed the amount necessary to fund the benefit attributable to the period of 

service and that is in addition to the regular employee contributions, if any, under the plan. 

The IRS has ruled that credit is not permissive service credit where it is purchased to 

provide enhanced retirement benefits for a period of service already credited under the plan, as 

the enhanced benefit is treated as credit for service already received.137 

 135 Sec. 415. 

136 Sec. 415(n)(3). 

137 Priv. Ltr. Rul. 200229051 (April 26, 2002). 
112

Nonqualified service

Service credit is not permissive service credit if more than five years of permissive 

service credit is purchased for nonqualified service or if nonqualified service is taken into 

account for an employee who has less than five years of participation under the plan. 

Nonqualified service is service other than service (1) as a Federal, State or local government 

employee, (2) as an employee of an association representing Federal, State or local government 

employees, (3) as an employee of an educational institution which provides elementary or 

secondary education, as determined under State law, or (4) for military service. Service under 

(1), (2) and (3) is nonqualified service if it enables a participant to receive a retirement benefit 

for the same service under more than one plan. 

Trustee-to-trustee transfers to purchase permissive service credit

Under EGTRRA, a participant is not required to include in gross income a direct trusteeto-trustee transfer to a governmental defined benefit plan from a section 403(b) annuity or a 

section 457 plan if the transferred amount is used (1) to purchase permissive service credit under 

the plan, or (2) to repay contributions and earnings with respect to an amount previously 

refunded under a forfeiture of service credit under the plan (or another plan maintained by a State 

or local government employer within the same State).138 

Description of Proposal

Permissive service credit

The proposal modifies the definition of permissive service credit by providing that 

permissive service credit means service credit which relates to benefits to which the participant is 

not otherwise entitled under such governmental plan, rather than service credit which such 

participant has not received under the plan. Credit qualifies as permissive service credit if it is 

purchased to provide an increased benefit for a period of service already credited under the plan 

(e.g., if a lower level of benefit is converted to a higher benefit level otherwise offered under the 

same plan) as long as it relates to benefits to which the participant is not otherwise entitled. 

The proposal allows participants to purchase credit for periods regardless of whether 

service is performed, subject to the limits on nonqualified service. 

Under the proposal, service as an employee of an educational organization providing 

elementary or secondary education can be determined under the law of the jurisdiction in which 

the service was performed. Thus, for example, permissive service credit can be granted for time 

spent teaching outside of the United States without being considered nonqualified service credit. 

 138 Secs. 403(b)(13) and 457(e)(17).
113

Trustee-to-trustee transfers to purchase permissive service credit

The proposal provides that the limits regarding nonqualified service are not applicable in 

determining whether a trustee-to-trustee transfer from a section 403(b) annuity or a section 457 

plan to a governmental defined benefit plan is for the purchase of permissive service credit. 

Thus, failure of the transferee plan to satisfy the limits does not cause the transferred amounts to 

be included in the participant’s income. As under present law, the transferee plan must satisfy 

the limits in providing permissive service credit as a result of the transfer. 

The proposal provides that trustee-to-trustee transfers under sections 457(e)(17) and 

403(b)(13) may be made regardless of whether the transfer is made between plans maintained by 

the same employer. The proposal also provides that amounts transferred from a section 403(b) 

annuity or a section 457 plan to a governmental defined benefit plan to purchase permissive 

service credit are subject to the distribution rules applicable under the Internal Revenue Code to 

the defined benefit plan. 

Effective Date

The proposal is generally effective as if included in the amendments made by section 

1526 of the Taxpayer Relief Act of 1997, except that the proposal regarding trustee-to-trustee 

transfers is effective as if included in the amendments made by section 647 of the Economic 

Growth and Tax Relief Reconciliation Act of 2001. 
114

B. Rollover of After-Tax Amounts in Annuity Contracts 

Present Law

Employee after-tax contributions may be rolled over from a tax-qualified retirement plan 

into another tax-qualified retirement plan, if the plan to which the rollover is made is a defined 

contribution plan, the rollover is accomplished through a direct rollover, and the plan to which 

the rollover is made provides for separate accounting for such contributions (and earnings 

thereon). After-tax contributions can also be rolled over from a tax-sheltered annuity (a “section 

403(b) annuity”) to another tax-sheltered annuity if the rollover is a direct rollover, and the 

annuity to which the rollover is made provides for separate accounting for such contributions 

(and earnings thereon). After-tax contributions may also be rolled over to an IRA. If the 

rollover is to an IRA, the rollover need not be a direct rollover and the IRA owner has the 

responsibility to keep track of the amount of after-tax contributions.139

Description of Proposal 

The proposal allows after-tax contributions to be rolled over from a qualified retirement 

plan to another qualified retirement plan (either a defined contribution or a defined benefit plan) 

or to a tax-sheltered annuity. As under present law, the rollover must be a direct rollover, and 

the plan to which the rollover is made must separately account for after-tax contributions (and 

earnings thereon). 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2005. 

 139 Sec. 402(c)(2); IRS Notice 2002-3, 2002-2 I.R.B. 289. 
115

C. Application of Minimum Distribution Rules to Governmental Plans 

Present Law 

Minimum distribution rules apply to tax-favored retirement arrangements, including 

governmental plans. In general, under these rules, distribution of minimum benefits must begin 

no later than the required beginning date. Minimum distribution rules also apply to benefits 

payable with respect to a plan participant who has died. Failure to comply with the minimum 

distribution rules results in an excise tax imposed on the plan participant equal to 50 percent of 

the required minimum distribution not distributed for the year. The excise tax may be waived in 

certain cases. 

In the case of distributions prior to the death of the plan participant, the minimum 

distribution rules are satisfied if either (1) the participant’s entire interest in the plan is 

distributed by the required beginning date, or (2) the participant’s interest in the plan is to be 

distributed (in accordance with regulations) beginning not later than the required beginning date, 

over a permissible period. The permissible periods are (1) the life of the participant, (2) the lives 

of the participant and a designated beneficiary, (3) the life expectancy of the participant, or 

(4) the joint life and last survivor expectancy of the participant and a designated beneficiary. In 

calculating minimum required distributions from account-type arrangements (e.g., a defined 

contribution plan or an individual retirement arrangement), life expectancies of the participant 

and the participant’s spouse generally may be recomputed annually. 

The required beginning date generally is April 1 of the calendar year following the later 

of (1) the calendar year in which the participant attains age 70-1/2 or (2) the calendar year in 

which the participant retires. 

The minimum distribution rules also apply to distributions to beneficiaries of deceased 

participants. In general, if the participant dies after minimum distributions have begun, the 

remaining interest must be distributed at least as rapidly as under the minimum distribution 

method being used as of the date of death. If the participant dies before minimum distributions 

have begun, then the entire remaining interest must generally be distributed within five years of 

the participant’s death. The five-year rule does not apply if distributions begin within one year 

of the participant’s death and are payable over the life of a designated beneficiary or over the life 

expectancy of a designated beneficiary. A surviving spouse beneficiary is not required to begin 

distributions until the date the deceased participant would have attained age 70-1/2. In addition, 

if the surviving spouse makes a rollover from the plan into a plan or IRA of his or her own, the 

minimum distribution rules apply separately to the surviving spouse. 

Description of Proposal

The proposal directs the Secretary of the Treasury to issue regulations under which a 

governmental plan is treated as complying with the minimum distribution requirements, for all 

years to which such requirements apply, if the plan complies with a reasonable, good faith 

interpretation of the statutory requirements. It is intended that the regulations apply for periods 

before the date of enactment. 
116

Effective Date 

The proposal is effective on the date of enactment. 
117

D. Waiver of 10-Percent Early Withdrawal Tax on Certain Distributions 

from Pension Plans for Public Safety Employees 

Present Law

Under present law, a taxpayer who receives a distribution from a qualified retirement 

plan prior to age 59-1/2, death, or disability generally is subject to a 10-percent early withdrawal 

tax on the amount includible in income, unless an exception to the tax applies. Among other 

exceptions, the early distribution tax does not apply to distributions made to an employee who 

separates from service after age 55, or to distributions that are part of a series of substantially 

equal periodic payments made for the life (or life expectancy) of the employee or the joint lives 

(or life expectancies) of the employee and his or her beneficiary. 

Description of Proposal

Under the proposal, the 10-percent early withdrawal tax does not apply to distributions 

from a governmental defined benefit pension plan to a qualified public safety employee who 

separates from service after age 50. A qualified public safety employee is an employee of a State 

or political subdivision of a State if the employee provides police protection, firefighting 

services, or emergency medical services for any area within the jurisdiction of such State or 

political subdivision. 

Effective Date 

The proposal is effective for distributions made after the date of enactment. 
118

E. Rollovers by Nonspouse Beneficiaries of Certain Retirement Plan Distributions 

Present Law

Tax-free rollovers

Under present law, a distribution from a qualified retirement plan, a tax-sheltered annuity 

“section 403(b) annuity”), an eligible deferred compensation plan of a State or local government 

employer (a “governmental section 457 plan”), or an individual retirement arrangement (an 

“IRA”) generally is included in income for the year distributed. However, eligible rollover 

distributions may be rolled over tax free within 60 days to another plan, annuity, or IRA.140 

In general, an eligible rollover distribution includes any distribution to the plan 

participant or IRA owner other than certain periodic distributions, minimum required 

distributions, and distributions made on account of hardship.141 Distributions to a participant 

from a qualified retirement plan, a tax-sheltered annuity, or a governmental section 457 plan 

generally can be rolled over to any of such plans or an IRA.142 Similarly, distributions from an 

IRA to the IRA owner generally are permitted to be rolled over into a qualified retirement plan, a 

tax-sheltered annuity, a governmental section 457 plan, or another IRA. 

Similar rollovers are permitted in the case of a distribution to the surviving spouse of the 

plan participant or IRA owner, but not to other persons. 

If an individual inherits an IRA from the individual’s deceased spouse, the IRA may be 

treated as the IRA of the surviving spouse. This treatment does not apply to IRAs inherited from 

someone other than the deceased spouse. In such cases, the IRA is not treated as the IRA of the 

beneficiary. Thus, for example, the beneficiary may not make contributions to the IRA and 

cannot roll over any amounts out of the inherited IRA. Like the original IRA owner, no amount 

is generally included in income until distributions are made from the IRA. Distributions from 

the inherited IRA must be made under the rules that apply to distributions to beneficiaries, as 

described below. 

 140 The IRS has the authority to waive the 60-day requirement if failure to waive the requirement 

would be against equity or good conscience, including cases of casualty, disaster, or other events beyond 

the reasonable control of the individual. Sec. 402(c)(3)(B).

141 Sec. 402(c)(4). Certain other distributions also are not eligible rollover distributions, e.g., 

corrective distributions of elective deferrals in excess of the elective deferral limits and loans that are 

treated as deemed distributions. 

142 Some restrictions or special rules may apply to certain distributions. For example, after-tax 

amounts distributed from a plan can be rolled over only to a plan of the same type or to an IRA. 
119

Minimum distribution rules

Minimum distribution rules apply to tax-favored retirement arrangements. In the case of 

distributions prior to the death of the participant, distributions generally must begin by the 

April 1 of the calendar year following the later of the calendar year in which the participant 

(1) attains age 70-1/2 or (2) retires.143 The minimum distribution rules also apply to distributions 

following the death of the participant. If minimum distributions have begun prior to the 

participant’s death, the remaining interest generally must be distributed at least as rapidly as 

under the minimum distribution method being used prior to the date of death. If the participant 

dies before minimum distributions have begun, then either (1) the entire remaining interest must 

be distributed within five years of the death, or (2) distributions must begin within one year of 

the death over the life (or life expectancy) of the designated beneficiary. A beneficiary who is 

the surviving spouse of the participant is not required to begin distributions until the date the 

deceased participant would have attained age 70-1/2. In addition, if the surviving spouse makes 

a rollover from the plan into a plan or IRA of his or her own, the minimum distribution rules 

apply separately to the surviving spouse. 

Description of Proposal

The proposal provides that benefits of a beneficiary other than a surviving spouse may be 

transferred directly to an IRA. The IRA is treated as an inherited IRA of the nonspouse 

beneficiary. Thus, for example, distributions from the inherited IRA are subject to the 

distribution rules applicable to beneficiaries. The proposal applies to amounts payable to a 

beneficiary under a qualified retirement plan, governmental section 457 plan, or a tax-sheltered 

annuity. To the extent provided by the Secretary, the proposal applies to benefits payable to a 

trust maintained for a designated beneficiary to the same extent it applies to the beneficiary. 

Effective Date

The proposal is effective for distributions made after December 31, 2005. 

 143 In the case of five-percent owners and distributions from an IRA, distributions must begin by 

the April 1 of the calendar year following the year in which the individual attains age 70-1/2. 
120

F. Faster Vesting of Employer Nonelective Contributions 

Present Law

Under present law, in general, a plan is not a qualified plan unless a participant’s 

employer-provided benefit vests at least as rapidly as under one of two alternative minimum 

vesting schedules. A plan satisfies the first schedule if a participant acquires a nonforfeitable 

right to 100 percent of the participant’s accrued benefit derived from employer contributions 

upon the completion of five years of service. A plan satisfies the second schedule if a participant 

has a nonforfeitable right to at least 20 percent of the participant’s accrued benefit derived from 

employer contributions after three years of service, 40 percent after four years of service, 60 

percent after five years of service, 80 percent after six years of service, and 100 percent after 

seven years of service.144 

Faster vesting schedules apply to employer matching contributions. Employer matching 

contributions are required to vest at least as rapidly as under one of the following two alternative 

minimum vesting schedules. A plan satisfies the first schedule if a participant acquires a 

nonforfeitable right to 100 percent of employer matching contributions upon the completion of 

three years of service. A plan satisfies the second schedule if a participant has a nonforfeitable 

right to 20 percent of employer matching contributions for each year of service beginning with 

the participant’s second year of service and ending with 100 percent after six years of service. 

Description of Proposal

The proposal applies the present-law vesting schedule for matching contributions to all 

employer contributions to defined contribution plans. 

Effective Date

The proposal is generally effective for contributions (including allocations of forfeitures) 

for plan years beginning after December 31, 2005. In the case of a plan maintained pursuant to 

one or more collective bargaining agreements, the proposal is not effective for contributions 

(including allocations of forfeitures) for plan years beginning before the earlier of (1) the later of 

the date on which the last of such collective bargaining agreements terminates (determined 

without regard to any extension thereof on or after the date of enactment) or January 1, 2006, or, 

or (2) January 1, 2008. The proposal does not apply to any employee until the employee has an 

hour of service after the effective date. In applying the new vesting schedule, service before the 

effective date is taken into account. 

 144 The minimum vesting requirements are also contained in Title I of the Employee Retirement 

Income Security Act of 1974 (“ERISA”). 
121

G. Allow Direct Rollovers from Retirement Plans to Roth IRAs 

Present Law

IRAs in general

There are two general types of individual retirement arrangements (“IRAs”): traditional 

IRAs, to which both deductible and nondeductible contributions may be made, and Roth IRAs. 

Traditional IRAs

An individual may make deductible contributions to an IRA up to the lesser of a dollar 

limit (generally $4,000 for 2005)145 or the individual’s compensation if neither the individual nor 

the individual’s spouse is an active participant in an employer-sponsored retirement plan.146 If 

the individual (or the individual’s spouse) is an active participant in an employer-sponsored 

retirement plan, the deduction limit is phased out for taxpayers with adjusted gross income 

(“AGI”) over certain levels for the taxable year. A different, higher, income phaseout applies in 

the case of an individual who is not an active participant in an employer sponsored plan but 

whose spouse is. 

To the extent an individual cannot or does not make deductible contributions to an IRA 

or contributions to a Roth IRA, the individual may make nondeductible contributions to a 

traditional IRA. 

Amounts held in a traditional IRA are includible in income when withdrawn (except to 

the extent the withdrawal is a return of nondeductible contributions). Includible amounts 

withdrawn prior to attainment of age 59-1/2 are subject to an additional 10-percent early 

withdrawal tax, unless the withdrawal is due to death or disability, is made in the form of certain 

periodic payments, or is used for certain specified purposes. 

Roth IRAs

Individuals with AGI below certain levels may make nondeductible contributions to a 

Roth IRA. The maximum annual contributions that can be made to all of an individuals IRAs 

(both traditional and Roth) cannot exceed the maximum deductible IRA contribution limit. The 

maximum annual contribution that can be made to a Roth IRA is phased out for taxpayers with 

income above certain levels. 

 145 The dollar limit is scheduled to increase until it is $5,000 beginning in 2008-2010. 

Individuals age 50 and older may make additional, catch-up contributions. 

146 In the case of a married couple, deductible IRA contributions of up to the dollar limit can be 

made for each spouse (including, for example, a homemaker who does not work outside the home), if the 

combined compensation of both spouses is at least equal to the contributed amount. 
122

Amounts held in a Roth IRA that are withdrawn as a qualified distribution are not 

includible in income, or subject to the additional 10-percent tax on early withdrawals. A 

qualified distribution is a distribution that (1) is made after the five-taxable year period beginning 

with the first taxable year for which the individual made a contribution to a Roth IRA, and 

(2) which is made after attainment of age 59-1/2, on account of death or disability, or is made for 

first-time homebuyer expenses of up to $10,000. 

Distributions from a Roth IRA that are not qualified distributions are includible in 

income to the extent attributable to earnings, and subject to the 10-percent early withdrawal tax 

(unless an exception applies). The same exceptions to the early withdrawal tax that apply to 

IRAs apply to Roth IRAs. 

Rollover contributions

If certain requirements are satisfied, a participant in a tax-qualified retirement plan, a taxsheltered annuity (sec. 403(b)), or a governmental section 457 plan may roll over distributions 

from the plan or annuity into a traditional IRA. Distributions from such plans may not be rolled 

over into a Roth IRA. 

Taxpayers with modified AGI of $100,000 or less generally may roll over amounts in a 

traditional IRA into a Roth IRA. The amount rolled over is includible in income as if a 

withdrawal had been made, except that the 10-percent early withdrawal tax does not apply. 

Married taxpayers who file separate returns cannot roll over amounts in a traditional IRA into a 

Roth IRA. Amounts that have been distributed from a tax-qualified retirement plan, a taxsheltered annuity, or a governmental section 457 plan may be rolled over into a traditional IRA, 

and then rolled over from the traditional IRA into a Roth IRA. 

Description of Proposal

The proposal allows distributions from tax-qualified retirement plans, tax-sheltered 

annuities, and governmental 457 plans to be rolled over directly from such plan into a Roth IRA, 

subject to the present law rules that apply to rollovers from a traditional IRA into a Roth IRA. 

For example, a rollover from a tax-qualified retirement plan into a Roth IRA is includible in 

gross income (except to the extent it represents a return of after-tax contributions), and the 10-

percent early distribution tax does not apply. Similarly, an individual with AGI of $100,000 or 

more could not roll over amounts from a tax-qualified retirement plan directly into a Roth IRA. 

Effective Date

The proposal is effective for distributions made after December 31, 2005. 
123

H. Elimination of Higher Early Withdrawal Tax on Certain SIMPLE Plan Distributions 

Present Law

SIMPLE plans

Under present law, certain small businesses can establish a simplified retirement plan 

called the savings incentive match plan for employees (“SIMPLE”) retirement plan. SIMPLE 

plans can be adopted by employers: (1) that employ 100 or fewer employees who received at 

least $5,000 in compensation during the preceding year; and (2) that do not maintain another 

employer-sponsored retirement plan. A SIMPLE plan can be either an individual retirement 

arrangement (an “IRA”)147 for each employee or part of a qualified cash or deferred arrangement 

(a “section 401(k) plan”).148 The rules applicable to SIMPLE IRAs and SIMPLE section 401(k) 

plans are similar, but not identical. 

If established in IRA form, a SIMPLE plan is not subject to the nondiscrimination rules 

generally applicable to qualified retirement plans (including the top-heavy rules) and simplified 

reporting requirements apply. If established as part of a section 401(k) plan, the SIMPLE does 

not have to satisfy the special nondiscrimination tests applicable to section 401(k) plans and is 

not subject to the top-heavy rules. The other qualified retirement plan rules apply to SIMPLE 

section 401(k) plans. 

Elective deferrals under a section 401(k) plan generally may not be distributable before 

the occurrence of certain specified events, such as severance of employment, death, disability, 

attainment of age 59-1/2, or financial hardship. This restriction on distributions applies to 

elective deferrals made under a SIMPLE section 401(k) plan, but not elective deferrals made 

under a SIMPLE IRA. 

Early withdrawal tax

Taxable distributions made from an IRA or from certain employer-sponsored retirement 

plans (including a section 401(k) plan) before age 59-1/2, death, or disability generally are 

subject to an additional 10-percent income tax. Early withdrawals from a SIMPLE plan 

generally are subject to the additional 10-percent tax. However, in the case of a SIMPLE IRA, 

early withdrawals during the two-year period beginning on the date the employee first 

participated in the SIMPLE IRA are subject to an additional 25-percent tax. 

 147 A SIMPLE IRA may not be in the form of a Roth IRA. References herein to IRAs do not 

refer to Roth IRAs. 

148 Because State or local governments generally are not permitted to maintain section 401(k) 

plans, they also generally are not permitted to maintain SIMPLE section 401(k) plans. However, a State 

or local government with a pre-May 6, 1986, grandfathered section 401(k) plan may adopt a SIMPLE 

section 401(k) plan. 
124

Description of Proposal

The proposal eliminates the 25-percent tax on early withdrawals from a SIMPLE IRA 

during the two-year period beginning on the date the employee first participated in the SIMPLE 

IRA. Thus, such withdrawals are subject to the 10-percent early withdrawal tax. 

Effective Date 

The proposal is effective for years beginning after December 31, 2005. 
125

I. SIMPLE Plan Portability 

Present Law

Under present law, certain small businesses can establish a simplified retirement plan 

called the savings incentive match plan for employees (“SIMPLE”) retirement plan. SIMPLE 

plans can be adopted by employers: (1) that employ 100 or fewer employees who received at 

least $5,000 in compensation during the preceding year; and (2) that do not maintain another 

employer-sponsored retirement plan. A SIMPLE plan can be either an individual retirement 

arrangement (an “IRA”)149 for each employee or part of a qualified cash or deferred arrangement 

(a “section 401(k) plan”).150 The rules applicable to SIMPLE IRAs and SIMPLE section 401(k) 

plans are similar, but not identical. 

If established in IRA form, a SIMPLE plan is not subject to the nondiscrimination rules 

generally applicable to qualified retirement plans (including the top-heavy rules) and simplified 

reporting requirements apply. If established as part of a section 401(k) plan, the SIMPLE does 

not have to satisfy the special nondiscrimination tests applicable to section 401(k) plans and is 

not subject to the top-heavy rules. The other qualified retirement plan rules apply to SIMPLE 

section 401(k) plans. 

Distributions from employer-sponsored retirement plans and IRAs (including SIMPLE 

plans) are generally includible in gross income, except to the extent the amount distributed 

represents a return of after-tax contributions (i.e., basis). If certain requirements are satisfied, 

distributions from a tax-favored retirement arrangement (i.e., a qualified retirement plan, a taxsheltered annuity, a governmental section 457 plan, or an IRA) may generally be rolled over on a 

nontaxable basis to another tax-favored retirement arrangement. However, a distribution from a 

SIMPLE IRA during the two-year period beginning on the date the employee first participated in 

the SIMPLE IRA may be rolled over only to another SIMPLE IRA. 

Description of Proposal

The proposal allows distributions from a SIMPLE IRA to be rolled over to another taxfavored retirement arrangement (i.e., an IRA, a qualified retirement plan, a tax-sheltered annuity, 

or a governmental section 457 plan) and distributions from another tax-favored retirement 

arrangement to be rollover over to a SIMPLE IRA. 

 149 A SIMPLE IRA may not be in the form of a Roth IRA. References herein to IRAs do not 

refer to Roth IRAs. 

150 Because State or local governments generally are not permitted to maintain section 401(k) 

plans, they also generally are not permitted to maintain SIMPLE section 401(k) plans. However, a State 

or local government with a pre-May 6, 1986, grandfathered section 401(k) plan may adopt a SIMPLE 

section 401(k) plan. 
126

Effective Date 

The proposal is effective for years beginning after December 31, 2005.
127

J. Eligibility for Participation in Eligible Deferred Compensation Plans 

Present Law

A section 457 plan is an eligible deferred compensation plan of a State or local 

government or tax-exempt employer that meets certain requirements. In some cases, different 

rules apply under section 457 to governmental plans and plans of tax-exempt employers. 

Amounts deferred under an eligible deferred compensation plan of a non-governmental 

tax-exempt organization are includible in gross income for the year in which amounts are paid or 

made available. Under present law, if the amount payable to a participant does not exceed 

$5,000, a plan may allow a distribution up to $5,000 without such amount being treated as made 

available if the distribution can be made only if no amount has been deferred under the plan by 

the participant during the two-year period ending on the date of the distribution and there has 

been no prior distribution under the plan. Prior to the Small Business Job Protection Act of 

1996, under former section 457(e)(9), benefits were not treated as made available because a 

participant could elect to receive a lump sum payable after separation from service and within 60 

days of the election if (1) the total amount payable under the plan did not exceed $3,500 and 

(2) no additional amounts could be deferred under the plan. 

Description of Proposal

Under the proposal, an individual is not precluded from participating in an eligible 

deferred compensation plan by reason of having received a distribution under section 457(e)(9) 

as in effect before the Small Business Job Protection Act of 1996. 

Effective Date 

The proposal is effective on the date of enactment. 
128

K. Benefit Transfers to the PBGC 

Present Law

Involuntary distributions and automatic rollovers 

If a qualified retirement plan participant ceases to be employed by the employer that 

maintains the plan, the plan may distribute the participant’s nonforfeitable accrued benefit 

without the consent of the participant (an “involuntary distribution”) and, if applicable, the 

participant’s spouse, if the present value of the benefit does not exceed $5,000.151 Generally, a 

participant may roll over an involuntary distribution from a qualified plan to an individual 

retirement arrangement (an “IRA”) or to another qualified plan. 

In the case of an involuntary distribution that exceeds $1,000 and that is an eligible 

rollover distribution from a qualified retirement plan, the plan administrator must roll the 

distribution over to an IRA (an “automatic rollover”) in certain cases.152 That is, the plan 

administrator must make a direct trustee-to-trustee transfer of the distribution to an IRA, unless 

the participant affirmatively elects to have the distribution transferred to a different IRA or a 

qualified plan or to receive it directly. 

Before making a distribution that is eligible for rollover, a plan administrator must 

provide the participant with a written explanation of the ability to have the distribution rolled 

over directly to an IRA or another qualified plan and the related tax consequences. In the case of 

an automatic rollover to an IRA, the written explanation provided by the plan administrator is 

required to explain that an automatic rollover will be made unless the participant elects 

otherwise. The plan administrator is also required to notify the participant in writing (as part of 

the general written explanation or separately) that the distribution may be transferred to another 

IRA. 

Missing participant benefits

In the case of a defined benefit pension plan that is subject to the plan termination 

insurance program under Title IV of the Employee Retirement Income Security Act of 1974 

(“ERISA”), is maintained by a single employer, and terminates under a standard termination, the 

plan administrator generally must purchase annuity contracts from a private insurer to provide 

 151 The portion of a participant’s benefit that is attributable to amounts rolled over from another 

plan may be disregarded in determining the present value of the participant’s vested accrued benefit. 

152 Sec. 401(a)(31)(B). This provision was enacted by section 657 of EGTRRA and applies to 

distributions after the issuance of final regulations by the Department of Labor providing safe harbors for 

satisfying fiduciary requirements related to automatic rollovers. Proposed regulations providing such a 

safe harbor were issued by the Department of Labor, to be effective six months after the issuance of final 

regulations. 69 Fed. Reg. 9900 (March 2, 2004). The provisions of EGTRRA generally do not apply for 

years beginning after December 31, 2010.
129

the benefits to which participants are entitled and distribute the annuity contracts to the 

participants. 

If the plan administrator of a terminating single employer plan cannot locate a participant 

after a diligent search (a “missing participant”), the plan administrator may satisfy the 

distribution requirement only by purchasing an annuity from an insurer or transferring the 

participant’s designated benefit to the Pension Benefit Guaranty Corporation (“PBGC”), which 

holds the benefit of the missing participant as trustee until the PBGC locates the missing 

participant and distributes the benefit.153

The PBGC missing participant program is not available to multiemployer plans or 

defined contribution plans and other plans not covered by Title IV of ERISA. 

Description of Proposal

The proposal provides an alternative to the automatic rollover to an IRA of an 

involuntary distribution that exceeds $1,000. Under the proposal, unless the participant elects to 

have the distribution transferred to an IRA or a qualified retirement plan or to receive it directly, 

the plan may provide for the transfer of the distribution to the PBGC, instead of to an IRA.154 

The written explanation provided to the participant by the plan administrator before the 

involuntary distribution must explain that a transfer to the PBGC will be made unless the 

participant elects otherwise. 

The proposal extends the provisions relating to the PBGC missing participant program to 

involuntary distributions that are transferred to the PBGC. Benefits transferred to the PBGC 

under the proposal are to be distributed by the PBGC to the participant upon application filed by 

the participant with the PBGC in such form and manner as prescribed by the PBGC in 

regulations. Benefits are to be distributed in a single sum (plus interest) or in another form as 

specified in PBGC regulations. 

The transfer of an involuntary distribution to the PBGC is treated as a transfer to an IRA 

(i.e., the amount transferred is not included in the participant’s income). An amount distributed 

by the PBGC is generally treated as a distribution from an IRA. 

Effective Date

The proposal is generally effective as if included in the amendments made by section 657 

of EGTRRA, i.e., after the issuance of final regulations by the Department of Labor. The 

extension of the PBGC missing participant program to involuntary distributions that are 

transferred to the PBGC is effective for distributions made after the issuance of final regulations 

implementing such extension. The PBGC is directed to issue such regulations not later than 

December 31, 2006. 

 153 Secs. 4041(b)(3)(A) and 4050 of ERISA. 

154 The provision applies to all automatic rollovers, not just those for missing participants. 
 130 

L. Missing Participants 

Present Law

In the case of a defined benefit pension plan that is subject to the plan termination 

insurance program under Title IV of the Employee Retirement Income Security Act of 1974 

(“ERISA”), is maintained by a single employer, and terminates under a standard termination, the 

plan administrator generally must purchase annuity contracts from a private insurer to provide 

the benefits to which participants are entitled and distribute the annuity contracts to the 

participants. 

If the plan administrator of a terminating single employer plan cannot locate a participant 

after a diligent search (a “missing participant”), the plan administrator may satisfy the 

distribution requirement only by purchasing an annuity from an insurer or transferring the 

participant’s designated benefit to the Pension Benefit Guaranty Corporation (“PBGC”), which 

holds the benefit of the missing participant as trustee until the PBGC locates the missing 

participant and distributes the benefit.155

The PBGC missing participant program is not available to multiemployer plans or 

defined contribution plans and other plans not covered by Title IV of ERISA. 

Description of Proposal

The PBGC is directed to prescribe rules for terminating multiemployer plans similar to 

the present-law missing participant rules applicable to terminating single-employer plans that are 

subject to Title IV of ERISA. 

In addition, plan administrators of certain types of plans not subject to the PBGC 

termination insurance program under present law are permitted, but not required, to elect to 

transfer missing participants’ benefits to the PBGC upon plan termination. Specifically, the 

proposal extends the missing participants program (in accordance with regulations) to defined 

contribution plans, defined benefit pension plans that have no more than 25 active participants 

and are maintained by professional service employers, and the portion of defined benefit pension 

plans that provide benefits based upon the separate accounts of participants and therefore are 

treated as defined contribution plans under ERISA. 

Effective Date

The proposal is effective for distributions made after final regulations implementing the 

proposal are prescribed. 

 155 Secs. 4041(b)(3)(A) and 4050 of ERISA. 
 131 

IX. ADMINISTRATIVE PROVISIONS 

A. Updating of Employee Plans Compliance Resolution System 

Present Law

A retirement plan that is intended to be a tax-qualified plan provides retirement benefits 

on a tax-favored basis if the plan satisfies all of the requirements of section 401(a). Similarly, an 

annuity that is intended to be a tax-sheltered annuity provides retirement benefits on a taxfavored basis if the program satisfies all of the requirements of section 403(b). Failure to satisfy 

all of the applicable requirements of section 401(a) or section 403(b) may disqualify a plan or 

annuity for the intended tax-favored treatment. 

The Internal Revenue Service (“IRS”) has established the Employee Plans Compliance 

Resolution System (“EPCRS”), which is a comprehensive system of correction programs for 

sponsors of retirement plans and annuities that are intended, but have failed, to satisfy the 

requirements of section 401(a), section 403(a), section 403(b), section 408(k), or section 408(p) 

as applicable.156 EPCRS permits employers to correct compliance failures and continue to 

provide their employees with retirement benefits on a tax-favored basis. 

The IRS has designed EPCRS to (1) encourage operational and formal compliance, 

(2) promote voluntary and timely correction of compliance failures, (3) provide sanctions for 

compliance failures identified on audit that are reasonable in light of the nature, extent, and 

severity of the violation, (4) provide consistent and uniform administration of the correction 

programs, and (5) permit employers to rely on the availability of EPCRS in taking corrective 

actions to maintain the tax-favored status of their retirement plans and annuities. 

The basic elements of the programs that comprise EPCRS are self-correction, voluntary 

correction with IRS approval, and correction on audit. The Self-Correction Program (“SCP”) 

generally permits a plan sponsor that has established compliance practices and procedures to 

correct certain insignificant failures at any time (including during an audit), and certain 

significant failures within a 2-year period, without payment of any fee or sanction. The 

Voluntary Correction Program (“VCP”) permits an employer, at any time before an audit, to pay 

a limited fee and receive IRS approval of a correction. For a failure that is discovered on audit 

and corrected, the Audit Closing Agreement Program (“Audit CAP”) provides for a sanction that 

bears a reasonable relationship to the nature, extent, and severity of the failure and that takes into 

account the extent to which correction occurred before audit. 

The IRS has expressed its intent that EPCRS will be updated and improved periodically 

in light of experience and comments from those who use it. 

 156 Rev. Proc. 2003-44, 2003-25 I.R.B. 1051. 
 132 

Description of Proposal

The proposal clarifies that the Secretary has the full authority to establish and implement 

EPCRS (or any successor program) and any other employee plans correction policies, including 

the authority to waive income, excise or other taxes to ensure that any tax, penalty or sanction is 

not excessive and bears a reasonable relationship to the nature, extent and severity of the failure. 

Under the proposal, the Secretary of the Treasury is directed to continue to update and 

improve EPCRS (or any successor program), giving special attention to (1) increasing the 

awareness and knowledge of small employers concerning the availability and use of EPCRS, 

(2) taking into account special concerns and circumstances that small employers face with 

respect to compliance and correction of compliance failures, (3) extending the duration of the 

self-correction period under SCP for significant compliance failures, (4) expanding the 

availability to correct insignificant compliance failures under SCP during audit, and (5) assuring 

that any tax, penalty, or sanction that is imposed by reason of a compliance failure is not 

excessive and bears a reasonable relationship to the nature, extent, and severity of the failure. 

Effective Date

The proposal is effective on the date of enactment. 
 133 

B. Extension to all Governmental Plans of Moratorium 

on Application of Certain Nondiscrimination Rules 

Present Law

A qualified retirement plan maintained by a State or local government is exempt from the 

requirements concerning nondiscrimination (sec. 401(a)(4)) and minimum participation 

(sec. 401(a)(26)). A qualified retirement plan maintained by a State or local government is also 

treated as meeting the participation and nondiscrimination requirements applicable to a qualified 

cash or deferred arrangement (sec. 401(k)(3)). Other governmental plans are subject to these 

requirements.157

Description of Proposal

The proposal exempts all governmental plans (as defined in sec. 414(d)) from the 

nondiscrimination and minimum participation rules. The proposal also treats all governmental 

plans as meeting the participation and nondiscrimination requirements applicable to a qualified 

cash or deferred arrangement. 

Effective Date

The proposal is effective for plan years beginning after December 31, 2005. 

 157 The IRS has announced that governmental plans that are subject to the nondiscrimination 

requirements are deemed to satisfy such requirements pending the issuance of final regulations addressing 

this issue. Notice 2003-6, 2003-3 I.R.B. 298; Notice 2001-46, 2001-2 C.B. 122. 
 134 

C. Notice and Consent Period Regarding Distributions 

Present Law

Notice and consent requirements apply to certain distributions from qualified retirement 

plans. These requirements relate to the content and timing of information that a plan must 

provide to a participant prior to a distribution, and to whether the plan must obtain the 

participant’s consent to the distribution. The nature and extent of the notice and consent 

requirements applicable to a distribution depend upon the value of the participant’s vested 

accrued benefit and whether the joint and survivor annuity requirements (sec. 417) apply to the 

participant. 

If the present value of the participant’s vested accrued benefit exceeds $5,000,158 the plan 

may not distribute the participant’s benefit without the written consent of the participant. The 

participant’s consent to a distribution is not valid unless the participant has received from the 

plan a notice that contains a written explanation of (1) the material features and the relative 

values of the optional forms of benefit available under the plan, (2) the participant’s right, if any, 

to have the distribution directly transferred to another retirement plan or individual retirement 

arrangement (“IRA”), and (3) the rules concerning the taxation of a distribution. If the joint and 

survivor annuity requirements are applicable, this notice also must contain a written explanation 

of (1) the terms and conditions of the qualified joint and survivor annuity (“QJSA”), (2) the 

participant’s right to make, and the effect of, an election to waive the QJSA, (3) the rights of the 

participant’s spouse with respect to a participant’s waiver of the QJSA, and (4) the right to make, 

and the effect of, a revocation of a waiver of the QJSA. The plan generally must provide this 

notice to the participant no less than 30 and no more than 90 days before the date distribution 

commences. 

Description of Proposal

Under the proposal, a qualified retirement plan is required to provide the applicable 

distribution notice no less than 30 days and no more than 180 days before the date distribution 

commences. The Secretary of the Treasury is directed to modify the applicable regulations to 

reflect the extension of the notice period to 180 days and to provide that the description of a 

participant’s right, if any, to defer receipt of a distribution shall also describe the consequences 

of failing to defer such receipt. 

Effective Date

The proposal and the modifications required to be made under the proposal apply to years 

beginning after December 31, 2005. In the case of a description of the consequences of a 

participant’s failure to defer receipt of a distribution that is made before the date 90 days after the 

date on which the Secretary of the Treasury makes modifications to the applicable regulations, 

 158 The portion of a participant’s benefit that is attributable to amounts rolled over from another 

plan may be disregarded in determining the present value of the participant’s vested accrued benefit. 
 135 

the plan administrator is required to make a reasonable attempt to comply with the requirements 

of the proposal. 
 136 

D. Pension Plan Reporting Simplification 

Present Law

A plan administrator of a pension, annuity, stock bonus, profit-sharing or other funded 

plan of deferred compensation generally must file with the Secretary of the Treasury an annual 

return for each plan year containing certain information with respect to the qualification, 

financial condition, and operation of the plan. Title I of ERISA also may require the plan 

administrator to file annual reports concerning the plan with the Department of Labor and the 

Pension Benefit Guaranty Corporation (“PBGC”). The plan administrator must use the Form 

5500 series as the format for the required annual return.159 The Form 5500 series annual 

return/report, which consists of a primary form and various schedules, includes the information 

required to be filed with all three agencies. The plan administrator satisfies the reporting 

requirement with respect to each agency by filing the Form 5500 series annual return/report with 

the Department of Labor, which forwards the form to the Internal Revenue Service and the 

PBGC. 

The Form 5500 series consists of 2 different forms: Form 5500 and Form 5500-EZ. 

Form 5500 is the more comprehensive of the forms and requires the most detailed financial 

information. The plan administrator of a “one-participant plan” generally may file Form 5500-

EZ, which consists of only one page. For this purpose, a plan is a one-participant plan if: (1) the 

only participants in the plan are the sole owner of a business that maintains the plan (and such 

owner’s spouse), or partners in a partnership that maintains the plan (and such partners’ 

spouses); (2) the plan is not aggregated with another plan in order to satisfy the minimum 

coverage requirements of section 410(b); (3) the plan does not provide benefits to anyone other 

than the sole owner of the business (or the sole owner and spouse) or the partners in the business 

(or the partners and spouses); (4) the employer is not a member of a related group of employers; 

and (5) the employer does not use the services of leased employees. In addition, the plan 

administrator of a one-participant plan is not required to file a return if the plan does not have an 

accumulated funding deficiency and the total value of the plan assets as of the end of the plan 

year and all prior plan years beginning on or after January 1, 1994, does not exceed $100,000. 

With respect to a plan that does not satisfy the eligibility requirements for Form 5500-EZ, 

the characteristics and the size of the plan determine the amount of detailed financial information 

that the plan administrator must provide on Form 5500. If the plan has more than 100 

participants at the beginning of the plan year, the plan administrator generally must provide more 

information. 

Description of Proposal

The Secretary of the Treasury and the Secretary of Labor are directed to modify the 

annual return filing requirements with respect to a one-participant plan to provide that if the total 

value of the plan assets of such a plan as of the end of the plan year does not exceed $250,000, 

 159 Treas. Reg. sec. 301.6058-1(a). 
 137 

the plan administrator is not required to file a return. In addition, the proposal directs the 

Secretary of the Treasury and the Secretary of Labor to provide simplified reporting 

requirements for plan years beginning after December 31, 2006, for certain plans with fewer than 

25 employees. 

Effective Date

The proposal relating to one-participant retirement plans is effective for plan years 

beginning on or after January 1, 2006. The proposal relating to simplified reporting for plans 

with fewer than 25 employees is effective on the date of enactment. 
 138 

E. Voluntary Early Retirement Incentive and Employment Retention Plans 

Maintained by Local Educational Agencies and Other Entities 

Present Law

Eligible deferred compensation plans of State and local governments and tax-exempt 

employers

A “section 457 plan” is an eligible deferred compensation plan of a State or local 

government or tax-exempt employer that meets certain requirements. For example, the amount 

that can be deferred annually under section 457 cannot exceed a certain dollar limit ($14,000 for 

2005). Amounts deferred under a section 457 plan are generally includible in gross income 

when paid or made available (or, in the case of governmental section 457 plans, when paid). 

Subject to certain exceptions, amounts deferred under a plan that does not comply with section 

457 (an “ineligible plan”) are includible in income when the amounts are not subject to a 

substantial risk of forfeiture. Section 457 does not apply to any bona fide vacation leave, sick 

leave, compensatory time, severance pay, disability pay, or death benefit plan. Additionally, 

section 457 does not apply to qualified retirement plans or qualified governmental excess benefit 

plans that provide benefits in excess of those that are provided under a qualified retirement plan 

maintained by the governmental employer. 

ERISA

ERISA provides rules governing the operation of most employee benefit plans. The rules 

to which a plan is subject depend on whether the plan is an employee welfare benefit plan or an 

employee pension benefit plan. For example, employee pension benefit plans are subject to 

reporting and disclosure requirements, participation and vesting requirements, funding 

requirements, and fiduciary provisions. Employee welfare benefit plans are not subject to all of 

these requirements. Governmental plans are exempt from ERISA. 

Age Discrimination in Employment Act

The Age Discrimination in Employment Act (“ADEA”) generally prohibits 

discrimination in employment because of age. However, certain defined benefit pension plans 

may lawfully provide payments that constitute the subsidized portion of an early retirement 

benefit or social security supplements pursuant to ADEA160, and employers may lawfully 

provide a voluntary early retirement incentive plan that is consistent with the purposes of 

ADEA.161 

 160 See ADEA sec. 4(l)(1). 

161 See ADEA sec. 4(f)(2). 
 139 

Description of Proposal

Early retirement incentive plans of local educational agencies and education associations

The proposal addresses the treatment of certain voluntary early retirement incentive plans 

under section 457, ERISA, and ADEA. 

Code section 457

Under the proposal, special rules apply under section 457 to a voluntary early retirement 

incentive plan that is maintained by a local educational agency or a tax-exempt education 

association which principally represents employees of one or more such agencies and that makes 

payments or supplements as an early retirement benefit, a retirement-type subsidy, or a social 

security supplement in coordination with a defined benefit pension plan maintained by a State or 

local government or by such an association. Such a voluntary early retirement incentive plan is 

treated as a bona fide severance plan for purposes of section 457, and therefore is not subject to 

the limits under section 457, to the extent the payments or supplements could otherwise be 

provided under the defined benefit pension plan. For purposes of the proposal, the payments or 

supplements that could otherwise be provided under the defined benefit pension plan are to be 

determined by applying the accrual and vesting rules for defined benefit pension plans.162 

ERISA

In addition, such voluntary early retirement incentive plans are treated as welfare benefit 

plans for purposes of ERISA (other than governmental plans that are exempt from ERISA). 

ADEA

The proposal also addresses the treatment under ADEA of voluntary early retirement 

incentive plans that are maintained by local educational agencies and tax-exempt education 

associations which principally represent employees of one or more such agencies, and that make 

payments or supplements that constitute the subsidized portion of an early retirement benefit or a 

social security supplement and that are made in coordination with a defined benefit pension plan 

maintained by a State or local government or by such an association. Under the proposal, for 

purposes of ADEA, such a plan is treated as part of the defined benefit pension plan and the 

payments or supplements under the plan are not severance pay that may be subject to certain 

deductions under ADEA. 

Employment retention plans of local educational agencies and education associations

The proposal addresses the treatment of certain employment retention plans under 

section 457 and ERISA. The proposal applies to employment retention plans that are maintained 

 162 The accrual and vesting rules have the effect of limiting the social security supplements and 

early retirement benefits that may be provided under a defined benefit pension plan; however, 

government plans are exempt from these rules. 
 140 

by local educational agencies or tax-exempt education associations which principally represent 

employees of one or more such agencies and that provide compensation to an employee (payable 

on termination of employment) for purposes of retaining the services of the employee or 

rewarding the employee for service with educational agencies or associations. 

Under the proposal, special tax treatment applies to the portion of an employment 

retention plan that provides benefits that do not exceed twice the applicable annual dollar limit 

on deferrals under section 457 ($14,000 for 2005). The proposal provides an exception from the 

rules under section 457 for ineligible plans with respect to such portion of an employment 

retention plan. This exception applies for years preceding the year in which benefits under the 

employment retention plan are paid or otherwise made available to the employee. In addition, 

such portion of an employment retention plan is not treated as providing for the deferral of 

compensation for tax purposes. 

Under the proposal, an employment retention plan is also treated as a welfare benefit plan 

for purposes of ERISA (other than a governmental plan that is exempt from ERISA). 

Effective Date

The proposal is generally effective on the date of enactment. The amendments to 

section 457 apply to taxable years ending after the date of enactment. The amendments to 

ERISA apply to plan years ending after the date of enactment. Nothing in the proposal alters or 

affects the construction of the Code, ERISA, or ADEA as applied to any plan, arrangement, or 

conduct to which the proposal does not apply. 
141

F. No Reduction in Unemployment Compensation as a Result of Pension Rollovers 

Present Law

Under present law, unemployment compensation payable by a State to an individual 

generally is reduced by the amount of retirement benefits received by the individual. 

Distributions from certain employer-sponsored retirement plans or IRAs that are transferred to a 

similar retirement plan or IRA (“rollover distributions”) generally are not includible in income. 

Some States currently reduce the amount of an individual’s unemployment compensation by the 

amount of a rollover distribution. 

Description of Proposal

The proposal amends the Code so that the reduction of unemployment compensation 

payable to an individual by reason of the receipt of retirement benefits does not apply in the case 

of a rollover distribution. 

Effective Date

The proposal is effective for weeks beginning on or after the date of enactment. 
142

G. Withholding on Certain Distributions from Governmental 

Eligible Deferred Compensation Plans 

Present Law

Before the Economic Growth and Tax Relief Reconciliation Act of 2001163

(“EGTRRA”), distributions from an eligible deferred compensation plan under section 457 (a 

“section 457 plan”) were subject to the withholding rules for wages, rather than the withholding 

rules for distributions from qualified retirement plans. Under the wage withholding rules, 

graduated withholding applies based on the amount of the wages. Under the withholding rules 

for qualified retirement plans, an individual may generally elect not to have taxes withheld from 

distributions. However, withholding is required at a 20-percent rate in the case of an eligible 

rollover distribution that is not automatically rolled over into another retirement plan. Eligible 

rollover distributions include distributions that are payable over a period of less than 10 years. 

EGTRRA conformed the rollover rules and withholding rules for governmental 

section 457 plans to the rules for qualified retirement plans.164 The EGTRRA changes are 

effective for distributions after December 31, 2001. As a result, as of 2002, required withholding 

at a 20-percent rate applies to distributions made from a governmental section 457 plan for a 

period of less than 10 years, including distributions that began before the effective date of the 

EGTRRA changes. 

Description of Proposal

Under the proposal, the pre-EGTRRA withholding rules may be applied to distributions 

from a governmental section 457 plan if the distribution is part of a series of distributions 

which began before January 1, 2002, and is payable for less than 10 years. 

Effective Date

The proposal is effective as if included in section 641 of EGTRRA. 

 163 Pub. L. No. 107-16. 

164 EGTRRA sec. 641. 
143

H. Provisions Relating to Plan Amendments 

Present Law

Present law provides a remedial amendment period during which, under certain 

circumstances, a plan may be amended retroactively in order to comply with the qualification 

requirements.165 In general, plan amendments to reflect changes in the law generally must be 

made by the time prescribed by law for filing the income tax return of the employer for the 

employer’s taxable year in which the change in law occurs. The Secretary of the Treasury may 

extend the time by which plan amendments need to be made. 

The Code and ERISA provide that, in general, accrued benefits cannot be reduced by a 

plan amendment.166 This prohibition on the reduction of accrued benefits is commonly referred 

to as the “anticutback rule.” 

Description of Proposal

The proposal permits certain plan amendments made pursuant to the changes made by the 

bill or by the Economic Growth and Tax Relief Reconciliation Act of 2001167 (“EGTRRA”), or 

regulations issued thereunder, to be retroactively effective. If the plan amendment meets the 

requirements of the proposal, then the plan will be treated as being operated in accordance with 

its terms and the amendment will not violate the anticutback rule. In order for this treatment to 

apply, the plan amendment is required to be made on or before the last day of the first plan year 

beginning on or after January 1, 2006, or such later date as provided by the Secretary of the 

Treasury. Governmental plans are given an additional two years in which to make required plan 

amendments. If the amendment is required to be made to retain qualified status as a result of the 

changes in the law (or regulations), the amendment is required to be made retroactively effective 

as of the date on which the change became effective with respect to the plan and the plan is 

required to be operated in compliance until the amendment is made. Amendments that are not 

required to retain qualified status but that are made pursuant to the changes made by the bill or 

EGTRRA (or applicable regulations) may be made retroactively effective as of the first day the 

plan is operated in accordance with the amendment. 

A plan amendment will not be considered to be pursuant to the bill or EGTRRA (or 

applicable regulations) if it has an effective date before the effective date of the proposal under 

the bill or EGTRRA (or regulations) to which it relates. Similarly, the proposal does not provide 

relief from the anticutback rule for periods prior to the effective date of the relevant proposal (or 

regulations) or the plan amendment. 

 165 Sec. 401(b). 

166 Code sec. 411(d)(6); ERISA sec. 204(g). 

167 Pub. L. No. 107-16. 
144

The Secretary of the Treasury is authorized to provide exceptions to the relief from the 

prohibition on reductions in accrued benefits. It is intended that the Secretary will not permit 

inappropriate reductions in contributions or benefits that are not directly related to the proposals 

under the bill or EGTRRA. For example, it is intended that a plan that incorporates the section 

415 limits by reference can be retroactively amended to impose the section 415 limits in effect 

before EGTTRA.168 On the other hand, suppose a plan incorporates the section 401(a)(17) limit 

on compensation by reference and provides for an employer contribution of three percent of 

compensation. It is expected that the Secretary will provide that, in that case, the plan cannot be 

amended retroactively to reduce the contribution percentage for those participants not affected by 

the section 401(a)(17) limit, even though the reduction will result in the same dollar level of 

contributions for some participants because of the increase in compensation taken into account 

under the plan as a result of the increase in the section 401(a)(17) limit under EGTRRA. As 

another example, suppose that under present law a plan is top-heavy and therefore a minimum 

benefit is required under the plan, and that under the provisions of EGTRRA, the plan is not 

considered to be top-heavy. It is expected that the Secretary will generally permit plans to be 

retroactively amended to reflect the new top-heavy provisions of EGTRRA. 

Effective Date

The proposal is effective on the date of enactment.

 168 See also, section 411(j)(3) of the Job Creation and Worker Assistance Act of 2002, which 

provides a special rule for plan amendments adopted on or before June 30, 2002, in connection with 

EGTRRA, in the case of a plan that incorporated the section 415 limits by reference on June 7, 2001, the 

date of enactment of EGTRRA. 
145

X. UNITED STATES TAX COURT MODERNIZATION 

A. Tax Court Procedure 

1. Jurisdiction of Tax Court over collection due process cases 

Present Law

In general, the Internal Revenue Service (“IRS”) is required to notify taxpayers that they 

have a right to a fair and impartial hearing before levy may be made on any property or right to 

property.169 Similar rules apply with respect to liens.170 The hearing is held by an impartial 

officer from the IRS Office of Appeals, who is required to issue a determination with respect to 

the issues raised by the taxpayer at the hearing. The taxpayer is entitled to appeal that 

determination to a court. The appeal must be brought to the United States Tax Court (the “Tax 

Court”), unless the Tax Court does not have jurisdiction over the underlying tax liability. If that 

is the case, then the appeal must be brought in the district court of the United States.171 If a court 

determines that an appeal was not made to the correct court, the taxpayer has 30 days after such 

determination to file with the correct court. 

The Tax Court is established under Article I of the United States Constitution172 and is a 

court of limited jurisdiction.173 The Tax Court only has the jurisdiction that is expressly 

conferred on it by statute. For example, the jurisdiction of the Tax Court includes the authority 

to redetermine the correct amount of an income, estate, or gift tax deficiency, to make certain 

types of declaratory judgments, and to determine certain worker classification status issues, but 

does not include jurisdiction over most excise taxes imposed by the Internal Revenue Code. 

Thus, the Tax Court lacks jurisdiction over the appeal of a due process hearing relating to certain 

collections matters. 

Description of Proposal

The proposal modifies the jurisdiction of the Tax Court by providing that all appeals of 

collection due process determinations are to be made to the Tax Court. 

Effective Date

The proposal applies to determinations made by the IRS after the date which is 60 days 

after the date of enactment.

 169 Sec. 6330(a). 

170 Sec. 6320. 

171 Sec. 6330(d). 

172 Sec. 7441. 

173 Sec. 7442.
 146 

2. Authority for special trial judges to hear and decide certain employment status cases 

Present Law

In connection with the audit of any person, if there is an actual controversy involving a 

determination by the IRS as part of an examination that (1) one or more individuals performing 

services for that person are employees of that person or (2) that person is not entitled to relief 

under section 530 of the Revenue Act of 1978, the Tax Court has jurisdiction to determine 

whether the IRS is correct and the proper amount of employment tax under such 

determination.174 Any redetermination by the Tax Court has the force and effect of a decision of 

the Tax Court and is reviewable. 

An election may be made by the taxpayer for small case procedures if the amount of the 

employment taxes in dispute is $50,000 or less for each calendar quarter involved.175 The 

decision entered under the small case procedure is not reviewable in any other court and should 

not be cited as authority. 

The chief judge of the Tax Court may assign proceedings to special trial judges. The 

Code enumerates certain types of proceedings that may be so assigned and may be decided by a 

special trial judge. In addition, the chief judge may designate any other proceeding to be heard 

by a special trial judge.176

Description of Proposal

The proposal clarifies that the chief judge of the Tax Court may assign to special trial 

judges any employment tax cases that are subject to the small case procedure and may authorize 

special trial judges to decide such small tax cases. 

Effective Date

The proposal is effective for any employment status proceeding in the Tax Court with 

respect to which a decision has not become final before the date of enactment. 

3. Confirmation of Tax Court authority to apply doctrine of equitable recoupment 

Present Law

Equitable recoupment is a common-law equitable principle that permits the defensive use 

of an otherwise time-barred claim to reduce or defeat an opponent’s claim if both claims arise 

from the same transaction. U.S. District Courts and the U.S. Court of Federal Claims, the two 

 174 Sec. 7436. 

175 Sec. 7436(c). 

176 Sec. 7443A(b) and (c).
 147 

Federal tax refund forums, may apply equitable recoupment in deciding tax refund cases.177 In 

Estate of Mueller v. Commissioner,

178 the Court of Appeals for the Sixth Circuit held that the 

Tax Court may not apply the doctrine of equitable recoupment. More recently, the Court of 

Appeals for the Ninth Circuit, in Branson v. Commissioner,

179 held that the Tax Court may apply 

the doctrine of equitable recoupment. 

Description of Proposal

The proposal confirms that the Tax Court may apply the principle of equitable 

recoupment to the same extent that it may be applied in Federal civil tax cases by the U.S. 

District Courts or the U.S. Court of Federal Claims. No inference should be drawn as to whether 

the Tax Court has the authority to continue to apply other equitable principles in deciding 

matters over which it has jurisdiction. 

Effective Date 

The proposal is effective for any action or proceeding in the Tax Court with respect to 

which a decision has not become final as of the date of enactment. 

4. Tax Court filing fees 

Present Law

The Tax Court is authorized to impose a fee of up to $60 for the filing of any petition for 

the redetermination of a deficiency or for declaratory judgments relating to the status and 

classification of 501(c)(3) organizations, the judicial review of final partnership administrative 

adjustments, and the judicial review of partnership items if an administrative adjustment request 

is not allowed in full.180 The statute does not specifically authorize the Tax Court to impose a 

filing fee for the filing of a petition for review of the IRS’s failure to abate interest or for failure 

to award administrative costs and other areas of jurisdiction for which a petition may be filed. 

The practice of the Tax Court is to impose a $60 filing fee in all cases commenced by petition.181

Description of Proposal

The proposal clarifies that the Tax Court is authorized to charge a filing fee of up to $60 

in all cases commenced by the filing of a petition. No negative inference should be drawn as to 

 177 See Stone v. White, 301 U.S. 532 (1937); Bull v. United States, 295 U.S. 247 (1935). 

178 153 F.3d 302 (6th Cir.), cert. den., 525 U.S. 1140 (1999). 

179 264 F.3d 904 (9th Cir.), cert. den., 535 U.S. 927 (2002). 

180 Sec. 7451. 

181 See Rule 20(a) of the Tax Court Rules of Practice and Procedure. 
 148 

whether the Tax Court has the authority under present law to impose a filing fee for any case 

commenced by the filing of a petition. 

Effective Date

The proposal is effective on the date of enactment. 

5. Appointment of Tax Court employees 

Present Law

The Tax Court is a legislative court established by the Congress pursuant to Article I of 

the U.S. Constitution (an “Article I” court).182 The Tax Court is authorized to appoint 

employees, subject to the rules applicable to employment with the Executive Branch of the 

Federal Government (generally referred to as “competitive service”), as administered by the 

Office of Personnel Management.183 

Employment with the Federal Executive Branch is governed by certain general statutory 

principles, such as recruitment of qualified individuals, fair and equitable treatment of employees 

and applicants, maintenance of high standards of employee conduct, and protection of employees 

against arbitrary action. The rules for employment in the Federal Executive Branch address 

various aspects of such employment, including: (1) procedures for the appointment of employees 

in the competitive service, including preferences for certain individuals (e.g., veterans); 

(2) compensation, benefits, and leave programs for employees; (3) appraisals of employee 

performance; (4) disciplinary actions; and (5) employee rights, including appeal rights. In 

addition, employees are protected from certain personnel practices (referred to as “prohibited 

personnel practices”), such as discrimination on the basis of race, color, religion, age, sex, 

national origin, political affiliation, marital status, or handicapping condition. 

Description of Proposal

The proposal extends to the Tax Court authority to establish its own personnel 

management system, similar to authority that applies to courts in the Federal Judicial Branch. 

Any personnel management system adopted by the Tax Court must: (1) include the merit system 

principles that govern employment with the Federal Executive Branch; (2) prohibit personnel 

practices that are prohibited in the Federal Executive Branch; and (3) in the case of an individual 

eligible for preference for employment in the Federal Executive Branch, provide preference for 

that individual in a manner and to an extent consistent with preference in the Federal Executive 

Branch. 

The proposal requires the Tax Court to prohibit discrimination on the basis of race, color, 

religion, age, sex, national origin, political affiliation, marital status, or handicapping condition. 

 182 Sec. 7441.

183 Sec. 7471. 
 149 

The Tax Court is also required to promulgate procedures for resolving complaints of 

discrimination by employees and applicants for employment. 

The proposal allows the Tax Court to appoint a clerk without regard to the Federal 

Executive Branch rules regarding appointments in the competitive service. Under the proposal, 

the clerk serves at the pleasure of the Tax Court. 

The proposal also allows the Tax Court to appoint other necessary employees without 

regard to the Federal Executive Branch rules regarding appointments in the competitive service. 

Under the proposal, these deputies and employees are subject to removal by the Tax Court. 

The proposal allows judges and special trial judges of the Tax Court to appoint law clerks 

and secretaries, in such numbers as the Tax Court may approve, without regard to the Federal 

Executive Branch rules regarding appointments in the competitive service. Under the proposal, a 

law clerk or secretary serves at the pleasure of the appointing judge. 

The proposal exempts law clerks from the sick leave and annual leave provisions 

applicable to employees of the Federal Executive Branch. Any unused sick or annual leave to 

the credit of a law clerk as of the effective date of the proposal remains credited to the individual 

and is available to the individual upon separation from the Federal Government, or upon transfer 

to a position subject to such sick leave and annual leave provisions. 

The proposal allows the Tax Court to fix and adjust the compensation of the clerk and 

other employees without regard to the Federal Executive Branch rules regarding employee 

classifications and pay rates. To the maximum extent feasible, Tax Court employees are to be 

compensated at rates consistent with those of employees holding comparable positions in the 

Federal Judicial Branch. The Tax Court may also establish programs for employee evaluations, 

premium pay, and resolution of employee grievances. 

In the case of an individual who is an employee of the Tax Court on the day before the 

effective date of the proposal, the proposal preserves certain rights that the employee is entitled 

to as of that day. The proposal preserves the right to: (1) appeal a reduction in grade or removal; 

(2) appeal an adverse action; (3) appeal a prohibited personnel practice; (4) make an allegation of 

a prohibited personnel practice; or (5) file an employment discrimination appeal. These rights 

are preserved for as long as the individual remains an employee of the Tax Court. 

Under the proposal, a Tax Court employee who completes at least one year of continuous 

service under a nontemporary appointment with the Tax Court acquires competitive service 

status for appointment to any position in the Federal Executive Branch competitive service for 

which the employee possesses the required qualifications. 

The proposal also allows the Tax Court to procure the services of experts and consultants 

in accordance with Federal Executive Branch rules. 

Effective Date

The proposal is effective on the date that the Tax Court adopts a personnel management 

system after the date of enactment of the proposal. 
 150 

6. Expanded use of practice fees 

Present Law

The Tax Court is authorized to impose on practitioners admitted to practice before the 

Tax Court a fee of up to $30 per year.184 These fees are to be used to employ independent 

counsel to pursue disciplinary matters. 

Description of Proposal

The proposal provides that Tax Court fees imposed on practitioners also are available to 

provide services to pro se taxpayers. 

Effective Date

The proposal is effective on the date of enactment. 

 184 Sec. 7475. 
 151 

B. Tax Court Pension and Compensation 

1. Judges of the Tax Court 

Present Law

The Tax Court is established by the Congress pursuant to Article I of the U.S. 

Constitution.185 The salary of a Tax Court judge is the same salary as received by a U.S. District 

Court judge.186 Present law also provides Tax Court judges with some benefits that correspond 

to benefits provided to U.S. District Court judges, including specific retirement and survivor 

benefit programs for Tax Court judges.187

Under the retirement program, a Tax Court judge may elect to receive retirement pay 

from the Tax Court in lieu of benefits under another Federal retirement program. A Tax Court 

judge may also elect to participate in a plan providing annuity benefits for the judge’s surviving 

spouse and dependent children (the “survivors’ annuity plan”). Generally, benefits under the 

survivors’ annuity plan are payable only if the judge has performed at least five years of service. 

Cost-of-living increases in benefits under the survivors’ annuity plan are generally based on 

increases in pay for active judges. 

Tax Court judges participate in the Federal Employees Group Life Insurance program 

(the “FEGLI” program). Retired Tax Court judges are eligible to participate in the FEGLI 

program as the result of an administrative determination of their eligibility, rather than a specific 

statutory provision. 

Tax Court judges are not covered by the leave system for Federal Executive Branch 

employees. As a result, an individual who works in the Federal Executive Branch before being 

appointed to the Tax Court does not continue to accrue annual leave under the same leave 

program and may not use leave accrued prior to his or her appointment to the Tax Court. 

Tax Court judges are not eligible to participate in the Thrift Savings Plan. 

Under the retirement program for Tax Court judges, retired judges generally receive 

retired pay equal to the rate of salary of an active judge and must be available for recall to 

perform judicial duties as needed by the court for up to 90 days a year (unless the judge consents 

to more). However, retired judges may elect to freeze the amount of their retired pay, and those 

who do so are not available for recall. 

 185 Sec. 7441. 

186 Sec. 7443(c). 

187 Secs. 7447 and 7448. 
 152 

Retired Tax Court judges on recall are subject to the limitations on outside earned income 

that apply to active Federal employees under the Ethics in Government Act of 1978. However, 

retired District Court judges on recall may receive compensation for teaching without regard to 

the limitations on outside earned income. Retired Tax Court judges who elect to freeze the 

amount of their retired pay (thus making themselves unavailable for recall) are not subject to the 

limitations on outside earned income. 

Description of Proposal

In general

The proposal makes various changes to the compensation and benefits rules that apply to 

Tax Court judges to eliminate disparities between the treatment of Tax Court judges and the 

treatment of other Federal judges. 

Survivor annuities for assassinated judges 

Under the proposal, benefits under the survivors’ annuity plan are payable if a Tax Court 

judge is assassinated before the judge has performed five years of service. 

Cost-of-living adjustments for survivor annuities

The proposal provides that cost-of-living increases in benefits under the survivors’ 

annuity plan are generally based on cost-of-living increases in benefits paid under the Civil 

Service Retirement System. 

Life insurance coverage

Under the proposal, a judge or retired judge of the Tax Court is deemed to be an 

employee continuing in active employment for purposes of participation in the Federal 

Employees Group Life Insurance program. In addition, in the case of a Tax Court judge age 65 

or over, the Tax Court is authorized to pay on behalf of the judge any increase in employee 

premiums under the FEGLI program that occur after April 24, 1999,188 including expenses 

generated by such payment, as authorized by the chief judge of the Tax Court in a manner 

consistent with payments authorized by the Judicial Conference of the United States (i.e., the 

body with policy-making authority over the administration of the courts of the Federal judicial 

branch). 

Accrued annual leave

Under the proposal, in the case of a judge who is employed by the Federal executive 

branch before appointment to the Tax Court, the judge is entitled to receive a lump-sum payment 

for the balance of his or her accrued annual leave on appointment to the Tax Court. 

 188 This date relates to changes in the FEGLI program, including changes to premium rates to 

reflect employees’ ages. 
 153 

Thrift Savings Plan participation

Under the proposal, Tax Court judges are permitted to participate in the Thrift Savings 

Plan. A Tax Court judge is not eligible for agency contributions to the Thrift Savings Plan. 

Exemption for teaching compensation from outside earned income limitations

Under the proposal, compensation earned by a retired Tax Court judge for teaching is not 

treated as outside earned income for purposes of limitations under the Ethics in Government Act 

of 1978. 

Effective Date

The proposals are effective on the date of enactment, except that: (1) the proposal relating 

to cost-of-living increases in benefits under the survivors’ annuity plan applies with respect to 

increases in Civil Service Retirement benefits taking effect after the date of enactment; (2) the 

proposal relating to FEGLI coverage applies to any individual serving as a Tax Court judge or 

any retired Tax Court judge on or after the date of enactment; (3) the proposal relating to 

payment of accrued annual leave applies to any Tax Court judge with an outstanding leave 

balance as of the date of enactment and to any individual appointed to serve as a Tax Court judge 

after such date; and (4) the proposal relating to teaching compensation of a retired Tax Court 

judge applies to any individual serving as a retired Tax Court judge on or after the date of 

enactment. 

2. Special trial judges of the Tax Court 

Present Law

The Tax Court is established by the Congress pursuant to Article I of the U.S. 

Constitution.189 The chief judge of the Tax Court may appoint special trial judges to handle 

certain cases.190 Special trial judges serve for an indefinite term. Special trial judges receive a 

salary of 90 percent of the salary of a Tax Court judge and are generally covered by the benefit 

programs that apply to Federal executive branch employees, including the Civil Service 

Retirement System or the Federal Employees’ Retirement System. 

Description of Proposal

In general

The proposal is generally designed to eliminate disparities between the treatment of 

special trial judges of the Tax Court and magistrate judges in courts established under Article III 

of the U.S. Constitution. 

 189 Sec. 7441. 

190 Sec. 7443A. 
 154 

Magistrate judges of the Tax Court 

Under the proposal, the position of special trial judge of the Tax Court is renamed as 

magistrate judge of the Tax Court. Magistrate judges are appointed (or reappointed) to serve for 

eight-year terms and are subject to removal in limited circumstances. 

Under the proposal, a magistrate judge receives a salary of 92 percent of the salary of a 

Tax Court judge. 

The proposal exempts magistrate judges from the leave program that applies to 

employees of the Federal executive branch and provides rules for individuals who are subject to 

such leave program before becoming exempt. 

Survivors’ annuity plan

Under the proposal, magistrate judges of the Tax Court may elect to participate in the 

survivors’ annuity plan for Tax Court judges. An election to participate in the survivors’ annuity 

plan must be filed not later than the latest of: (1) twelve months after the date of enactment of 

the proposal; (2) six months after the date the judge takes office; or (3) six months after the date 

the judge marries. 

Retirement annuity program for magistrate judges

The proposal establishes a new retirement annuity program for magistrate judges of the 

Tax Court, under which a magistrate judge may elect to receive a retirement annuity from the 

Tax Court in lieu of benefits under another Federal retirement program. A magistrate judge may 

elect to be covered by the retirement program within five years of appointment or five years of 

date of enactment. A magistrate judge who elects to be covered by the retirement program 

generally receives a refund of contributions (with interest) made to the Civil Service Retirement 

System or the Federal Employees’ Retirement System. 

A magistrate judge may retire at age 65 with 14 years of service and receive an annuity 

equal to his or her salary at the time of retirement. For this purpose, service may include service 

performed as a special trial judge or a magistrate judge, provided the service is performed no 

earlier than 9-1/2 years before the date of enactment of the proposal. The proposal also provides 

for payment of a reduced annuity in the case a magistrate judge with at least eight years of 

service or in the case of disability or failure to be reappointed. 

A magistrate judge receiving a retirement annuity is entitled to cost-of-living increases 

based on cost-of-living increases in benefits paid under the Civil Service Retirement System. 

However, such an increase cannot cause the retirement annuity to exceed the current salary of a 

magistrate judge. 

Contributions of one percent of salary are withheld from the salary of a magistrate judge 

who elects to participate in the retirement annuity program. Such contributions must be made 

also with respect to prior service for which the magistrate judge elects credit under the retirement 

annuity program. No contributions are required after 14 years of service. A lump sum refund of 
 155 

the magistrate judge’s contributions (with interest) is made if no annuity is payable, for example, 

if the magistrate judge dies before retirement. 

A magistrate judge’s right to a retirement annuity is generally suspended or reduced in 

the case of employment outside the Tax Court. 

The proposal includes rules under which annuity payments may be made to a person 

other than the magistrate judge in certain circumstances, such as divorce or legal separation, 

under a court decree, a court order, or court-approved property settlement. 

The proposal establishes the Tax Court Judicial Officers’ Retirement Fund (the “Fund”). 

Amounts in the Fund are authorized to be appropriated for the payment of annuities, refunds, and 

other payments under the retirement annuity program. Contributions withheld from a magistrate 

judge’s salary are deposited in the Fund. In addition, the proposal authorizes to be appropriated 

to the Fund amounts required to reduce the Fund’s unfunded liability to zero. For this purpose, 

the Fund’s unfunded liability means the estimated excess, actuarially determined on an annual 

basis, of the present value of benefits payable from the Fund over the sum of (1) the present 

value of contributions to be withheld from the future salary of the magistrate judges and (2) the 

balance in the Fund as of the date the unfunded liability is determined. 

Under the proposal, a magistrate judge who elects to participate in the retirement annuity 

program is also permitted to participate in the Thrift Savings Plan. Such a magistrate judge is 

not eligible for agency contributions to the Thrift Savings Plan. 

Retirement annuity rule for incumbent magistrate judges

The proposal provides a transition rule for magistrate judges in active service on the date 

of enactment of the proposal. Under the transition rule, such a magistrate judge is entitled to an 

annuity under the Civil Service Retirement System or the Federal Employees’ Retirement 

System based on prior service that is not credited under the magistrate judges’ retirement annuity 

program. If the magistrate judge made contributions to the Civil Service Retirement System or 

the Federal Employees’ Retirement System with respect to service that is credited under the 

magistrate judges’ retirement annuity program, such contributions are refunded (with interest). 

A magistrate judge who elects the transition rule is also entitled to the annuity payable 

under the magistrate judges’ retirement program in the case of retirement with at least eight years 

of service or on failure to be reappointed. This annuity is based on service as a magistrate judge 

or special trial judge of the Tax Court that is performed no earlier than 9-1/2 years before the 

date of enactment of the proposal and for which the magistrate judge makes contributions of one 

percent of salary. 

Recall of retired magistrate judges

The proposal provides rules under which a retired magistrate judge may be recalled to 

perform services for a limited period. 

Effective Date
 156 

The proposals are effective on date of enactment. 
 157 

XI. OTHER PROVISIONS 

A. Transfer of Funds Attributable to Black Lung Trust Funds 

to Combined Benefit Fund 

Present Law

Qualified black lung benefit trusts

A qualified black lung benefit trust is exempt from Federal income taxation. 

Contributions to a qualified black lung benefit trust generally are deductible to the extent such 

contributions are necessary to fund the trust. 

Under present law, no assets of a qualified black lung benefit trust may be used for, or 

diverted to, any purpose other than (1) to satisfy liabilities, or pay insurance premiums to cover 

liabilities, arising under the Black Lung Acts, (2) to pay administrative costs of operating the 

trust, (3) to pay accident and health benefits or premiums for insurance exclusively covering 

such benefits (including administrative and other incidental expenses relating to such benefits) 

for retired coal miners and their spouses and dependents (within certain limits) or (4) investment 

in Federal, State, or local securities and obligations, or in time demand deposits in a bank or 

insured credit union. Additionally, trust assets may be paid into the national Black Lung 

Disability Trust Fund, or into the general fund of the U.S. Treasury. 

The amount of assets in qualified black lung benefit trusts available to pay accident and 

health benefits or premiums for insurance exclusively covering such benefits (including 

administrative and other incidental expenses relating to such benefits) for retired coal miners and 

their spouses and dependents may not exceed a yearly limit or an aggregate limit, whichever is 

less. The yearly limit is the amount of trust assets in excess of 110 percent of the present value 

of the liability for black lung benefits determined as of the close of the preceding taxable year of 

the trust. The aggregate limit is the excess of the sum of the yearly limit as of the close of the 

last taxable year ending before October 24, 1992, plus earnings thereon as of the close of the 

taxable year preceding the taxable year involved over the aggregate payments for accident of 

health benefits for retired coal miners and their spouses and dependents made from the trust 

since October 24, 1992. Each of these determinations is required to be made by an independent 

actuary. 

In general, amounts used to pay retiree accident or health benefits are not includible in 

the income of the company, nor is a deduction allowed for such amounts. 

United Mine Workers of America Combined Benefit Fund

The United Mine Workers of America (“UMWA”) Combined Benefit Fund was 

established by the Coal Industry Retiree Health Benefit Act of 1992 to assume responsibility of 

payments for medical care expenses of retired miners and their dependents who were eligible for 

heath care from the private 1950 and 1974 UMWA Benefit Plans. The UMWA Combined 

Benefit Fund is financed by assessments on current and former signatories to labor agreements 

with the UMWA, past transfers from an overfunded United Mine Workers pension fund, and 

transfers from the Abandoned Mine Reclamation Fund. 
 158 

Description of Proposal

The proposal eliminates the aggregate limit on the amount of excess black lung benefit 

trust assets that may be used to pay accident and health benefits or premiums for insurance 

exclusively covering such benefits (including administrative and other incidental expenses 

relating to such benefits) for retired coal miners and their spouses and dependents. In addition, 

under the proposal, each fiscal year, the Secretary of the Treasury will transfer to the UMWA 

Combined Benefit Fund an amount which the Secretary estimates to be the additional amounts 

received in the Treasury for that fiscal year by reason of the elimination of the aggregate limit. 

The Secretary will adjust the amount transferred for any year to the extent necessary to correct 

errors in any estimate for any prior year. Any amount transferred to the UMWA Combined 

Benefit Fund under the proposal will be used to proportionately reduce the unassigned 

beneficiary premium of each assigned operator for the plan year in which transferred. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2002. 
 159 

B. Tax Treatment of Company-Owned Life Insurance (“COLI”) 

Present Law

Amounts received under a life insurance contract

Amounts received under a life insurance contract paid by reason of the death of the 

insured are not includible in gross income for Federal tax purposes.191 No Federal income tax 

generally is imposed on a policyholder with respect to the earnings under a life insurance 

contract (inside buildup). 192 

Distributions from a life insurance contract (other than a modified endowment contract) 

that are made prior to the death of the insured generally are includible in income to the extent 

that the amounts distributed exceed the taxpayer’s investment in the contract (i.e., basis). Such 

distributions generally are treated first as a tax-free recovery of basis, and then as income.193

Premium and interest deduction limitations194

Premiums

Under present law, no deduction is permitted for premiums paid on any life insurance, 

annuity or endowment contract, if the taxpayer is directly or indirectly a beneficiary under the 

contract.195 

 191 Sec. 101(a). 

192 This favorable tax treatment is available only if a life insurance contract meets certain 

requirements designed to limit the investment character of the contract (sec. 7702). 

193 Sec. 72(e). In the case of a modified endowment contract, however, in general, distributions 

are treated as income first, loans are treated as distributions (i.e., income rather than basis recovery first), 

and an additional 10-percent tax is imposed on the income portion of distributions made before age 59-1/2 

and in certain other circumstances (secs. 72(e) and (v)). A modified endowment contract is a life 

insurance contract that does not meet a statutory “7-pay” test, i.e., generally is funded more rapidly than 

seven annual level premiums (sec. 7702A).

194 In addition to the statutory limitations described below, interest deductions under companyowned life insurance arrangements have also been limited by recent cases applying general principles of 

tax law. See Winn-Dixie Stores, Inc. v. Commissioner, 113 T.C. 254 (1999), aff’d 254 F.3d 1313 (11th 

Cir. 2001), cert. denied, April 15, 2002; Internal Revenue Service v. CM Holdings, Inc., 254 B.R. 578 (D. 

Del. 2000), aff'd, 301 F.3d 96 (3d Cir. 2002); American Electric Power, Inc. v. U.S., 136 F. Supp. 2d 762 

(S. D. Ohio 2001), aff’d, 326 F.3d 737 (6th Cir. 2003), reh. denied, 338 F.3d 534 (6th Cir. 2003), cert. 

denied, U.S. No. 03-529 (Jan. 12, 2004); but see Dow Chemical Company v. U.S., 250 F. Supp. 2d 748 

(E.D. Mich. 2003), modified, 278 F. Supp. 2d 844 (E.D. Mich. 2003). 

195 Sec. 264(a)(1). 
 160 

Interest paid or accrued with respect to the contract

No deduction generally is allowed for interest paid or accrued on any debt with respect to 

a life insurance, annuity or endowment contract covering the life of any individual.196 An 

exception is provided under this provision for insurance of key persons. 

Interest that is otherwise deductible (e.g., is not disallowed under other applicable rules or 

general principles of tax law) may be deductible under the key person exception, to the extent 

that the aggregate amount of the debt does not exceed $50,000 per insured individual. The 

deductible interest may not exceed the amount determined by applying a rate based on a 

Moody’s Corporate Bond Yield Average-Monthly Average Corporates. A key person is an 

individual who is either an officer or a 20-percent owner of the taxpayer. The number of 

individuals that can be treated as key persons may not exceed the greater of (1) five individuals, 

or (2) the lesser of five percent of the total number of officers and employees of the taxpayer, or 

20 individuals.197 

Pro rata interest limitation

A pro rata interest deduction disallowance rule also applies. Under this rule, in the case 

of a taxpayer other than a natural person, no deduction is allowed for the portion of the 

taxpayer’s interest expense that is allocable to unborrowed policy cash surrender values.198 

Interest expense is allocable to unborrowed policy cash values based on the ratio of (1) the 

taxpayer’s average unborrowed policy cash values of life insurance, annuity and endowment 

contracts, to (2) the sum of the average unborrowed cash values (or average adjusted bases, for 

other assets) of all the taxpayer’s assets. 

Under the pro rata interest disallowance rule, an exception is provided for any contract 

owned by an entity engaged in a trade or business, if the contract covers an individual who is a 

20-percent owner of the entity, or an officer, director, or employee of the trade or business. The 

exception also applies to a joint-life contract covering a 20-percent owner and his or her spouse. 

“Single premium” and “4-out-of-7” limitations

Other interest deduction limitation rules also apply with respect to life insurance, annuity 

and endowment contracts. Present law provides that no deduction is allowed for any amount 

paid or accrued on debt incurred or continued to purchase or carry a single premium life 

insurance, annuity or endowment contract.199 In addition, present law provides that no deduction 

 196 Sec. 264(a)(4). 

197 Sec. 264(e)(3). 

198 Sec. 264(f). This applies to any life insurance, annuity or endowment contract issued after 

June 8, 1997.

199 Sec. 264(a)(2). 
 161 

is allowed for any amount paid or accrued on debt incurred or continued to purchase or carry a 

life insurance, annuity or endowment contract pursuant to a plan of purchase that contemplates 

the systematic direct or indirect borrowing of part or all of the increases in the cash value of the 

contract (either from the insurer or otherwise).200 Under this rule, several exceptions are 

provided, including an exception if no part of four of the annual premiums due during the initial 

seven-year period is paid by means of such debt (known as the “4-out-of-7 rule”). 

Definitions of highly compensated employee

Present law defines highly compensated employees and individuals for various purposes. 

For purposes of nondiscrimination rules relating to qualified retirement plans, an employee, 

including a self-employed individual, is treated as highly compensated with respect to a year if 

the employee (1) was a five-percent owner of the employer at any time during the year or the 

preceding year or (2) either (a) had compensation for the preceding year in excess of $95,000 

(for 2005) or (b) at the election of the employer had compensation in excess of $95,000 (for 

2005) and was in the highest paid 20 percent of employees for such year.201 The $95,000 dollar 

amount is indexed for inflation. 

For purposes of nondiscrimination rules relating to self-insured medical reimbursement 

plans, a highly compensated individual is an employee who is one of the five highest paid 

officers of the employer, a shareholder who owns more than 10 percent of the value of the stock 

of the employer, or is among the highest paid 25 percent of all employees.202

Description of Proposal

The proposal provides generally that, in the case of an employer-owned life insurance 

contract, the amount excluded from the applicable policyholder's income as a death benefit 

cannot exceed the premiums and other amounts paid by such applicable policyholder for the 

contract. The excess death benefit is included in income. 

Exceptions to this income inclusion rule are provided. In the case of an employer-owned 

life insurance contract with respect to which the notice and consent requirements of the proposal 

are met, the income inclusion rule does not apply to an amount received by reason of the death of 

an insured individual who, with respect to the applicable policyholder, was an employee at any 

time during the 12-month period before the insured's death, or who, at the time the contract was 

issued, was a director or highly compensated employee or highly compensated individual. For 

this purpose, such a person is one who is either: (1) a highly compensated employee as defined 

under the rules relating to qualified retirement plans, determined without regard to the election 

 200 Sec. 264(a)(3). 

201 Sec. 414(q). For purposes of determining the top-paid 20 percent of employees, certain 

employees, such as employees subject to a collective bargaining agreement, are disregarded. 

202 Sec. 105(h)(5). For purposes of determining the top-paid 25 percent of employees, certain 

employees, such as employees subject to a collective bargaining agreement, are disregarded. 
 162 

regarding the top-paid 20 percent of employees; or (2) a highly compensated individual as 

defined under the rules relating to self-insured medical reimbursement plans, determined by 

substituting the highest-paid 35 percent of employees for the highest-paid 25 percent of 

employees.203

In the case of an employer-owned life insurance contract with respect to which the notice 

and consent requirements of the proposal are met, the income inclusion rule does not apply to an 

amount received by reason of the death of an insured, to the extent the amount is (1) paid to a 

member of the family204 of the insured, to an individual who is the designated beneficiary of the 

insured under the contract (other than an applicable policyholder), to a trust established for the 

benefit of any such member of the family or designated beneficiary, or to the estate of the 

insured; or (2) used to purchase an equity (or partnership capital or profits) interest in the 

applicable policyholder from such a family member, beneficiary, trust or estate. It is intended 

that such amounts be so paid or used by the due date of the tax return for the taxable year of the 

applicable policyholder in which they are received as a death benefit under the insurance 

contract, so that the payment of the amount to such a person or persons, or the use of the amount 

to make such a purchase, is known in the taxable year for which the exception from the income 

inclusion rule is claimed. 

An employer-owned life insurance contract is defined for purposes of the proposal as a 

life insurance contract which (1) is owned by a person engaged in a trade or business and under 

which such person (or a related person) is directly or indirectly a beneficiary, and (2) covers the 

life of an individual who is an employee with respect to the trade or business of the applicable 

policyholder on the date the contract is issued. 

An applicable policyholder means, with respect to an employer-owned life insurance 

contract, the person (including related persons) that owns the contract, if the person is engaged in 

a trade or business, and if the person (or a related person) is directly or indirectly a beneficiary 

under the contract. 

For purposes of the proposal, a related person includes any person that bears a 

relationship specified in section 267(b) or 707(b)(1)205 or is engaged in trades or businesses that 

are under common control (within the meaning of section 52(a) or (b)). 

 203 As under present law, certain employees are disregarded in making the determinations 

regarding the top-paid groups. 

204 For this purpose, a member of the family is defined in section 267(c)(4) to include only the 

individual's brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal 

descendants. 

205 The relationships include specified relationships among family members, shareholders and 

corporations, corporations that are members of a controlled group, trust grantors and fiduciaries, taxexempt organizations and persons that control such organizations, commonly controlled S corporations, 

partnerships and C corporations, estates and beneficiaries, commonly controlled partnerships, and 

partners and partnerships. Detailed rules apply to determine the specific relationships.
 163 

The notice and consent requirements of the proposal are met if, before the issuance of the 

contract, (1) the employee is notified in writing that the applicable policyholder intends to insure 

the employee’s life, and is notified of the maximum face amount at issue of the life insurance 

contract that the employer might take out on the life of the employee, (2) the employee provides 

written consent to being insured under the contract and that such coverage may continue after the 

insured terminates employment, and (3) the employee is informed in writing that an applicable 

policyholder will be a beneficiary of any proceeds payable on the death of the employee. 

For purposes of the proposal, an employee includes an officer, a director, and a highly 

compensated employee; an insured means, with respect to an employer-owned life insurance 

contract, an individual covered by the contract who is a U.S. citizen or resident. In the case of a 

contract covering the joint lives of two individuals, references to an insured include both of the 

individuals. 

The proposal requires annual reporting and recordkeeping by applicable policyholders 

that own one or more employer-owned life insurance contracts. The information to be reported 

is (1) the number of employees of the applicable policyholder at the end of the year, (2) the 

number of employees insured under employer-owned life insurance contracts at the end of the 

year, (3) the total amount of insurance in force at the end of the year under such contracts, (4) the 

name, address, and taxpayer identification number of the applicable policyholder and the type of 

business in which it is engaged, and (5) a statement that the applicable policyholder has a valid 

consent (in accordance with the consent requirements under the proposal) for each insured 

employee and, if all such consents were not obtained, the total number of insured employees for 

whom such consent was not obtained. The applicable policyholder is required to keep records 

necessary to determine whether the requirements of the reporting rule and the income inclusion 

rule of new section 101(j) are met. 

Effective Date

The amendments made by this section generally apply to contracts issued after the date of 

enactment, except for contracts issued after such date pursuant to an exchange described in 

section 1035 of the Code. In addition, certain material increases in the death benefit or other 

material changes will generally cause a contract to be treated as a new contract, with an 

exception for existing lives under a master contract. Increases in the death benefit that occur as a 

result of the operation of section 7702 of the Code or the terms of the existing contract, provided 

that the insurer's consent to the increase is not required, will not cause a contract to be treated as 

a new contract. In addition, certain changes to a contract will not be considered material changes 

so as to cause a contract to be treated as a new contract. These changes include administrative 

changes, changes from general to separate account, or changes as a result of the exercise of an 

option or right granted under the contract as originally issued. 

Examples of situations in which death benefit increases would not cause a contract to be 

treated as a new contract include the following: 

1. Section 7702 provides that life insurance contracts need to either meet the cash value 

accumulation test of section 7702(b) or the guideline premium requirements of section 

7702(c) and the cash value corridor of section 7702(d). Under the corridor test, the 
 164 

amount of the death benefit may not be less than the applicable percentage of the cash 

surrender value. Contracts may be written to comply with the corridor requirement by 

providing for automatic increases in the death benefit based on the cash surrender 

value. Death benefit increases required by the corridor test or the cash value 

accumulation test do not require the insurer's consent at the time of increase and occur 

in order to keep the contact in compliance with section 7702. 

2. Death benefits may also increase due to normal operation of the contract. For 

example, for some contracts, policyholder dividends paid under the contract may be 

applied to purchase paid-up additions, which increase the death benefits. The insurer's 

consent is not required for these death benefit increases. 

3. For variable contacts and universal life contracts, the death benefit may increase as a 

result of market performance or the contract design. For example, some contracts 

provide that the death benefit will equal the cash value plus a specified amount at risk. 

With these contracts, the amount of the death benefit at any time will vary depending 

on changes in the cash value of the contract. The insurance company's consent is not 

required for these death benefit increases.