The Worker, Retiree, and Employer Recovery Act of 2008: An Overview
Released: 2009-01-29T00:00:00

There has been a great deal of concern over the effect of the current economic downturn on retirement plans. One company recently reported that at the end of 2008, the "chaos" in the financial markets led to a $409 billion deficit in defined benefit pension plan funding for the plans of S&P 1500 companies. The report indicated that this deficit will negatively affect corporate earnings in 2009. Due in part to the large investment losses in pension plans and other retirement accounts, in December of 2008, Congress unanimously enacted H.R. 7327 , the Worker, Retiree, and Employer Recovery Act of 2008 ("WRERA" or "the Act"). While several provisions of WRERA make technical corrections to the Pension Protection Act of 2006 ("PPA"), the Act also provides some temporary relief from certain requirements that may be difficult for pension plans to meet due to current economic conditions. This report provides an overview of some of the key provisions of WRERA, in particular, the provisions relating to the funding of single and multiemployer plans, the temporary waiver for required minimum distributions, as well as certain technical corrections and other provisions that affect the two primary types of pension plans, defined benefit and defined contribution plans, as well as individual retirement accounts and annuities (IRAs).

WRERA's Provisions Relating to the Economic Crisis

Title II of WRERA contains provisions designed to protect both individuals and retirement plans from the potentially large losses of plan amounts due to the decline of the stock market and the current economic climate. These provisions include a temporary waiver of the required minimum distributions, and temporary relief from funding rules created by the PPA that apply to single and multi-employer plans. In essence, these provisions permit a delay in taking required distributions and meeting pension funding obligations, in an effort to give retirement plans and accounts more time for economic conditions to improve and for the losses in investments to be recovered.

Temporary Waiver of Minimum Distribution Rules

Under section 401(a)(9) of the Internal Revenue Code, employer-sponsored retirement plans, such as 401(k), 403(b) and 457 plans, and individual retirement accounts and annuities ("IRAs") must make certain annual required minimum distributions in order to maintain their "qualified" (i.e., tax-favorable) status. The theory behind these required distributions is to ensure that tax-deferred retirement accounts that have been established to provide income during retirement are not used as permanent tax shelters or as vehicles for transmitting wealth to heirs. For employer-sponsored plans, required minimum distributions to participants must start no later than April 1 of the year after the year in which the participant either attains age 70 ½,or retires, whichever is later. For traditional IRAs, required minimum distributions must commence by April 1 following the year the IRA owner reaches age 70 ½. Alternative minimum distribution requirements apply to beneficiaries in the event that the participant dies before the entire amount in the participant's account is distributed. Failure to make a required distribution results in an excise tax equal to 50 percent of the required minimum distribution amount that was not distributed for the year, which is imposed on the participant or beneficiary.

Following the decline in the stock market, there was concern about individuals taking these required distributions when there has not been enough time to recover losses. Section 201 of WRERA suspends the minimum distribution requirements, both initial and annual required distributions, for defined contribution arrangements, including IRAs, for calendar year 2009. Thus, plan participants and beneficiaries are allowed, but are not required, to take required minimum distributions for 2009. However, it should be noted that the required distributions for 2008, or for years after 2009, are not waived by the new law.

Amendment of the Funding Transition Rule for Single-Employer Plans

The Internal Revenue Code sets out certain minimum funding standards that apply to defined benefit plans. The funding standards for single-employer plans were completely revamped by the PPA, which created more stringent standards than under prior law. When fully phased in, the new funding requirements established by the PPA will generally require plan assets to be equal to 100 percent of plan liabilities on a present value basis. Under these standards, when the value of a plan's assets is less than the plan's "funding target," a plan's minimum required contribution for a plan year is comprised of the plan's " target normal cost," (i.e. , the present value of the benefits expected to be accrued or earned during the year, minus certain plan expenses), plus a "shortfall amortization base," an amount which is established if the plan has a funding shortfall. However, under a special exemption, if the value of the plan's assets is equal to or greater than the funding target, then the shortfall amortization amount will be zero. The PPA also created a transition rule, under which a shortfall amortization base does not have to be established if, for plan years beginning in 2008 and ending in 2010, the plan's assets are equal to a certain percentage of the plan's funding target for that year. The percentage of the funding target is 92 percent for 2008, 94 percent for 2009, and 96 percent for 2010. In other words, the PPA, through this transition rule, gave pension plans a three year period to ease into the new plan funding requirements, in which plans could gradually increase the value of the plan assets, thus relieving them from the burden of having to contribute a large part of the funding shortfall in one year.

The PPA placed a limitation on the transition rule, under which the rule will not apply with respect to any plan year after 2008 unless the shortfall amortization base was zero (e.g., the plan failed to meet the transition rule, or be 92 percent funded in 2008). Section 202 of WRERA allows plans to follow the transition rule even if the plan's shortfall amortization base was not zero in the preceding year. Thus, a plan that was not 92 percent funded in 2008 would only be required to be 94 percent funded in 2009, instead of 100 percent. This provision gives plans some additional time to be 100 percent funded, a requirement that may have become more difficult to fulfill because of the decline in the financial markets and the resulting loss of value of plan assets.

Temporary Modification on Freezing Benefit Accruals

As provided by the PPA, underfunded single-employer defined benefit plans may be subject to certain restrictions on benefits and benefit accruals. Under one of these restrictions, if a plan's "adjusted funding target attainment percentage" (AFTAP) is less than 60 percent (i.e., generally speaking, if a plan is less than 60 percent funded) for a plan year, a plan must stop providing future benefit accruals. Section 203 of WRERA provides that for the first plan year beginning during the period of October 1, 2008 through September 30, 2009, this restriction on benefit accruals is determined using the AFTAP from the preceding year, instead of the current year, if the AFTAP for the preceding year is greater. Thus, this provision allows a plan to look to the previous year's funding levels in order to determine whether there must be a restriction of benefit accruals. For plans that have lost a lot in the value of plan assets, looking to the AFTAP for the previous year may allow some plans to continue providing future benefit accruals that would otherwise have to cease them. However, plans that have higher funding levels for the current year will not be affected by this provision.

Temporary Delay of Designation of Endangered or Critical Status for Multiemployer Plans

Under section 432 of the Internal Revenue Code as created by the PPA, multiemployer plans failing to meet certain funding levels may be subject to certain additional funding obligations and benefit restrictions. These additional requirements depend on whether the plan is in "endangered" or "critical" status. A multiemployer plan is considered to be endangered if it is less than 80 percent funded or if the plan has an accumulated funding deficiency for the plan year, or is projected to have a deficiency within the next six years. A plan that is less than 80 percent funded and is projected to have an accumulated funding deficiency is considered to be "seriously endangered." Endangered plans must adopt a funding improvement plan, which contains options for a plan to attain a certain increase in the plan's funding percentage, while avoiding accumulated funding deficiencies. A multiemployer plan is considered to be in critical status if, for example, the plan is less than 65 percent funded and the sum of the fair market value of plan assets, plus the present value of reasonably anticipated employer and employee contributions for the current plan year and each of the next six plan years is less than the present value of all benefits projected to be payable under the plan during the current plan year and each of the next six years (plus administrative expenses). Plans in critical status must develop a rehabilitation plan containing options to enable the plan to cease being in critical status by the end of the rehabilitation period, generally 10 years. The rehabilitation plan may include reductions in plan expenditures and future benefit accruals. Employers may also have to pay a surcharge in addition to other plan contributions.

Each year, a plan's actuary must certify whether or not the plan is in endangered or critical status. Under section 204 of WRERA a sponsor of a multiemployer defined benefit pension plan may elect for the status of the plan year that begins during the period between October 1, 2008 and September 30, 2009, to be the same as the plan's certified status for the previous year. Accordingly, if a plan was not in endangered or critical status for the prior year, the sponsor may elect to retain this status and may avoid additional plan funding requirements. A plan that was in endangered or critical status during the preceding year does not have to update its funding improvement plan, rehabilitation plan, or schedule information until the plan year following the year that the plan's status remained the same. However, for plans that are in critical status, the Act clarifies that the freezing of the certification status does not relieve the plan from certain requirements.

Temporary Extension of the Funding Improvement and Rehabilitation Periods for Multiemployer Pension Plans in Critical and Endangered Status

Section 432 of the Internal Revenue Code provides that a multiemployer plan that is in endangered or critical status must meet certain additional funding requirements. In general, endangered plans must adopt a funding improvement plan, and critical plans must adopt a rehabilitation plan. Under both a funding improvement and a rehabilitation plan, there is a 10-year period under which a plan must meet a certain funding percentage. Seriously endangered plans have 15 years to improve their funding percentage. Section 205 of WRERA provides that a plan sponsor of a plan in endangered or critical status may elect, for a plan year beginning in 2008 or 2009, to extend the funding improvement period or the rehabilitation period by three years, to 13 years instead of 10 years. Plans in seriously endangered status have a funding improvement period of 18 years, rather than 15 years. The provision gives plans more time to meet their funding obligations. An election must be made by the plan in order to take advantage of this relaxed funding requirement.

Technical Corrections to the Pension Protection Act of 2006

WRERA made several technical corrections to the Pension Protection Act of 2006 (PPA). Some of the corrections are effective as if they were enacted as part of the PPA, while other provisions are to be applied prospectively. The technical corrections include the following:

Rollovers to Non-Spouse Beneficiaries

In general, distributions from retirement plans or accounts are subject to tax in the year they are distributed. Prior to the PPA, in the event that a participant died, distributions from the retirement plan of a participant could transfer (or "rollover") into a surviving spouse's IRA tax-free. This rollover scheme was not available to non-spouse beneficiaries. Under section 402(c)(11) of the Internal Revenue Code, as created by the PPA, certain tax-qualified plans (e.g., a 401(k)) could offer a direct rollover of a distribution to a nonspouse beneficiary (e.g., a sibling, parent, or a domestic partner). The direct rollover must be made to an individual retirement account or annuity (IRA) established on behalf of the designated beneficiary that will be treated as an inherited IRA. As a result, the rollover amounts would not be included in the beneficiary's income in the year of the rollover.

The Internal Revenue Service had previously taken the position that section 402(c)(11) permitted, but did not require, plans to provide this type of rollover option. Section 108(f) of the WRERA clarifies that distributions to a nonspouse beneficiary's inherited IRA are to be considered "eligible rollover distributions," and plans are thus required to allow these beneficiaries to make these direct rollovers. Plans must also provide direct rollover notices in order to maintain plan qualification. This provision is effective for plan years beginning on January 1, 2010.

Missing Participants Program

In general, an employer that chooses to terminate a fully funded defined benefit plan must comply with certain requirements with regard to participants or beneficiaries whom the plan administrator cannot locate after a diligent search. For these individuals, a plan administrator may either purchase an annuity from an insurer or transfer the missing participant's benefits to the PBGC. Prior to the PPA, the missing participant requirements only applied to single-employer plans. The PPA amended these requirements to apply to multiemployer plans, defined contribution plans, and other plans that do not have termination insurance through the PBGC. Section 104(e) of WRERA specifies that the missing participant requirements apply to plans that at no time provided for employer contributions. WRERA also narrows the missing participant requirements to defined contribution plans (and other pension plans not covered by PBGC's termination insurance) that are qualified plans. The requirements of this section take effect as if they were included in the PPA.

Lump-Sum Payments for Underfunded Plans

Under the funding rules created by the PPA, single-employer defined benefit plans that fall below certain funding levels are subject to several additional requirements. One of these requirements prevents plans that have a funding percentage of less than 60 percent from making "prohibited payments," (i.e., certain accelerated forms of distribution, such as a lump sum payment) to plan participants. Current law also specifies that if the present value of a participant's vested benefit exceeds $5,000, the benefit may not be immediately distributed without the participant's consent. Accordingly, if the vested benefit is less than or equal to $5,000 this consent requirement does not apply. Section 101 of WRERA amends the definition of "prohibited payment" to exclude benefits which may be distributed without the consent of the participant. As a result, lump sum payments of $5,000 or less may be paid by an underfunded plan that is otherwise precluded from paying larger lump sum distributions. This amendment applies to plan years beginning in 2008.

Disclosure Requirements for Distress/Involuntary Terminations

Under ERISA, pension plans must meet extensive notice and reporting requirements that disclose information about the plan to participants and beneficiaries as well as government agencies. Among these disclosures is a requirement that a terminating single-employer defined benefit plan provide "affected parties" with certain information required to be submitted to the Pension Benefit Guaranty Corporation (PBGC). Section 105 of WRERA clarifies that in order for a plan to terminate in a distress termination, a plan administrator must not only provide affected parties with information that the administrator had to disclose to the PBGC along with the written notice of intent to terminate, but also certain information that was provided to the PBGC after the notice was given. This information may include a certification by an enrolled actuary regarding the amount of the current value of the assets of the plan, the actuarial present value of the benefit liabilities under the plan, and whether the plan's assets are sufficient to pay benefit liabilities.

Further, in an involuntary termination, certain confidentiality provisions exist that prevent the plan administrator or sponsor from providing information about the termination in a form which includes any information that may be associated with, or identify affected parties. Section 105 of WRERA extends this confidentiality protection disclosure of this information by the PBGC.

Selected Other Provisions of WRERA

Other notable provisions included in WRERA are the following:

Rollover of Amounts Received in Airline Carrier Bankruptcy to Roth IRAs

Roth IRAs, a type of individual retirement arrangement, are a popular retirement savings vehicle. While contributions to a Roth IRA are not deductible, qualified distributions from a Roth IRA are not included in an individual's gross income. Roth IRAs are subject to certain contribution limitations, however, these limitations do not apply to qualified rollover contributions. Section 125 of the WRERA permits a "qualified airline employee" who receives an "airline payment amount" to transfer any portion of this amount to a Roth IRA as a qualified rollover contribution. This transfer must occur within 180 days of receipt of the amount (or, if later, within 180 days of the enactment of WRERA). Thus, if such amounts are transferred to the former employee's Roth IRA, the employee may benefit, as qualified distributions from Roth IRAs are tax free. This section also provides that certain income limitations placed upon Roth IRA qualified rollover contributions should not apply to this transfer.

Determination of Plan Assets to Account for Expected Earnings

In order to determine the minimum required contribution that must be made to a single-employer defined benefit plan, and the extent (if any) to which a plan is underfunded, the value of plan assets must be determined. For purposes of the minimum funding rules, the value of the plan's assets is, in general, the fair market value of the assets. However, the Internal Revenue Code, as amended by the PPA, permits plans to calculate the value of the assets by averaging fair market values, but only if (1) the averaging method is permitted under regulations, (2) the calculation is not over a period of more than 24 months, and (3) the averaged amount cannot result in a determination that is at any time less than 90 percent or more than 110 percent of fair market value. This averaging method may be more beneficial for plan sponsors in an economic downturn, as an averaging approach can produce lower asset values when asset values are rising, and higher asset values when asset values are decreasing. Section 121 of WRERA provides that plans using the averaging method must adjust such averaging to account not only for the amount of contributions and distributions to the plan, but also for expected investment earnings, subject to a cap. It has been noted that this provision could result in smaller underfunded amounts and, therefore, smaller required contributions.

Plan Asset Valuation for Airline Plans

The PPA created certain relaxed funding requirements for defined benefit plans maintained by a commercial airline or an airline catering service. Under the PPA, plan sponsors of these plans could elect to amortize unfunded plan liabilities over an extended period of 10 years, or may instead follow special rules that permit these plan sponsors to amortize unfunded liabilities over 17 years. Plan sponsors selecting the17-year amortization period, referred to by the Act as an "alternative funding schedule," had to comply with certain benefit accrual requirements, which included freezing some of the benefits offered under the plan and eliminating others. In determining the minimum required contribution to the plan each year for purposes of these special rules, the PPA provided that the value of plan assets generally is the fair market value of the assets. Section 126 of WRERA provides that plans following the alternative funding schedule may determine the value of plan assets in the same manner as other single-employer plans. Thus, plans can use a fair market value determination, or they may use the averaging method as laid out in Section 430(g)(3) of the Internal Revenue Code.