Guest Article

(From the April 14, 2003 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits. Hyperlinks within the article have been added by BenefitsLink.)

Treasury and IRS Issue Final 204(h) Notice Regulations

The Treasury Department's "theme of the week" for last week appears to have been cash balance plans. In addition to withdrawing a portion of proposed cash balance regulations and holding hearings on the rest [...] the Department issued final regulations relating to enhanced notice requirements for defined benefit plan amendments that significantly reduce future benefit accruals. 68 FR 17277 (April 9, 2003). Congress enacted the enhanced notice requirements as part of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) in response to the controversy over cash balance conversions.

The final regulations are very similar to the proposed regulations [67 FR 19713 (April 23, 2002)] Treasury issued almost exactly one year ago. The major changes are summarized below.

Summary of Statutory Requirements

In general, before a tax-qualified defined benefit plan or money purchase pension plan (collectively referred to as "applicable pension plans") is amended to provide for a significant reduction in the rate of future benefit accrual, the plan administrator must provide a written notice [the so-called "204(h) notice"] to "applicable individuals"-- i.e., participants and alternate payees whose future benefit accrual rates "may reasonably be expected to be significantly reduced" by the amendment-- and to any employee organizations representing them. Governmental plans and church plans generally are not subject to this notice requirement.

The statute offers little guidance as to when an amendment causes a "significant reduction in the rate of future benefit accrual" [aka, a "204(h) amendment"]. However, if the amendment eliminates or significantly reduces an early retirement benefit or retirement-type subsidy, the plan administrator specifically is required to provide the 204(h) notice.

Congress delegated to the Treasury Department the authority to prescribe the form and content requirements for the 204(h) notice. Beyond the general directives that the notice be written "in a manner calculated to be understood by the average plan participant" and that it provide "sufficient information ... to allow applicable individuals to understand the effect of the plan amendment," the Code and ERISA are silent on these issues. In addition, Treasury is specifically authorized to provide a simplified form of notice, or an exemption from the 204(h) notice requirement, for plans that offer participants a choice between the old and new benefit formulas or for plans with fewer than 100 participants with accrued benefits.

When notice is required, it must be provided "within a reasonable time" before the amendment's effective date. (In most cases, the final regulation requires notice at least 45 days before the amendment's effective date.) If the plan administrator provides the notice before the amendment is adopted, the notice requirement will be satisfied only if there are no subsequent material modifications to the amendment.

If notice is required, but not provided, the employer (or, in the case of a multiemployer plan, the plan) may be liable for a $100 per person per day excise tax until notice is provided. Furthermore, in the case of "egregious" failures to satisfy the notice requirements, all applicable individuals (not just those affected by the egregious failure) will be entitled to continue to accrue benefits under the pre-amendment plan unless they are better off under the new regime. An "egregious" failure, according to ERISA sec. 204(h), is one that is within the plan sponsor's control and is intentional or a failure to provide most applicable individuals with most of the information they are entitled to receive. Intentional failures include those in which the plan administrator discovers an unintentional failure, but fails to promptly correct it.

Final Regs Follow Proposed Regs but Include Some Changes

Following is a summary of the differences between the proposed and final regulations:

• Timing Requirements for 204(h) Notices. The final regulations retain the general rule in the proposed regulations that plan administrators must provide 204(h) notice to applicable individuals at least 45 days before the amendment's effective date, and the special timing rules for small plans and for certain business transactions. But the final regulations also add a special 15-day-before-the-amendment's-effective-date rule for multiemployer plans at Q&A 9(c).

• Money Purchase Pension Plan Mergers and Conversions. The IRS issued Rev. Rul. 2002-42, 2002-28 I.R.B. 76 last year to clarify employers must send a 204(h) notice when they merge their money purchase pension (MPP) plans with their profit-sharing plans or simply convert their MPP plans into profit-sharing plans. The final regulations include a similar clarification at Q&A 8(b).

• Rate of Future Benefit Accrual. The proposed and final regulations provide "an amendment to a defined benefit plan reduces the rate of future benefit accrual only if it is reasonably expected that the amendment will reduce the amount of the future annual benefit commencing at normal retirement age (or at actual retirement age, if later) for benefits accruing for a year." Q&A 6(b)(1). According to the preamble to the final regulations, one commentator objected to this language because it could require plan administrators to provide 204(h) notices for amendments that increase benefits in one year and decrease them in the next even though the aggregate benefit over the two-year period might be increased (or at least not reduced). The final regulations address this concern by adding a clarifying example that indicates, "where a reduction occurs at the same time as an immediate increase in accrued benefits such that the participant's aggregate benefit can never be less than what it would have been had the amendment not been adopted, the reduction is not significant." The new example appears at Q&A 8(d).

• Reduction in Rate of Future Benefit Accrual for Individual Account Plans. The proposed regulations [Q&A 6(b)(2)] provide an amendment reduces the rate of future benefit accrual under a MPP plan "only if it is reasonably expected to reduce the amounts allocated in the future to participants' accounts for a year." One commentator expressed concern this language could lead MPP plan sponsors to conclude anticipated reductions are insignificant "solely because expected future investment returns might offset a portion of the reduction in the contribution formula." In response, Treasury and IRS changed the relevant language in Q&A 6(b)(2) to read as follows: "... an amendment to an individual account plan reduces the rate of future benefit accrual only if it is reasonably expected that the amendment will reduce the amount of contributions or forfeitures allocated for any future year."

• Determination of Applicable Individuals. The proposed regulations [Q&A 10(e)] provided, "Whether a participant or alternate payee is an applicable individual is determined based on all relevant facts and circumstances at the time the section 204(h) notice must be provided (or is provided, if earlier)." In response to a request for a more definite determination date, Treasury changed Q&A 10(e) to read: "Whether a participant or alternate payee is an applicable individual is determined on a typical business day that is reasonably proximate to the time the section 204(h) notice is provided [or the latest date for providing section 204(h) notice, if earlier], based on all elevant facts and circumstances." The final regulations further clarify the new rule in Q&A 10(f), Example 8.

• Content of Section 204(h) Notice. The final regulations clarify a number of issues relating to the content requirements for 204(h) notices in Q&A 11. According to the preamble to the final regulations, these include (1) clarifying that the notice must permit the applicable individual to determine the approximate magnitude of the reduction applicable to that individual, and that this requirement can be satisfied by providing illustrative examples that satisfy certain conditions, and (2) clarifying that plan administrators can provide individualized benefit statements instead of illustrative examples if the statements include the same information as illustrative examples.

• Benefit Changes Made by Collective Bargaining Agreements. In some cases, changes to a collective bargaining agreement can cause a reduction in the rate of future benefit accrual for multiemployer plan participants even if the plan is not amended. For example, this may happen if the benefit formula in the plan document incorporates the collective bargaining agreement by reference. The final regulations include a new subparagraph (2) under Q&A 7(a), and a new Example 2 under Q&A 7(c), to clarify, "... if all or part of a plan's rate of future benefit accrual, or an early retirement benefit or retirement-type subsidy provided under the plan, depends on provisions in another document that are referenced in the plan document, a change in the provisions of the other document is an amendment of the plan."

Effective Date

The enhanced notice requirements apply to plan amendments taking effect on or after the EGTRRA effective date of June 7, 2001, subject to certain transition rules. The final regulations generally apply to plan amendments effective on or after September 2, 2003. But Q&A 7(a)(2), which relates to reductions in benefit accruals caused solely by changes to collective bargaining agreements, applies to changes effective on or after January 1, 2004. Between now and the applicable effective dates, plan sponsors must make a good faith effort to comply with the statutory requirements [ERISA sec. 204(h) and IRC sec. 4980F], which generally means following the proposed regulations at a minimum.

The information in this Washington Bulletin is general information only and not intended to provide advice or guidance for specific situations. Contact your Deloitte advisor for information regarding your specific circumstances. If you have questions or need additional information about this article and you do not have a Deloitte advisor, please contact Martha Priddy Patterson (202.879.5634) or Robert B. Davis (202.879.3094). Human Capital Advisory Services, Deloitte LLP, 555 12th Street NW, Suite 500, Washington, DC 20004-1207. Copyright 2003, Deloitte.