Each year, employers face a variety of legal changes related to their employee benefit plans, and 2006 is no different. Some of these developments will cause administrative headaches, but others will provide new opportunities.
Here is a summary of some of the most significant changes for the 2006 tax year:
Roth 401(k)
Employers may now permit an employee to make special after-tax (Roth) contributions to a 401(k) plan. The advantage of this optional feature is that the employee may later qualify to receive a tax-free distribution of the entire Roth 401(k) account, including accumulated earnings.
This option may be attractive to employees who believe that their income tax rate during retirement will be higher than their current rate, and may be particularly appealing to an employee who wished to make Roth IRA contributions, but was prohibited by the Roth IRA’s income restrictions. However, strict accounting requirements apply to Roth 401(k) accounts, which may increase their costs and reduce their appeal.
IRS plan correction program
The IRS maintains a comprehensive program that permits most employers to correct a variety of retirement plan errors, frequently without paying a penalty or notifying the IRS. Because the IRS believes that this program is fair and inexpensive, it generally takes a less lenient approach if it discovers errors during a plan audit. The IRS is expected to modify the program in 2006 to make certain corrections less expensive. For example, the required contribution to correct the exclusion of an eligible employee from a 401(k) plan generally will be lower. Also, it is expected that the IRS will expand the program to cover correction of selected errors related to plan loans.
An employer that discovers a retirement plan error should contact its benefits counsel to determine if the matter can be corrected under this program.
Retirement plan fees
Increasingly, regulators and employees are paying attention to retirement plan fees. Evidence shows that even a minor difference in fees can have a significant impact on an employee’s account balance over the course of his or her career.
Employers who sponsor retirement plans must ensure that fees charged by service providers are reasonable. However, given the complexity and variances among service providers’ platforms, many employers do not understand the fees that are charged.
The U.S. Department of Labor is considering measures to help employers and employees better understand their plans’ fees. These changes may include modifications to the annual report (Form 5500) and changes to participant disclosure requirements.
Prescription drug coverage
Onerous new notice requirements now apply to health plans that offer prescription drug coverage to Medicare eligible employees or retirees. The notice must be provided to the Centers for Medicare and Medicaid Services (CMS) and all Medicare eligible employees, retirees, spouses, and dependents. The notice must explain whether the plan’s prescription drug coverage is "creditable," which means that it is at least as good as the coverage provided under the standard Medicare Part D prescription drug program. CMS has made model notices available on its website (www.cms.hss.gov). Employers generally will be obligated to notify CMS and the applicable individuals on at least an annual basis.
Health savings accounts
If an employer contributes to an employee’s health savings account (HSA) and the contribution is not made through the employer’s cafeteria plan, then the employer must make "comparable" contributions to the HSAs of all eligible employees who have the same category of coverage (single or family) as the employee who received the HSA contribution. The IRS recently indicated that the employer need only make comparable contributions to "comparable participating employees." There are three categories of comparable participating employees: (a) current employees who work 30 or more hours per week, (b) current employees who work less than 30 hours per week, and (c) former employees (other than former employees who are participating in the employer’s high deductible plan by virtue of COBRA).
The IRS has explained that an employer may choose to contribute to the HSA of one category of comparable participating employees but not another. This explanation provides comfort to employers who were concerned that they had to make HSA contributions on behalf of all HSA-eligible employees.
Cafeteria plan grace periods
The IRS has relaxed the "use-it-or-lose-it rule" that applies to flexible spending accounts. Under this rule, an employee must forfeit any flexible spending account balance that remains at the end of the plan year. This provision has been one of the primary disincentives for employees to participate in flexible spending accounts.
The IRS now permits employers to add a "grace period" of up to 2-1/2 months after the end of the plan year during which an employee may incur expenses and be reimbursed from the previous year’s flexible spending account election.
Given the prominent financial role that benefit plans play, it is vital that employers understand and comply with all benefit laws. It is also important that employers are aware of all the benefits alternatives available to them. If they are not, they may fail to maximize the perceived value of the benefits in their employees’ eyes.
