Vested Interests
Under the Pension Protection Act of 2006 (PPA), and generally effective for plan years commencing after December 31, 2006, defined contribution plans must satisfy one of the following two types of minimum vesting schedules: either (i) a three-year cliff vesting schedule or (ii) a six-year graded vesting schedule.
Using a three-year cliff vesting schedule, a plan satisfies the PPA vesting requirements if an employee who has completed at least three years of service has a nonforfeitable right to 100% of his/her accrued benefit derived from employer contributions. Using a six-year graded vesting schedule, a plan satisfies the PPA vesting requirements if an employee has a nonforfeitable right to a percentage of his/her accrued benefit derived from employer contributions determined as detailed above.
The three-year cliff vesting and the six-year graded vesting schedule need not apply to an employee unless he/she has at least one hour of service during a plan year beginning after December 31, 2006. (Due to the potential recordkeeping issues, a plan sponsor may wish to apply the new schedule to contributions made on and after January 1, 2007, and to those made prior to January 1, 2007.)
Surprising Twists
The above seems straightforward and simple enough until we look behind the curtain. In all the hoopla associated with the PPA, people have taken little notice of the final regulations issued under Section 411 of the Internal Revenue Code and its application to amendments made to vesting schedules. However, these final rules intersect with the PPA’s new vesting requirements and, as a result, apply the Section 411(d)(6) anti-cutback rules in unexpected ways to the amendments made to vesting schedules.
Consider the following: If Company X maintains a 401(k) plan with a five-year cliff vesting schedule applicable to any company discretionary non-elective contributions, and if Company X elects a six-year graded vesting schedule to comply with the new requirements under the PPA, would a participant with at least three years of service for vesting still have the right to continue with the original five-year cliff vesting schedule? Under the final regulations to Section 411(d)(6), the answer is yes. The participants must be given the better of the two schedules. Plan amendments that otherwise would decrease a participant’s accrued benefit or impose new restrictions/conditions on a participant’s protected rights will violate the anti-cutback rules under Section 411.
Practical Issues
So far we have described only the legal requirements associated with these new rules. There are, of course, administrative complexities associated with an automated recordkeeping process where the above vesting issues (whether in the context of amendment to the vesting schedule as required by the PPA or from amendment to the vesting schedule resulting from plan mergers) must be implemented. In some cases, the only way to maintain multiple vesting schedules may be to convert the automated process to a manual process, an option not favored by most plans (or providers).
While the vesting issues have an impact on distributions and loan calculations, they also extend to any document or record that provides information on vesting (i.e., quarterly statements, online account information, and summary plan descriptions). Thus, prior to amending any vesting schedule, a plan sponsor and/or its adviser would be best served by discussing the mechanics of potentially maintaining multiple vesting schedules on a recordkeeping system. The discussion may lead to a decision matrix based heavily on administrative viability rather than cost.
Quana C. Jew is a partner at the law firm of Arent Fox, focusing on ERISA, employee benefits, and executive compensation. Quana has served as a guest lecturer in the employee benefits area for various law school, bar seminar, and employee benefits-related organizations. She also serves on the Advisory Board of the Women’s Pension Exchange. Most recently, Washingtonian magazine named Quana as one of Washington’s best tax lawyers.