Pension Trends   Volume VII, No. 3, August 2006    

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Good News Contained in 2006 Pension Legislation
          

Good News Contained in 2006 Pension Legislation

President Bush has just signed the Pension Protection Act of 2006 (PPA) into law. PPA is primarily intended to shore up the funding of large defined benefit pension plans. It does its intended job very well, maybe too well. We will discuss this concern later in this article.

PPA also contains provisions that effect changes other than pension funding. Many of these changes are positive. They add clarity and encourage plan sponsorship. For example, PPA encourages auto enrollment in 401(k) plans. If a plan has an auto enrollment feature, an employee is automatically enrolled to make salary deferral contributions in the 401(k) plan unless he or she takes positive action to opt out.

Auto enrollment has proven to significantly increase the number of employees who participate in a 401(k) plan. The same inertia that keeps some employees from ever taking positive action to sign up for a 401(k) plan, keeps employees who are signed up via automatic enrollment from taking positive action to get out. A problem facing some plan sponsors is that in some states auto enrollment may run afoul of state employment laws. PPA creates a federal override of any state law that may inhibit auto enrollment.

PPA contains provisions which will continue to encourage small employers to sponsor defined benefit plans. For example, pension laws have, since the enactment of Employee Retirement Income Security Act of 1974 (ERISA), allowed an employer to provide benefits to its employees based on compensation earned before a defined benefit plan was set up. A literal reading of ERISA did not support this idea, but it is fair and logical. It has been the standard practice before ERISA and for the 30 years since ERISA was enacted.

Nonetheless, the IRS recently proposed regulations that would disallow recognition of compensation earned before the start of a plan. Thanks to a strong lobbying effort by supporters of small business, including our own Catherine MacLeod and Paul Engstrom, PPA codifies recognition of pre-plan compensation.

A final example of the good news is contained in the additional funding rules for defined benefit pension plans. When the new funding rules become effective, generally in 2008, we expect one result to be higher tax deductible contributions for defined benefit plans. This should not be a surprising result because contributing more money sooner is the best way to ensure better funding of a defined benefit pension plan.

That is some of the good news. Now to the bad and the likely-to-be ugly. Although all plans will be impacted by PPA, the more onerous aspects fall primarily on sponsors of large defined benefit plans. Funding volatility and the complexity of the rules governing the funding have been major complaints of large plan sponsors. PPA did little to address these concerns and in the end added to the complexity problem. Consider that my copy of ERISA, which in 1974 completely rewrote the pension laws, created the PBGC, minimum funding requirements, and fiduciary standards for pension plans, contains 311 pages. PPA with a much narrower focus is 904 pages in length. Enough said.

The likely-to-be ugly is what the future may hold for American workers in large defined benefit plans. The U.S. pension system is voluntary. There is no requirement that an employer sponsor a retirement plan. In an effort to shore up the funding of large defined benefit plans – an appropriate goal considering the many plans that have terminated and left the PBGC to pay for their unfunded benefits – PPA may cause more sponsors of large defined benefit plans to terminate their plans and convert to defined contribution plans or no plan at all. And who ends up on the short end of that scenario? The American worker.

It remains to be seen how the private pension system will react to PPA. It is in everyone’s best interest to have a strong and vibrant third leg of the retirement stool so the baby boom generation can enjoy a reasonable standard of living when they retire.

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This newsletter has been published in order to share general information with our professional contacts. The information presented in this newsletter should not be acted upon without first seeking the advice of a CPA, attorney or other benefit professional.