President Bush has signed the Pension Protection Act of 2006 into law, which overhauls pension funding rules, clarifies cash balance plan rules, encourages automatic enrollment in 401(k) plans, and much more. The law spans a massive 907 pages, and we describe some of its key provisions here.
Defined Contribution Plans For plan years beginning after Dec. 31, 2007, employers may automatically enroll workers in 401(k) plans. Employees can opt out of participation retroactively and receive their contributions back without penalty. The law supersedes any state payroll deduction laws that might prohibit automatic enrollment. Under these new provisions, automatic enrollment plans must annually issue a notice explaining the right to opt out and change the contribution rate, time periods for making elections, and the default investment option. The plan must also match 100 percent of deferrals up to one percent of the employee’s compensation, and 50 percent of between one and six percent of compensation, and comply with minimum contribution rates.
- 401(k) automatic enrollment.
- Vesting. For plan years beginning on or after Jan. 1, 2007, all employer contributions must be 100 percent vested after three years or at the rate of 20 percent a year starting with year two.
- Employer stock diversification rights. Plans holding publicly traded employer stock (except certain Employee Stock Ownership Plans) must allow all plan participants to diversify how their elective deferrals and after-tax contributions will be invested. For participants with three or more years of service, the plan must allow participants to diversify how other contributions made on their behalf will be invested. Plans must give participants at least three materially different investment options. These provisions will be phased in over three years beginning Jan. 1, 2007.
- Investment advice. To encourage employers and plan providers to offer investment advice, the sct permits “eligible investment advice arrangements,” which are exempt from prohibited transaction rules, beginning Jan. 1, 2007. Under these arrangements, the advice must be based on computer models meeting certain criteria (to be established by the U.S. Department of Labor (DOL)) or the provider/advisor’s compensation may not vary based on the investments selected. Notice requirements also apply.
- Benefits statements. For plan years beginning on or after Jan. 1, 2007, benefits statements must be provided at least quarterly if the plan permits participant direction of investments. If participants don’t direct investments, annual statements are required. The statements will need to include new boilerplate disclosure language (with model notices to be developed by the DOL).
Cash Balance and Pension Equity PlansThe act provides that cash balance and other hybrid defined benefit plans, such as pension equity plans, don’t violate the Age Discrimination in Employment Act, retroactive to conversions occurring on or after June 29, 2005, provided that vesting is complete after three years and interest credits don’t exceed a market rate of return.
- Age discrimination protections.
- Vesting. Cash balance and pension equity plans must provide for 100 percent vesting after three years of service.
- Conversions. When a traditional plan is converted to a cash balance or pension equity arrangement, the act imposes new requirements on conversions to prohibit “wearaway.” Wearaway occurs when a participant is barred from accruing additional benefits for a period following the conversion because their accrued benefits determined under the pre-conversion formula are higher than the value of their opening cash balance. Wearaway tends to impact older, longer-term employees.
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Defined Benefit Plans A new method will apply to determine the level of a plan’s funding for plan years beginning on or after Jan. 1, 2008. If a plan is “at risk”—less than 80 percent funded—the employer generally will be barred from amending the plan to increase or establish new benefits, change the rate of benefit accrual, or change the vesting rate. Also, if a plan is underfunded, the plan administrator must notify participants within 30 days after the plan becomes subject to these restrictions.
- Minimum funding.
- Statements and notices. Within two months after the deadline for filing the plan’s annual report, participants must receive a notice regarding the plan’s funded status, investment policy and allocation, etc. The DOL will develop a model notice. Participants must also receive benefits statements at least once every three years, plus an annual notice stating that an annual statement is available on request.
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