Protecting retirement benefits is a hot-button issue, especially when the news cycle periodically tells us about the risks of a shortfall in the Social Security Administration’s ability to pay out benefits over the long term. These headlines serve to highlight the fact that employees and employers alike are faced with risks in where we put our retirement savings. Combine this with the fact that many companies have themselves faced an inability to pay out their pension obligations, and you can see where legislation was warranted to try to remedy this situation.
In 2006, the Pension Protection Act (PPA) was signed into law. The PPA covers pensions, as the name implies, but it also covers a lot of aspects relating to any defined benefit plan—including 401(k)s, which have become the default retirement savings plan for many employees now that pensions are tough to come by.
The PPA legislation is around 400 pages long and covers a lot of ground. There are provisions related to pensions, but also provisions related to 401(k) programs, individual retirement accounts (IRAs), and more.
Let’s take a look at some of the main provisions of the PPA and how it affects employers that have defined contribution plans for their employees. We’ll focus primarily on how the PPA affected employer-sponsored 401(k)s, since those are now the primary retirement benefit on offer[i].
PPA: 401(k) Administrative Changes
Here are some of the main 401(k)-related provisions of the PPA that directly affect employers:
- Employers are now allowed to automatically enroll employees into the organization’s 401(k) program. The employee must have the ability to opt out or to change the contribution level, but the law says an employer can make the initial enrollment automatic instead of voluntary. This is often referred to as an opt-out provision because the employee must take action to opt out but does not have to do anything to enroll. (If employees opt out within 90 days of enrollment, their automatic contributions can be refunded to them with no tax penalties.)
- Along with automatic enrollment, employers can set up default investment options that the contributions will go into, which are often based on the employee’s age. (The defaults are usually set up to have higher risk the younger the employee is, and lower risk the closer to retirement age the employee is.)
- With automatic enrollment, the employer also has the option to set up the plan to automatically increase the employee’s contribution level over time, such as increasing it by 1% every year, up to 6% contribution.
- The PPA also expanded the notices that are required to be given to all defined contribution plan participants.
- It also changed the regulations to allow employers to offer personalized investment advice to employees as part of the 401(k) benefit.
These automatic provisions have meant improved retirement savings—and thus improved financial security in retirement—for many people who otherwise might not have ever set up their own 401(k) benefit.
The PPA also has many detailed regulations affecting pensions and other similar defined contribution plans. While the full provisions are quite extensive (beyond the scope of this article), in short, employers have new funding requirements for pensions to reduce the chance of the pension fund being unable to meet its obligations to former employees.
- Organizations with pension plans that are not 100% funded are required to make “deficit reduction contributions” until they are fully funded and have a time limit to do so. In other words, they must make payments into their plan to make up the shortfall. This reduces the chance of any organization defaulting on pension obligations.
- Any organization that has a pension fund that is underfunded will also be responsible to pay a higher premium to the Pension Benefit Guaranty Corporation (PBGC) to mitigate the increased risk of default. This also helps to shore up the PBGC shortfall that occurred due to too many companies defaulting on their pension obligations in past years.
- With less than 80% funding in a plan, the organization cannot make changes that would increase their financial liability.
This is just a high-level overview; the PPA goes into much greater depth on these points and also includes more topics, like IRAs, retirement tax credits, and plenty more details around the changes noted above. These changes alone have made a lot of progress in not only ensuring that pension plans remain solvent but also helping the average employee save more toward retirement.
*This article does not constitute legal advice. Always consult legal counsel with specific questions.
[i] It’s important to note that the Pension Protection Act is much more comprehensive than the 401(k) provisions outlined here; be sure to consult legal counsel with questions about pensions, 401(k) administration, or other related queries.
About Bridget Miller:
Bridget Miller is a business consultant with a specialized MBA in International Economics and Management, which provides a unique perspective on business challenges. She’s been working in the corporate world for over 15 years, with experience across multiple diverse departments including HR, sales, marketing, IT, commercial development, and training.