New law helps firms boost employee retirement savings

Although the Pension Protection Act of 2006 – signed into law last August by President Bush – is best known for enhancing the funding of traditional defined benefit pension plans, it also includes provisions that change 401(k) plans and other types of employer-sponsored defined contribution plans to allow employers to assist employees saving for retirement.

A simple but important change permanently extends the retirement savings provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001, (EGTRRA). All of the favorable savings provisions of EGTRRA — including increasing employee contribution limits for 401(k) and 403(b) retirement plans, adding catch-up contributions for those age 50 and older, adding Roth 401(k) plans and providing incentives for small businesses to offer pension plans — were scheduled to expire or “sunset” at the end of 2010.

These changes are now permanent, as are the changes to simplify the complex testing for 401(k) and 403(b) plans.

Additional provisions make it easier for employers to include automatic enrollment provisions in their plans. These provisions will increase the participation by employees in 401(k) plans. As the name suggests, automatic enrollment requires employees to contribute to a 401(k) plan, unless the employee affirmatively elects not to participate. Previously, employers were reluctant to use automatic enrollment because of concern over possible state law prohibitions and liability for the investment choice made on behalf of employees.

The act eliminates any state law concerns by pre-empting or superceding any state payroll law, such as New Hampshire’s RSA 275:48, that would prohibit automatic enrollment by requiring advance written consent from an employee prior to any payroll deduction. The act also contains provisions that will insulate plan fiduciaries from liability if participants fail to exercise investment options, which commonly occurs when automatic enrollment is utilized. This protection will apply when an employer invests the assets in a default investment choice that meets certain standards to be established by the U.S. Department of Labor.

To further increase employee retirement savings, the act provides added incentives for employers that add automatic enrollment features in 2008.

If an employer adds an automatic enrollment feature that provides for an increasing level of automatic deferrals and required employer contributions, the plan is treated as meeting discrimination tests that often limit the ability of higher-paid employees to make salary deferral contributions.

In this case, the employer is not obligated to make contributions that are otherwise required if greater than 60 percent of plan assets are in the hands of higher-paid business owners, the so-called “top-heavy” contributions.

Disclosure rules

The act also amends the fiduciary rules of the Employee Retirement Income Security Act of 1974 (ERISA) to encourage employers to provide investment advice so employees can make better choices in saving for retirement.

The amended ERISA rules permit investment professionals to provide advice even in potential conflict-of-interest situations by requiring such professionals to either charge the same fee for advice to any employee, regardless of size of account balance or provide advice based on computer modeling developed by an independent financial expert.

These rules are designed to prevent investment professionals from obtaining a greater monetary benefit from recommending certain investments rather than others. If an employer provides investment advice to employees, the employer is still responsible to prudently select investment alternatives and investment advisers and to monitor the selected adviser.

In addition, the employer must arrange for an annual independent audit of the investment advisor program. With these changes in place, employees may more readily seek investment advice in order to make informed decisions about retirement savings.

The act also further encourages employee participation in the management of their retirement savings. By requiring employers to update employees more frequently as to the value of their retirement savings and to provide new information on how to save for retirement.

Employees must be provided with a quarterly statement that includes, among other things, the employee’s total account balance, the amounts that are vested or the earliest date that amounts will become vested, the value of each investment, an explanation of any limitations or restrictions on the employee’s right to direct an investment as well as a warning of the risk that a portfolio may not be adequately diversified if it holds more than 20 percent of its assets in the stock of one company.

Also under the act, employers who previously vested employer contributions in defined contribution plans on an all-or-nothing basis after five years must now fully vest employer contributions after three years. Similarly, employers who allowed employees to vest gradually over a seven-year period must now accelerate the vesting so that employees are 100 percent vested after six years.

The act also makes it easier for employees who have saved during employment to keep funds in retirement vehicles by increasing the options available to transfer retirement funds from one vehicle to another.

The act expands the rollover options for after-tax contributions so that such contributions can be rolled over from one qualified retirement plan to another, to a tax-sheltered annuity (403(b) plan) or to an IRA. The act also allows distributions from tax-qualified retirement plans, 403(b) plans and governmental 457 plans to be rolled over directly into a Roth IRA. nhbr

John E. Rich Jr., a director of McLane, Graf, Raulerson & Middleton, is a frequent speaker on employee benefit plan and pension, estate planning and tax-related topics. He can be contacted directly at 628-1438 or john.rich@mclane.com.