Pension law means changes ahead for retirement plans

Signed into law on Aug. 17 the federal Pension Protection Act of 2006 is designed to improve funding of defined benefit pension plans, both to protect workers and to limit costly bailouts of failed plans by the Pension Benefit Guaranty Corp.

In general, the act requires plan sponsors to fund them more rapidly and increases the resources available to the PBGC for assuming payment obligations of failed plans, and limits employer conduct (such as lump-sum payouts or benefit increases) that can place under-funded plans at risk. The relatively few employers who continue to sponsor such plans must familiarize themselves with these rules and prepare to comply with them in a timely manner.

The act also makes important changes in the rules applicable to defined contribution plans, including 401(k) and traditional profit-sharing plans. For example, the act encourages employers to enroll workers automatically into 401(k) plans by overturning state laws that generally prohibit wage deductions without specific employee authorization.

In addition, the U.S. Department of Labor is required to provide relief for plan fiduciaries with respect to default investment fund options under such automatic enrollment arrangements. The act also provides a safe harbor, permitting automatic increases in contributions over time, and “qualified automatic contribution arrangements” will be deemed to satisfy certain 401(k) plan nondiscrimination requirements.

The act also makes permanent a number of benefit plan changes contained in previous tax legislation, including expanded annual contributions to IRAs and 401(k) plans, bonus “catch-up” contributions for individuals age 50 and older, the provisions for Roth 401(k) plans that became effective this year, and additional tax advantages for Section 529 college savings plans.

As a result, these provisions will continue beyond their original 2010 expiration date.

Other changes

In many small and mid-sized plans the owners and/or senior management serve as plan trustees. As fiduciaries subject to stringent ERISA requirements, these individuals will be pleased to learn that the act also includes substantial relief dealing with “blackout” periods, during which participant plan investment choices are limited and with “mapping” current plan investments to new investment options.

In a change long sought by the investment industry, the act also specifically permits qualified fiduciary advisers to deliver personally-tailored investment advice to participants in 401(k) plans and other tax-advantaged savings vehicles.

The act also permits advice to be provided by entities that would otherwise face conflicts of interest, pursuant to an “eligible investment service arrangement.” These arrangements must be disclosed to participants and are subject to annual audit, and the compensation received by the adviser must be reasonable and not vary on the basis of the investments selected. However, under current law, the plan sponsor must still act prudently in selecting and monitoring the adviser.

In a change designed to increase employee flexibility, the act permits defined benefit and money purchase pension plans to make distributions to active employees who have reached age 62. This change may facilitate transition into retirement by senior management employees who need access to their retirement benefits but, for financial or other reasons, are reluctant to retire completely.

Also included in the act are new rules governing distributions of plan benefits.

In most cases, a plan offering a qualified joint benefit and survivor annuity must offer both 50 percent and 75 percent survivor annuity options, and the elimination of certain subsidized annuity arrangements is restricted. Many participants will now be able to roll over eligible distributions directly from a qualified plan into a Roth IRA. Also, non-spousal beneficiaries of qualified plans will be able to roll over distributions directly to an IRA, and for the next two years IRA owners who have reached age 70-1/2 will be able to make tax-free IRA rollovers directly to most charitable organizations.

Many act provisions will require, permit or encourage amendments to current retirement plans. For those changes required by law (for example, with respect to accelerated vesting for nonelective contributions), amendments will generally be required by the last day of the plan year beginning in 2009.

Naturally, the plan must be operated in accordance with the applicable requirements in the meantime. For example, the new vesting requirement is effective for all plan years beginning after Dec. 31, 2006. While most of the key provisions of the act will become effective at that time, some do not take effect until 2008 or even later.

While the new law is of crucial interest to sponsors of defined benefit pension plans, employers offering 401(k) plans and other defined contribution plans — as well as management and other employees who maintain IRAs or other savings vehicles — also need to review the act carefully and consider its implications for their benefit programs.

For example, many 401(k) plan sponsors will wish to consider adding an automatic enrollment feature or, if they haven’t done so already, a Roth 401(k) option. In any event, all employers will need to review their programs to ensure that required plan amendments are made in a timely manner, and that in the meantime their plans are properly administered in accordance with the act.

Douglas R. Chamberlain, an attorney with the Concord-based law firm of Sulloway & Hollis, practices extensively in the area of employee benefits. He can be reached at 224-2341 or dchamberlain@sulloway.com.

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