Pension Protection Act of 2006 Signed Into Law

On August 17, President Bush signed the Pension Protection Act of 2006 ("PPA") into law. The PPA, which covers over 900 pages, is the most extensive retirement plan legislation in decades. Among other changes, the PPA includes new funding rules for defined benefit plans, rules for "hybrid" plans (such as cash balance plans), and rules designed to increase participation in employer-sponsored defined contribution plans. The PPA also makes permanent a number of favorable provisions relating to pension plans and individual retirement accounts that were due to expire in 2010. Many of the changes are effective for plan years beginning in 2008, while others are effective immediately or for plan years beginning in 2007.

This article summarizes some of the more important provisions of the PPA. To view the full text of the PPA, go here then type H.R. 4 into the Search Bill Text box.

Defined Contribution Plans

Automatic Enrollment. A number of studies have shown that automatic enrollment in 401(k) plans significantly increases employee participation. Despite this evidence, many employers have been reluctant to adopt automatic enrollment provisions because of perceived legal risks. The PPA addresses these risks and provides additional incentives for employers to add an automatic enrollment feature to their 401(k) plans. Among other changes, the PPA (1) relieves automatic enrollment plans that satisfy specified requirements from certain nondiscrimination requirements; (2) preempts state laws applicable to automatic enrollment features; (3) provides a method for correcting automatic enrollment errors; and (4) eliminates the 10% excise tax on excess contributions under an automatic enrollment plan that are corrected within six months after the end of the plan year. These provisions apply immediately.

Faster Vesting. Contributions to all defined contribution plans are subject to a faster 3-year cliff or 6-year graded vesting schedule. These changes are effective for contributions made for plan years beginning on or after January 1, 2007.

Investment Advice. Current law restricts the ability of financial service providers to give personal investment advice to participants in 401(k) plans or IRAs. The PPA allows such advice, provided that requirements designed to prevent conflicts of interest are followed. One way of providing such advice, in the case of retirement plans, is through the use of computer modeled investment advice programs certified by the Departments of Labor and Treasury. This change is effective for advice given after 2006.

Participant Benefit Statements. Defined contribution plans must provide participants with quarterly benefit statements, if participants direct investments, or annual statements, if participants do not direct investments. These requirements generally apply to plan years beginning after 2006.

Employer Stock Diversification. The PPA requires that plans holding publicly-traded employer stock permit participants to diversify such investments. Participants whose elective deferrals and employee contributions are invested in employer stock must be able to diversify immediately. In general, participants with at least three years of vesting service must be able to diversify other contributions invested in employer stock. Stand-alone ESOPs that do not contain elective deferrals, matching contributions, or employee contributions are exempt from the new requirements. This change is effective in 2007, but there is a three year phase-in for existing account balances.

Roth Contributions. The PPA makes permanent Roth 401(k) and 403(b) contributions.

Distributions to Qualified Reservists. Under current law, an individual who receives a retirement distribution before age 59, death, or disability is generally subject to a 10% early withdrawal tax in addition to ordinary income taxes. The PPA creates an exception to the additional tax for distributions from an IRA, 401(k) plan, or other similar arrangement to certain reservists who have been called to active duty. To qualify for the exemption, the reservist must have been called up to active duty between September 11, 2001, and December 31, 2007, for a period longer than 179 days.

Defined Benefit Plans

Funding Requirements. The PPA completely overhauls the funding rules for defined benefit plans in an attempt to make them more secure. The new rules, which are quite complicated, generally apply to plan years beginning in 2008, although transition rules apply to the 2006 and 2007 plan years. The new rules include the following changes:

        A plan's funding target has been increased to 100% of the plan's accrued liabilities.

        After a phase-in period, the interest rate used for plan funding purposes will be based on the high-quality corporate bond yield curve, averaged over 24 months. Plan sponsors may elect to use the full yield curve without averaging.

        In determining the funded status of a plan, asset values can be based on the prior and current year asset values.

        Unfunded liabilities must be amortized over a seven-year period.

        The IRS is required to prescribe a mortality table to be used for funding purposes.

        If a plan is "at-risk", it will be subject to higher required contributions and PBGC premiums.

        There are new restrictions on the ability of underfunded plans to increase benefits.

Deduction Limits. Plan contributions in excess of the deductible limits are subject to a 10% excise tax. The PPA encourages plans to create a funding cushion by increasing the limits on deductible contributions. Special transition rules apply to plan years beginning in 2006 and 2007.

Phased Retirement. Current rules prohibit defined benefit plans from distributing retirement benefits to active employees before the plan's normal retirement age. The PPA allows plans to distribute retirement benefits to active employees who have reached age 62, even if the plan's normal retirement age is later than age 62. This change generally applies to distributions made in plan years beginning after 2006.

Funding Retiree Health Benefits. Under current law, a defined benefit plan may transfer excess assets to a separate account to fund retiree health benefits for the current year. The PPA allows the transfer of excess assets to fund future retiree health benefits as well. This change applies to any transfer after August 17, 2006.

Hybrid/Cash Balance Plans

The PPA addresses much of the legal uncertainty surrounding cash balance and other hybrid plans. For example, the PPA makes it clear that the typical cash balance plan does not violate age discrimination laws, as has been alleged in numerous class actions. These provisions are limited to periods on or after June 29, 2005, and the law provides that, in interpreting pre-PPA law, no inference is to be taken from the PPA provisions. As a condition of this treatment, hybrid plans will have to satisfy new interest crediting rules, beginning in 2008. The PPA also allows addresses the "whipsaw" issue that has been the source of numerous class action lawsuits, providing a way in which a cash balance plan can use the hypothetical account balance as the lump sum benefit.

Finally, the PPA contains rules for the conversion of traditional defined benefit plans to hybrid plans, which applies to conversions after June 29, 2005.

Other Provisions

Temporary Benefit Enhancements Made Permanent. The PPA makes permanent certain pension and IRA provisions due to expire in 2010, including higher contribution limits for retirement plans, special catch-up contributions for participants age 50 and older, and Roth 401(k) provisions.

New Reporting and Disclosure Requirements. New reporting and disclosure requirements include:

       The creation of a new annual funding notice for all defined benefit plans covered by the PBGC, which must be distributed to each participant and beneficiary, each labor organization representing participants, and the PBGC within 120 days after the end of each plan year;

  Revised Form 5500 Annual Report requirements, including new electronic filing requirements and repeal of the summary annual report requirement for most plans;

       Revised rules as to which plans must file plan actuarial and employer financial information on a Form 4010 with the PBGC (generally plans with less than 80% funding) and expanded content of filings;

       Separate benefit statement requirements for defined benefit plans and defined contribution plans. The PPA directs the Department of Labor to develop model benefit statements; and

        The creation of a new notice of diversification rights for defined contribution plans that require investment in company stock (generally effective in 2007), which must be provided at least 30 days before a participant is eligible to diversify out of company stock and must include a description of the importance of diversification, for which the Department of Labor is to provide a model.

Section 529 Plans. The PPA makes permanent the provisions of Section 529 providing for qualified tuition programs. These programs allow an individual to establish a tax-deferred account to pre-pay qualified higher education expenses or save for future qualified higher education expenses.

The PPA has extensive and far-reaching effects on employee benefit plans and only a few of the provisions set forth in the 900-page law are addressed here. If you would like additional information about the PPA, or if you need assistance in bringing your plans and operations into compliance with the new law, please contact your Ice Miller employee benefits attorney, Marc Sciscoe, Cynthia Purvis, Tiffany Sharpley, or Craig Burke.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice.  The reader must consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.


2006 Ice Miller LLP