On August 17, 2006 President Bush signed The Pension Protection Act of 2006 (the "Act"), federal legislation that impacts all aspects of retirement plans. Although the Act is best known for enhancing the funding of traditional defined benefit pension plans, it also includes numerous provisions that change 401(k) plans and other types of employer sponsored defined contribution plans to allow employers to assist employees saving for retirement.
EGTRRA Changes Made Permanent
A simple but important change made by the Act was to permanently extend 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.
401(k) Plan Automatic Enrollment
Additional provisions in the Act 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. Prior to the Act, 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 preempting 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, as 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 US Department of Labor. The employee must be provided a notice that explains the employee's rights to exercise investment control and explains how contributions will be invested in the absence of any investment election by the employee. These provisions were effective in 2006.
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 certain contributions that are otherwise required if greater than 60% of plan assets are in the hands of higher paid business owners, the so-called "top heavy" contributions.
Protections for Employers Who Offer Investment Advice
In addition to provisions encouraging employee retirement savings, the Act amends the fiduciary rules of the Employee Retirement Income Security Act of 1974 ("ERISA"). These changes 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 a) charge the same fee for advice to any employee, regardless of size of account balance or b) provide advice based on computer modeling developed by an independent financial expert. These rules are designed to prevent situations in which investment professionals obtain 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 advisors and to monitor the investment advisor who is selected. 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.
New Benefit Statement and Disclosure Rules
Other provisions of the Act further encourage employee participation in the management of their retirement savings. These provisions require 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 a quarterly statement that must include (1) the employee's total account balance; (2) the amounts that are vested or the earliest date that amounts will become vested; (3) the value of each investment and (4) an explanation of any limitations or restrictions on the employee's right to direct an investment. The benefit statements must also include an explanation of the importance of a well-balanced and diversified investment portfolio for long-term retirement security. The explanation must further include a warning of the risk that a portfolio may not be adequately diversified if it holds more than 20% of its assets in the stock of one company (for example, employer stock). Participants or beneficiaries must also be directed to the US Department of Labor's website for resources on individual investing and diversification.
Faster Vesting of Employer Contributions
Employees who switch jobs before being fully vested in their retirement accounts will be able to retain a larger portion of their retirement savings attributable to employer contributions as the result of additional changes. 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.
Other Changes to Help Employees Save for Retirement
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 roll over 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.
John E. Rich, Jr. is a Director of McLane, Graf, Raulerson & Middleton, Professional Association. Mr. Rich is a frequent speaker on employee benefit plan and pension, estate planning, and tax-related topics, and can be contacted directly at (603) 628-1438, or by email at [email protected]. The McLane Law Firm is the largest full-service law firm in the state of New Hampshire, with offices in Concord, Manchester and Portsmouth.