The Pension Protection Act of 2006
by Michael J. Bogdan, Esq.

In August, the Pension Protection Act of 2006 was signed into law and will affect nearly all Pension, 401(k) and other retirement plans in the United States.

The Act introduces sweeping changes to defined contribution/401(k) plans.  Automatic enrollment features within 401(k) plans are encouraged under the Act.  Automatic contributions are a way to boost participation in 401(k) plans and protect procrastinators from themselves.  The Act encourages companies to automatically enroll all workers in their 401(k) plan and force the employee to opt out.  However, research shows that most employees will not opt out once they are enrolled for participation in the plan.  The Employee Benefit Research Institute estimates that automatic enrollment can increase 401(k) participation from about 66 percent of eligible workers to more than 90 percent.  Under the Act, beginning in 2008 employers will be able designate that 3 percent of a workers pay be automatically deposited into their 401(k) account and increase these contributions each year until they reach 6 percent.

The Act also makes permanent the higher contribution levels for 401(k) plans that were scheduled to disappear after 2010.  Employee contributions 401(k) plans, currently limited to $15,000 for 2006, are now scheduled to remain constant and will increase annually with inflation in $500 increments. Catch-up contributions, which allow employees over 50 years old to contribute money over and above the regular limits, will also increase.

Roth 401(k) features inside a defined contribution plan, which allow workers to contribute after tax dollars in exchange for tax-free distributions in retirement, were made permanent by the Act.  The Roth 401(k) is a great option for young employees who will benefit from decades of tax free growth or for anyone who believes taxes will be higher in the future.

In addition to the above discussed changes, the Act included many other tools designed to reform employer sponsored retirement plans.  These changes included the authorization of cash balance plans and other hybrid pension plan designs which incorporate characteristics of both defined contribution and defined benefit plans, permitting employees to diversify if employer stock is found within a participant’s account, and a faster vesting schedule which limits the vesting of non-elective contributions to a three-year cliff or six year graded vesting schedule for all qualified defined contribution plans.  Plans are also now allowed to offer a so called “working retirement” by allowing participants age 62 or older to receive benefits even though they are still working for the employer.

For defined benefits/traditional pension plans, the law’s requirement boosts minimum pension funding from the current 90 percent of liabilities to 100 percent of liabilities by 2008.  This will likely be cause for concern for many employers sponsoring defined benefit plans and may prompt employers to investigate freezing their pension plans.  New law also prevents severely under-funded pension plans from making promises of future benefits that they may not be able to keep.  In addition, the insurance premiums paid to the Pension Benefit Guarantee Corporation, the federal agency that takes over pension payments for current or future retirees when an employer goes bankrupt.

The provisions of the Act have a wide range of effective dates.  The majority of the changes will take effect in 2007 or 2008 but some are retroactive or have delayed effective dates.  The Act contains numerous other changes not summarized in this Legal Alert.  Employers and Plan Administrators should begin the process of evaluating the effects of the Pension Reform Act on their plans as soon as possible.  If you have any questions regarding this article, please contact one of the attorneys of the Krugliak, Wilkins, Griffiths & Dougherty Employee Benefits Group.

NOTE: This general summary of the law should not be used to solve individual problems since slight changes in the fact situation may require a material variance in the applicable legal advice.