What's Inside the Pension Protection Act

July 31, 2006 (PLANSPONSOR.com) - The pension reform bill passed by the House early Saturday morning "represent[s] the most sweeping changes to America's pension laws in more than 30 years," according to House Majority Leader John Boehner (R- Ohio), a bill sponsor and advocate of many of the pension reform provisions.

On the other hand, opponents, primarily those on the other side of the aisle from Boehner, thought the Pension Protection Act of 2006 failed to live up to its name.   “This tilts the table toward the decisions by companies to terminate or to freeze those plans,” said Congressman George Miller (D-California).   In a  statement posted on his Web site, Representative Miller, who is the senior Democrat on the House Education and the Workforce Committee, also cautioned that, “because this bill misses its opportunity to slow the severe underfunding of private pension plans, shore up the federal pension insurance agency, and encourage companies to keep offering traditional pensions to their employees, workers’ retirement security will continue to erode.”

Those concerns notwithstanding, the bill passed by the House encompasses a number of massive changes for plan sponsors, even if their final status remains uncertain (see  Pension Reform Takes an Unexpected Detour ).   H.R. 4:

  • Provides a permanent interest rate based on a modified “yield curve,” rather than a single rate for all plans;
  • Prohibits employers from using credit balances if their plans are funded at less than 80%;
  • Triggers accelerated contributions for “at-risk” plans. Plans are deemed “at risk” if the plan falls below 70% funded status using the worst-case scenario assumptions (i.e., employers cannot count credit balances and must assume employees take the most expensive benefits and retire at the earliest possible date).   If an employer does not meet this test, it can forgo at-risk status only if it is 80% funded using standard assumptions (this test would be phased in over three years, starting at 65% in 2008 and rising to 70% in 2009, 75% in 2010, and 80% in 2011, according to a summary of the provisions).   If a company meets one of the two tests, it would avoid the at-risk designation; however, it would still be required to make up its overall funding shortfall over seven years like any other underfunded plan;
  • Reduces the smoothing of interest rates to two years (instead of five for assets and four for liabilities under current law);
  • Allows employers to make additional maximum deductible contributions of up to 180% of current liability;
  • Prohibits employers and union leaders from increasing benefits if a plan is less than 80% funded, unless the benefits are paid for immediately;
  • Prohibits additional benefit accruals for lump sum distributions or shutdown benefits from plans funded at less than 60%;
  • Restricts the use of deferred executive compensation arrangements for employers with severely underfunded plans;
  • Permanently establishes an employer-paid termination premium of $1,250 per participant if a plan sponsor terminates its employee pension plan upon entering bankruptcy.   The plan sponsor would pay the premium after the company emerges from bankruptcy;
  • Requires employers to make sufficient contributions to plans in order to meet a 100% funding target and erase funding shortfalls over seven years.

However, the version passed by the House also includes some special provisions for the airline industry.   The bill gives airlines that opt for a "hard freeze" of their pension plans an additional 10 years to meet their funding obligations, while an employer-paid termination premium of $2,500 per plan participant also must be paid by these airlines if they terminate their employee pension plan upon entering bankruptcy (it would be paid after the company emerges from bankruptcy).   It also gives airlines that opt for a "soft freeze" of their pension plans an additional three years to meet their funding obligations (with identical employer-paid termination premium provisions as the hard freeze terminations).   For these airlines, the bill also extends the deficit reduction contribution relief - which was included in the 2004 Pension Funding Equity Act - through 2007 (see  IMHO: Wait Loss ).

For cash balance plan sponsors, the bill sanctions the design, "ending the legal uncertainty surrounding cash balance pension plans and ensuring they remain a viable retirement security option for workers and employers," according to a summary of the bill.   It establishes an age discrimination standard for all defined benefit plans that clarifies current law with respect to age discrimination requirements under ERISA - but only on a prospective basis.

"Multi" Tasking

There are new provisions for multi-employer plans in the bill that identify underfunded multi-employer pension plans and establish quantifiable benchmarks for measuring a plan's funding improvement.   The bill also provides new notice requirements for underfunded plans, changes the amortization schedule for any plan benefit amendments from 30 years to 15 years, increases the maximum deductible limit to 140% of current liability, and requires plan trustees to improve the health of the plan by one-third within 10 years if a plan is less than 80% funded or will hit a funding deficiency within seven years.   H.R. 4 would also prohibit benefit increases if the increase causes the plan to fall below 65% funded status, and establishes new funding standards and possible benefit restrictions for multiemployer plans that are funded at less than 65%.

The Pension Protection Act steps up a focus on plan disclosures:

  • Requiring both single and multiemployer plans to include more detailed and specific information on their Form 5500 filings;
  • Enhancing Form 4010 disclosure requirements and making all Form 4010 information filed with the PBGC available to the public, except for sensitive corporate proprietary information, while also establishing an 80% at-risk threshold that determines whether plans pose a threat to the PBGC and therefore must file 4010 information;
  • Requiring both single and multiemployer pension plans to notify workers and retirees of the funded status of their plan within 120 days after the close of the plan year;
  • Prohibiting companies from forcing employees to invest any of their own retirement savings contributions in the stock of the employer;
  • Requiring companies to give workers quarterly benefit statements that include information about accounts, including the value of their assets, their rights to diversify, and the importance of maintaining a diversified portfolio;
  • Making clear that companies have a fiduciary responsibility for workers' savings during "blackout" periods.

Advice and DC-Oriented Provisions

The pension reform bill also includes provisions that could have an impact on investment advice provided to participants.   Under the bill, only qualified "fiduciary advisers" fully regulated by applicable banking, insurance, and securities laws may offer investment advice, and that advice must be prudent, objective, and for the exclusive purpose of providing benefits to the plan's participants and beneficiaries.

Plan sponsors will remain responsible for prudently selecting and reviewing advice providers, while the advisers themselves will be personally liable for the advice they give.   Additionally, under the agreement, fiduciaries for employer-sponsored plans that provide investment advice may tailor their recommendations to an individual's own unique needs based on a proprietary computer model that takes into account the personal and subjective criteria about their financial and family circumstances.   However, that model must be certified and audited by an independent party, and the advice must be provided in a manner that is "not biased in favor of investments offered by the fiduciary adviser or a person with a material affiliation or contractual relationship to the fiduciary."   Qualified advice providers must disclose in plain, easy-to-understand language any fees or potential conflicts.   That disclosure must be made when advice is first given, and at least annually thereafter.   It also must be made whenever the worker requests the information, and whenever there is a material change to the adviser's fees or affiliations.

Automatic Enrollment

The bill also would encourage employers to automatically enroll workers in defined contribution pension plans; it would make permanent the individual retirement account (IRA) and pension provisions enacted under the Economic Growth Tax Relief and Recovery Act of 2001 (EGTRRA); and would extend permanently indexing to inflation the "Savers' Credit," which is set to expire after December 31, 2006.  

The bill would give taxpayers the option of "split tax refunds," in which they may choose to deposit a portion of their federal tax refund directly into an IRA, waives the 10% early distribution penalty for public safety employees who participate in governmental pension plans with a Deferred Retirement Option Plan (DROP) benefit feature, and allows tax-free rollovers from the IRA or pension of a deceased individual to an IRA or pension of a designated beneficiary, rather than restricting that ability to a spouse's account, as under current law.   It also would permit disabled individuals to contribute to an IRA even if they do not have earned income.