How the Pension Protection Act May Impact Your Firm

How the Pension Protection Act May Impact Your Firm

By Patricia Lawrence, NYSSCPA Human Resources Manager

Clients who sponsor retirement savings plans—whether they are large or small corporations or not-for-profits—will likely experience increased operating costs due to the impact of the Pension Protection Act of 2006. Likewise, your accounting firm might feel these same effects.

When President Bush signed the Pension Protection Act of 2006 (PPA) into law on Aug. 17 of this year, he approved many provisions that, among other things, repealed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). The PPA also made permanent the contribution limits for IRAs and other qualified plans; simplified automatic enrollment; improved investment options and diversification rules; provided added fiduciary protection for default investments, and expanded hardship withdrawal reasons.

What follows is a breakdown of some of the major changes to be ushered in by the PPA regarding employee contributions to their retirement plans. Note that increased pension contributions is merely one element of many addressed by the Pension Protection Act 2006.

Contribution Limits

Contribution limits for the various types of retirement savings plans such as 401(k), 457, 403(b) , SIMPLE, IRA and the like have increased over the last five years and some will continue to increase through indexing.

Some see the “catch-up” contributions as a welcomed, unique and overdue benefit initiated under EGTRRA for individuals aged 50 years and older. This provision allows older employees to save more for retirement in excess of the annual elective deferral limit, thus permitting these individuals to save at a faster rate as they got closer to retirement.

Automatic Enrollment

The PPA encourages the use of automatic enrollment in 401(k) and 403(b) plans, and has created a new “safe harbor” provision for qualified automatic contribution arrangements. Automatic enrollment puts individuals in the driver’s seat by permitting them to opt out of participation in a retirement savings plan rather than opting in. If an employee wanted to opt out of a company or firm’s retirement savings plan, a specific request would be required.

Automatic salary deferral, another feature under the automatic enrollment provision, would “automatically escalate salary deferrals.” Automatically increasing the salary deferral percentage when employees receive a salary increase, for example, would allow them to save at a steady rate. This feature could also significantly reduce the paperwork for both employers and employees. Automatic enrollment will become effective in 2008.

Prohibited Transaction Exemption

The PPA creates a new prohibited transaction exemption under the Employee Retirement Income Securities Act of 1974 (ERISA) that permits related parties, such as investment providers, to give investment advice (including, for example, recommendation of the advisor’s own funds) to plan participants and IRA owners if either a) the advisor’s fees don’t vary based on the investment selected by the participant or b) (for employer-sponsored retirement plans, but not IRAs) the advice is based on a computer model certified by an independent expert, and certain other requirements, including detailed disclosure requirements, are satisfied.

The PPA also addresses the diversification requirements for defined contribution plans in that it requires that plan participants be permitted to invest their own pre-tax and after-tax contributions in investments other than employer stock. In addition, participants are allowed to invest employer contributions in investments other than employer stock after three years of service. The PPA also provides protection to retirement plan fiduciaries in situations where employees’ accounts are placed in a default investment because the participant failed to make an affirmative investment election.

Hardship Distribution

PPA expanded the hardship rules for 401(k)s, 403(b)s, 457s and nonqualified deferred compensation plans if the participant’s plan beneficiary incurs the hardship or in the event of an unforeseeable emergency distribution. Two new hardship reasons have been added: “funeral expenses” and “repairing a principal residence” if the repair falls within IRS guidelines. The IRS is expected to issue theses rules within 180 days of the enactment of the PPA.

Be Aware of Potential Cost Increases

In an effort to promote and encourage continued retirement savings in the United States., the Pension Protection Act of 2006 benefits most of the players in the retirement arena—the employee, the investment advisor and the fiduciary—but in most cases at increased costs to employers who provide retirement benefits to their employees. For more information on the PPA, visit the U.S. Department of Labor’s Web site at www.dol.gov.

Patricia Lawrence can be reached at plawrence@nysscpa.org.