The Pension Protection Act of 2006 contains good news for retirement plan sponsors and participants. What should advisors do as a result? Consider the following.
EGTRRA provisions are permanent. In 2002, the Economic Growth and Tax Relief Reconciliation Act reset the annual dollar limit for 401(k) salary deferrals to $11,000 and established catch-up contributions of $1,000 per year for those age 50 and over. EGTRRA also prescribed annual $1,000 increases from 2002 to 2006. PPA made these provisions, which originally were set to expire in 2010, permanently. It also preserves the higher level of 401(k) salary deferrals. As of 2007, it provides for cost-of-living increases in $500 increments.
What advisors should do: Notify clients each year to advise them of the 401(k) and catch-up limits for the year. Employees can be encouraged to participate in their employer’s 401(k) because these permanent increases could make it easier for them to reach retirement goals in less time.
ERISA now preempts state laws regarding 401(k) automatic enrollments. Some states (California being one) had said that the practice of automatic enrollment violates state wage payment laws requiring an election signed by an employee before an employer can withhold monies from his wages. Effective with PPA, ERISA preempts state law to the extent that such law would interfere with an automatic enrollment arrangement.
What advisors should do: An automatic enrollment feature will usually result in increased participation. Advise clients who do not wish to adopt a Safe Harbor 401(k) plan, or who otherwise want to encourage employees to take advantage of their 401(k) arrangement, that automatic enrollment may be a good practice.
Accelerated vesting now required. For pre-2007 plan years, non-top heavy plans could use 5-year cliff vesting (100% vesting after 5 years of service) or 7-year graded or 3/20 vesting (20% vesting after 3 years of service increasing by 20% with each additional year of service thereafter until vesting reaches 100% after 7 years of service).
For plan years beginning in 2007, accelerated vesting is required. There are now 2 minimum vesting schedules available for employer contributions. There is 6-year graded or 2/20 vesting (20% vesting after 2 years of service increasing by 20% with each additional year of service thereafter until vesting reaches 100% after 6 years of service) or 3-year cliff vesting (100% vesting after 3 years of service.) Plans can always allow for faster vesting.
What advisors should do: Make sure that clients’ plans are amended to reflect one of these new vesting schedules.
Rollovers of IRAs for non-spouse beneficiaries now allowed. Prior to PPA, only spouse beneficiaries were allowed to roll over a distribution from a qualified plan, a 403(b) plan or a 457 plan to an IRA without tax consequences. With PPA, effective for distributions after Dec. 31, 2006, non-spouse beneficiaries may also roll their distribution to an IRA.
What advisors should do: Advise clients of the new law and ensure election forms and procedures are updated to reflect it.
Quarterly pension benefit statements. Defined contribution plans, such as 401(k)s, must provide at least quarterly pension benefit statements to plan participants or beneficiaries who have the right to direct the investments of their accounts. These statements must include:
o Total value of assets as of most recent valuation, including the value of each investment.
o The vested percentage of the account balance or how to determine the vested percentage.
o An explanation of permitted disparity (also known as Social Security integration) if the plan’s employer contribution is allocated using that method.
o A disclosure regarding the importance of a diversified portfolio.
o An explanation of any restrictions or limitations on a participant’s ability to direct an investment.
o The Department of Labor’s website for information on individual investing and diversification.
For plans where participants or beneficiaries do not have the right to direct account investments, the pension benefit statement must be provided once each calendar year.
What advisors should do: Make sure clients are providing pension benefit statements no later than 45 days after the end of the calendar quarter to all plan participants and beneficiaries who have the right to direct the investments of their accounts.
Combined defined contribution and defined benefit plans. The deduction limit for employer contributions to a DC plan is 25% of the aggregate compensation of the plan participants. Before PPA, when an employer sponsored both a DC and defined benefit plan, where some employees were covered by both plans, this same 25% limit applied to the combination of plans.
With PPA, a 6% employer contribution is allowed in a DC plan even when the DB required funding amount is greater than 25% of compensation. Because of this 6% cushion, if the required contribution to the DB plan is 12% of compensation, a contribution of 19% of compensation could be made to the profit sharing plan. That is, the sum of the DB and DC plan contributions could equal up to 31% of the aggregate compensation of plan participants and still be deductible.
Be careful, though, as this does not mean an employer could contribute 31% to a profit sharing plan just because it also sponsors a DB plan. The 25% limit applies separately to each plan.
What advisors should do: Review clients who have DB plans. They might also want to adopt a 401(k) profit sharing plan and make an employer contribution of 6% of compensation. Remember, salary deferrals don’t count against the deduction limit. Even better, the advisor might recommend a 3% non-elective Safe Harbor 401(k) Plan as a supplemental plan, since this would avoid non-discrimination testing on the salary deferrals and would allow highly compensated employees to contribute the full salary deferral limit.
Jeane Wechsler is vice president-administration with Contemporary Pensions, Inc., a Portal Group Holdings Company based in Walnut Creek, Calif. Her e-mail address is .