Pension Reform

The sweeping Pension Protection Act of 2006 was signed into law by President Bush on August 17. The Act contains new rules for automatic enrollment in 401(k) plans, changes in funding requirements of defined benefit plans, and extension of contribution limits under the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), among many other changes.

Automatic Enrollment

One of the significant aspects of the pension act is new rules to encourage employers/plan sponsors to adopt automatic enrollment in order to boost employee participation in 401(k) plans. These automatic enrollment rules are effective for plan years beginning after Dec. 31, 2007, except for the ERISA preemption rule, which is effective on the enactment date. The effective date, however, need not be a barrier to employers who want to set up an automatic system sooner. Prior to Dec. 31, 2007, plan sponsors can establish automatic enrollment in compliance with current IRS rules.

Here are some of the more important provisions relating to automatic enrollment:

Employers must provide notice to participants they automatically enroll in 401(k) plans explaining their right to elect out of the plan or to change contribution levels; the time period for contributions; and the default investment options in the absence of any election from the participant.

The Act creates a new non-discrimination "safe harbor" for both the ADP and ACP tests for automatic enrollment plans. To qualify for the safe harbor, the plan must provide a default salary deferral contribution of at least 3% that increases annually by 1% increments to at least 6%, but no more than 10%.

A plan satisfies the contribution safe harbor by either making matching contributions of 100% of elective deferrals up to 1% of compensation, plus an additional 50% of elective deferrals on the next 5% of compensation; or by making a non-elective contribution of at least 3% of an employee's compensation for all eligible employees.

Employee contributions must be 100% vested after two years of service to qualify for safe harbor treatment.

Automatic enrollment plans may give participants a 90-day period to opt out of the plan and withdraw the contributions made on their behalf and any earnings. These distributions are not subject to the 10% penalty that normally applies to early distributions (prior to age 59�).

A plan is treated as complying with section 404(c) of ERISA, which provides limited protection against fiduciary duty violations as long as it provides participants with proper notice of their rights to elect out of the plan and invests contributions in accordance with Department of Labor (DOL) guidelines which will be established soon. The DOL guidelines will set rules for investing automatic enrollment contributions where the participant did not choose an investment option.

It should be noted that the new pension act does not require 401(k) plans to adopt automatic enrollment, nor to follow the safe harbor design specified in the new rules. However, if 401(k) plans do not follow the Act�s safe harbor provisions they must continue to comply with existing regulations.

Financial Advice

The Act permits employers to obtain financial advice for participants without violating ERISA fiduciary rules.

A registered investment company, bank, insurance company, or broker may give investment advice to participants and not be treated as engaging in a prohibited transaction provided the fee does not change depending on a participant�s investment choices; or the advice is based on a computer model certified by an independent third party.

New Hybrid Plan

Under the Pension Protection Act, a new type of "hybrid" plan that combines features of both defined benefit and automatic enrollment 401(k) plans has been created. Employers with 500 employees or fewer may establish these plans beginning in 2010, provided they have a single plan document and trust fund. Plan sponsors operating combined defined benefit/automatic enrollment plans need only file one Form 5500 annual report.

In addition, there will be specific rules regarding minimum benefit and contribution levels, vesting, and uniformity of benefits, rights, and features.

If you have any questions regarding Pension Reform, or any other human resources topic, please contact Jack Lipovac at (515) 221-1718 or or lipovacj@hr-onesource.com.

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