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The Pension Protection Act of 2006


Over three decades ago, President Gerald R Ford signed The Employee Retirement Income Security Act (ERISA) into law. Nearly every American was affected by its passage, and an institutional asset management business of unbelievable scale was created. On August 17, 2006, just days short of the 32nd anniversary of ERISA's enactment, President Bush signed off on the Pension Protection Act (PPA). It promised, as ERISA did before it, to change everything.

Among the most significant changes for defined benefit plans, the PPA:

  • 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;
  • Reduces the smoothing of interest rates to two years;
  • Allows employers to make additional maximum deductible contributions of up to 180% of current liability;
  • Prohibits 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 premium is paid after emerging from bankruptcy);
  • Requires employers to meet a 100% funding target and erase funding shortfalls over seven years. The final version included some special provisions for the airline industry that give these plans longer to resolve funding issues, but also imposes a higher premium on plans that terminate their pensions while entering bankruptcy. For cash balance plan sponsors, the bill sanctioned the design by establishing 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. The Pension Protection Act also stepped up focus on plan disclosure:
  • Requiring more detailed and specific information on Form 5500 filings;
  • Enhancing 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 plans within 120 days after the close of the plan year;

On the defined contribution side, the PPA prohibits forcing employees to invest any of their own retirement savings contributions in the stock of the employer; requires 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; while also making clear that companies have a fiduciary responsibility for workers' savings during "blackout" periods.

The Pension Protection Act removed the sunset provisions of the Economic Growth and Tax Relief and Reconciliation Act (EGTRRA) thus maintaining higher deferral limits, the catch-up contribution provisions for older workers, and keeps in place the Saver’s Credit and Roth 401(k), to name just a few.

The bill made clear that its provisions supersede state wage-withholding laws, a potential concern of employers with workers in states that require an employee signature before withholding from their pay. Plan sponsors were offered a new safe harbor for 401(k) that relieves a sponsor of the need to do ADP/ACP testing and excludes the plan from Top Heavy consideration, if the plan is a qualified automatic contribution arrangement. To qualify, a “qualified percentage of compensation” must be deferred—no more than 10% of compensation and, under the arrangement, the automatic deferral for participants must be at least 3% of pay in the first year, increasing 1% a year until it reaches 6% of pay. The plan also must provide either a non-elective contribution of 3% of pay or a matching contribution equal to the participant contribution as a percentage of pay or the matching contribution as a percentage of the participant contribution.

Employees must be notified of the planned automatic enrollment and investment selection with enough time between receipt of the notice and when the first elective contribution is made to make an affirmative election, and must be given the ability to “opt out” of the “opt-in,” if they so choose. These provisions need not be applied retroactively to current employees with an election in effect. Although the state preemption was effective immediately upon enactment of the bill into law, the safe harbor does did not go into effect until 2008.

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