The Pension Protection Act Improves the Playing Field for Retirement Savings.

By Erin Corcoran

A new era of retirement savings began when President George W. Bush signed the Pension Protection Act of 2006 (PPA) on Aug. 17, 2006. This law establishes a new set of rules designed to enhance pension plans and encourage Americans to save more for retirement.

"The federal government has created an insurance system for businesses offering private pensions, and that insurance is funded by premiums collected from these employers," President Bush said when he signed the PPA. "When some businesses fail to fund their pension plans and are unable to meet their obligations to their employees, it puts a strain on the entire system."

The PPA strengthens the Employee Retirement Income Security Act of 1974 (ERISA). ERISA was developed to protect the interests of participants in employee benefit plans. It also aims to ensure that companies that offer defined benefit (DB) plans meet their pension promises.

Funds for All

The PPA requires companies with pension plans to be 100 percent funded on a current-liability basis by 2015, instead of 90 percent. Those companies with underfunded plans can no longer skip pension payments and are responsible for contributing money on a regular basis.

Take Away Items Here are key elements of the Pension Protection Act of 2006 Pension Plans Requires companies with underfunded pension plans to pay additional premiums to the PBGC. Extends a requirement for companies that terminate their pensions to pay additional premiums to the PBGC. Closes loopholes that allowed companies with underfunded pension plans to skip pension payments. Raises the cap on the amount employers can put into their pension plans. Underfunded companies are not allowed to promise pension benefits to their workers. Defined contribution plans Makes higher contribution limits permanent for IRAs and 401(k)s. Removes barriers that prevent companies from automatically enrolling their employees in defined contribution plans. Provides greater access to professional advice about investing for retirement.

"Going forward, pension plans will be better funded with more assets backing pension funds," says Steve Utkus, director of the Vanguard Center for Retirement Research.

Additionally, now companies are allowed to overfund their pension plans and add money when the company has a surplus at the end of the year. Before, they only could add a certain amount to their plans each year. Allowing companies to add more money during an excess period will build a cushion that can keep pension plans healthy in case the company has a bad year.

"Before this law, companies couldn't overfund their plans, but Congress has changed that," Utkus says. "Companies can put more money in a plan when they are doing well and build their pension funds."

Another stitch woven into the PPA is "pension promises." Employers are not allowed to promise pension benefits to employees if they are at risk and do not have enough money to finance their plans. Companies with underfunded pension plans cannot dig themselves deeper in the hole by promising extra benefits to their workers without paying for those promises up front.

The law also requires companies to pay extra funding and premiums to the Pension Benefit Guaranty Corporation (PBGC) when they terminate their pensions. The PBGC is the nation's pension insurance system that backs pension plans when companies can no longer support their pension plans. It was created by ERISA to encourage private pension plans as well as to provide pension benefits payment and keep pension insurance premiums at a minimum.

"Companies that terminate their pension plans must provide extra funding to the PBGC. The amount varies with the number of employees and retirees in the employer's pension system," says Rob Smith, manager of government relations at Ceridian, a human resource, transportation and retail information services company.

Incentives for Offering 401(k) Tools

The PPA encourages Americans to build ownership and financial independence by using more savings tools via defined contribution (DC) plans, such as 401(k) plans. The law also creates investment advice opportunities that were not available before to the 401(k) regime.

According to Ceridian, the PPA created a special safe harbor for nondiscrimination testing for automatic enrollment plans in which employers can choose to participate. To qualify for this safe harbor, employers need to meet certain tests relating to employee eligibility, minimum percentage automatic contributions, employer matching, two-year 100 percent vesting of employer contributions and 90-day employee opt-out and employee notice.

"This is particularly attractive for smaller and mid-market companies where 401(k)s are the most popular savings plans," Smith says. "It is a huge effort to get employees to save, and research has proven that automatic enrollment can increase employee participation in 401(k)s by nearly 30 percent."

If companies choose to participate under the safe harbor, the PPA creates incentives for employers to provide certain retirement savings tools for their employees. These tools include auto-enrollment into a company's defined contribution plan as well as providing third-party investment advice. Even though these options are not mandatory, "it's a great first step and it opens doors for more laws to be made," Utkus says.

The incentives for companies to provide these tools include waiving the nondiscrimination testing rule. This rule states that if the number of lower-paid employees that join in a company's DC plan doesn't match the number of higher-paid employees, then the higher-paid employees can't contribute the maximum allocation ($15,000) into their plan. However, if the company offers a qualified auto enrollment plan that meets the safe harbor requirements, this will be waived. "It's great that Congress started this approach, but the downside is that incentive for employers is relatively modest," Utkus says. "Yet, it's something valuable that has been added to the law."

One of the most significant changes made by the PPA was the indefinite extension of the pre-tax contribution limit of $15,000. Before, this temporary limit was established, the maximum contribution was $10,000.

"The $15,000 limit was first created because DB plans were dropping and Congress wanted to promote DC plans," Smith says. "This bill boosted the amount employees could contribute to their 401(k)s and it brought DC plans into greater popularity. Making it permanent will have a significant effect on future retirees."

The bottom line for the Pension Protection Act is that "it is good news for baby boomers that are short on savings," Utkus says. "They can be confident that their employers will keep their pension promises."