(From the August 7, 2006 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)
Pension Reform Bill On Its Way to the President!
Late on August 3, the Senate approved H.R. 4, the Pension Protection Act of 2006, a comprehensive pension reform bill the House passed on July 28. Because the Senate did not amend H.R. 4, the bill now goes directly to the President, who is planning to sign it. Thus, the legislative process that started almost two years ago finally is coming to an end. But the fun is just beginning for plan sponsors and other stakeholders, who now must sift through the 1,100+ page bill and begin learning a whole new set of funding rules for single-employer defined benefit plans, among other things.
Deloitte's Global Employer Rewards Integrated Services Offering is producing two booklets on the new law. The first, Securing Retirement: An Overview of the Pension Protection Act of 2006, is already available. The second, which will be available sometime this week, will take a more focused look at the new funding and related rules for single-employer defined benefit plans.
Overview of Funding Rules
The bill would wholly re-write the funding rules for single-employer defined benefit plans. Essentially, plans would be subject to a 100 percent of current liability funding target, and more funding would be required of "at-risk" plans. All funding shortfalls would be amortized over seven years, and the ability to use credit balances to offset minimum required contributions would be curtailed.
The new rules generally would be effective beginning in 2008, although some provisions would be effective earlier and others would be phased-in over a period of several years. Until 2008 the current funding rules would continue to apply, and plan sponsors would be permitted to use the long-term corporate bond rate (instead of the 30-year Treasury bond rate) to calculate plan liabilities. This is the same rate used for 2004 and 2005 plan years pursuant to temporary funding relief Congress enacted in 2004.
Some of the key features of the proposed new funding and related rules are as follows.
- Valuing Assets and Liabilities. Plan asset values could be averaged over 24 months, subject to a cap of 110 percent of market value as of the plan's valuation date. The present value of plan liabilities would be calculated using a 3-segment corporate bond yield curve. (The three segments would be 0-5 years, 6-20 years, and 20+ years.) The corporate yield curve would be based on a 24-month average of yields on the top three grades of corporate bonds. Treasury would establish the standard mortality table, but some large employers may be permitted to use plan-specific mortality tables.
- Credit Balances. Plans with credit balances in their funding standard accounts under the current rules would be permitted to carry over such balances and apply them toward future contributions required by the new rules. Also, plan sponsors who contribute more than required under the new rules would be permitted to carry prefunding balances for use in future years. These carryover and prefunding balances would have to be adjusted each year to reflect the rate of return on plan assets for the previous year. The new law would require plans to be at least 80 percent funded in order for plan sponsors to use carryover or prefunding balances to reduce their minimum required contributions. Additionally, plan sponsors would be required to reduce the value of plan assets by any prefunding balance (but not by any carryover balance) for purposes of determining if the 80 percent threshold is satisfied.
- Amortization of Funding Shortfalls. Plan sponsors would be required to amortize funding shortfalls over seven years. For purposes of determining if a funding shortfall exists, plan sponsors would be required to reduce plan assets by any carryover and prefunding balances.
- At-Risk Plans. Certain severely underfunded plans (i.e., "at-risk plans") would be subject to higher minimum required contributions. The new rules would not base at-risk status on the plan sponsor's credit rating. Instead, they would utilize a two-part test based on the plan's funded status. Specifically, a plan would be at-risk if it is less than 80 percent funded without regard to at-risk liabilities, and less than 70 percent funded when at-risk liabilities are taken into account. (Plan sponsors would be required to reduce plan assets by any carryover and prefunding balances for purposes of determining at-risk status.) The at-risk liability would be determined by assuming all workers eligible to retire in the next ten years would retire as early as possible. The at-risk liability would be increased by a load of 4 percent of liability plus $700 per participant for any plan at-risk for the current year and for two of the previous four years.
- Maximum Deductible Contributions. Plan sponsors would be permitted to deduct contributions equal to the plan's normal cost for the year plus the amount needed to fully fund the funding target, plus a cushion of 50 percent of the funding target, beginning with contributions after 2007. For 2006 and 2007 the deduction limit would be 150 percent of the plan's current liability.
- Lump Sums. Plans would be required to calculate lump-sum distribution amounts using the three-segment yield curve. However, unlike the yield curve used for funding, the yield curve used for lump sums would be based on a monthly interest rate. The yield curve would be phased in over five years beginning in 2008. For purposes of applying the IRC ? 415(b) limit to lump sum distributions, plans would have to use an interest rate not less than the greatest of 5.5 percent, 105 percent of the minimum distribution interest rate, or the plan-specified rate. This would apply to distributions beginning in 2006.
- Benefit Limitations. The new rules would impose limits on benefit increases, accelerated forms of benefits, shutdown benefits, and future benefit accruals for certain underfunded plans. Plan sponsors would not be permitted to amend their plans to increase benefits if their plans were less than 80 percent funded. In the case of plans between 60 percent and 80 percent funded, lump sum distributions could not exceed the lesser of the participant's PBGC guaranteed benefit or 50 percent of the lump sum the participant otherwise would receive. (The balance would be payable as an annuity.) For plans less than 60 percent funded, shutdown benefits could not be triggered, accelerated benefit payments (including lump sums) would be prohibited, and future benefit accruals would be frozen. Plan sponsors would have to reduce plan assets by any carryover and prefunding balances before calculating their plans' funded status for purposes of these rules. However, these limitations would not apply to plans that are 100 percent funded before reducing plan assets by any carryover and prefunding balances.
- Restrictions on Funding Executive Compensation. Plan sponsors would be prohibited from setting aside or reserving funds to pay nonqualified deferred compensation to certain executives if they sponsor an at-risk plan or if they previously have terminated an underfunded plan, or if they or a member of their controlled group, is bankrupt.
- PBGC Premiums. The Deficit Reduction Act (DRA) of 2005 increased the PBGC's flat-rate premium to $30 per participant beginning in 2006 and provided for automatic annual premium adjustments for inflation, and created a temporary bankruptcy exit premium. The DRA did not make any changes to the variable-rate premium, which is $9 per $1,000 of unfunded vested benefits. However, this bill would require plans to use a three-segment yield curve to calculate unfunded vested benefits for calculating the variable-rate premium and eliminate the full funding exception to the variable-rate premium. It also would make the bankruptcy exit premium permanent.
- PBGC Guarantee. The bill would treat plant shutdown or other contingent events as plan amendments so the PBGC guarantee would be phased in over a five-year period, effective for events occurring after July 26, 2005. In the case of plans terminating after the plan sponsor files for bankruptcy, the plan termination date would be the bankruptcy date for purposes of determining the applicable maximum guarantee and the five-year phase in of the guarantee, among other things.
- ERISA ? 4010 Filings with the PBGC. The bill would require all plans less than 80 percent funded to file plan actuarial and employer financial information with the PBGC. Additionally, the bill would require additional funding information, including termination liabilities, as part of these ? 4010 filings. Finally, the PBGC would have to submit a summary report of all ? 4010 filings to Congress each year.
- Disclosure. The bill would require all defined benefit plans to furnish a detailed funding notice to the PBGC, participants, beneficiaries, and unions representing participants no more than 120 days after the beginning of each plan year. Also, defined benefit plans would be required to provide individual benefit statements every three years or upon request. As an alternative, plans could notify participants each year about how to go about obtaining an individual statement.
In addition to the defined benefit plan funding and related provisions, the bill contains numerous other provisions relating to qualified retirement plans -- including defined contribution plans. Following is a brief summary of some of the more significant of these provisions.
- Hybrid Plans. The bill would provide rules for testing all defined benefit plans, including cash balance and other hybrid plans, for compliance with the age discrimination rules in the IRC, ERISA, and the Age Discrimination in Employment Act. Hybrid plans would be subject to certain specific requirements relating to vesting and investment credits. The bill would prohibit "wearaways" when converting traditional defined benefit formulas to hybrid formulas, and eliminate the "whipsaw" problem by permitting hybrid plans to pay lump sums equal to the balance in the recipient's hypothetical account. These provisions (other than the whipsaw provision) generally would be effective for periods beginning on or after June 29, 2005, and apply on a prospective basis only.
- Automatic Enrollment. The bill would preempt state wage garnishment laws to the extent they interfere with an employer's ability to offer an automatic enrollment feature to its 401(k) plan. It also would provide fiduciary relief with respect to default investment options and establish a matching safe harbor for nondiscrimination testing available to qualified automatic contribution arrangements.
- Investment Advice. The bill would create a prohibited transaction exemption relating to investment advice provided by a party-in-interest, if the investment advice is provided through a computer model that has been certified by an independent third party. Another exemption would be available for advisers whose compensation does not vary with the investments selected.
- Phased Retirement. The bill would permit defined benefit plans to make in-service distributions beginning at age 62, thus facilitating phased retirement arrangements.
- Employer Stock Diversification Requirements. The bill would require 401(k) plans to permit participants to immediately diversify employer stock holdings attributable to employee contributions or elective deferrals. Employer stock holdings attributable to employer contributions could be diversified any time after the employee has been a participant in the plan for three years.
- EGTRRA Permanence. The bill would make the EGTRRA pension reform provisions -- including higher benefit and contribution limits, catch-up contributions, Roth 401(k)s, etc. -- permanent.
|The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations.
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Copyright 2006, Deloitte.
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