On August 3, 2006, the Senate passed H.R. 4, which will be known as the Pension Protection Act of 2006 once it is signed into law. The Act – which exceeds 900 pages in length – embodies a long list of benefits-related amendments to the Internal Revenue Code of 1986, as amended (the Code), and the Employee Retirement Income Security Act of 1974, as amended (ERISA). Among other things, the Act will result in broad-ranging and significant changes in the funding requirements for defined benefit pension plans, impose potentially heavy new financial obligations on employers participating in multiemployer pension plans, and change important aspects of plan administration for many 401(k) and other defined contribution plans.
Pension Plan Funding
The Act will bring about significant changes in how single employer and multiemployer defined benefit plans are funded. For single employer plans, pension liabilities will be valued for funding purposes using a modified yield curve, based on a two-year average of corporate bond rates, that takes into account whether the liabilities will become due within five years, between five years and 20 years, or after 20 years. Single employer plans that are less than 80 percent funded will not be permitted to take credit balances into account. The Act also will impose stepped up funding requirements for single employer plans that are “at risk” (i.e., plans that are less than 70 percent funded based on special “at risk” testing assumptions). The enhanced funding requirements for “at risk” plans will be phased in through 2011.
The Act establishes funding thresholds to categorize multiemployer plans as “endangered,” “seriously endangered,” and “critical.” Trustees of endangered and seriously endangered plans must develop and implement funding improvement plans designed to meet certain improvement targets over 10 or 15 years.
Trustees of “critical” status multiemployer plans – those plans funded below 65 percent – must develop a rehabilitation plan designed to bring the multiemployer pension plan out of critical status in 10 years. To put a rehabilitation plan into effect, the Act empowers multiemployer plan trustees to reduce certain retirement benefits, impose a five percent surcharge on contributions (rising to 10 percent under some circumstances in subsequent years), and propose additional measures to the collectively bargained parties, including a “default proposal” that will take effect unless an alternative is adopted by the parties.
The collectively bargained parties’ failure to agree on a rehabilitation plan can result in penalties of $1,100 per day under ERISA or excise taxes under the Code. In addition, if a collective bargaining agreement that was in force when the plan entered critical status expires, and the parties to that agreement fail to agree to contribution or benefit schedules consistent with the trustees’ rehabilitation plan proposal, the trustees will implement the “default schedule” under which contributions will be increased to the extent deemed necessary to emerge from critical status after benefits and future benefit accruals have been reduced to the maximum extent permitted by law.
The Act creates an exemption from the prohibited transaction rules permitting a fiduciary to offer investment advice to plan participants with respect to particular investment options under a defined contribution plan, and to receive a fee or other compensation for the investment advice. The exemption applies only if certain detailed form, content, disclosure, and record-keeping requirements are met.
New Diversification Requirements for Public Company Defined Contribution Plans
The Act also imposes new diversification requirements on most qualified plans other than certain employee stock ownership plans (ESOPs) that hold or are deemed to hold publicly traded employer securities. In essence, participants in such plans must be permitted to divest employer securities from their employee contribution and elective deferral contribution accounts and to reinvest in any one or more of at least three other investment media that satisfy certain diversification characteristics. The same rule applies to employer contribution accounts of participants with three or more years of service.
Non-Discrimination Safe Harbor for “Negative Election” 401(k) Plans
Section 902 of the Act resolves any lingering doubts regarding the validity under state law of so-called “negative election” plans, under which the default option for participants who do not take affirmative steps to enroll is a predetermined rate for elective deferral contributions. Section 902 creates a non-discrimination safe harbor for Section 401(k) plans that are “qualified automatic contribution arrangements.” A qualified automatic contribution arrangement must comply with several conditions to satisfy the non-discrimination safe harbor, one of which is an automatic elective deferral rate equal to at least three percent through the end of the participant’s first full plan year of participation, four percent during the next plan year, five percent during the next and six percent thereafter.
Withdrawal Liability Provisions
The Act eliminates some features of current law that reduce the amount of withdrawal liability assessments multiemployer plans can make under certain circumstances. Perhaps of greater importance, Section 204(b) of the Act adds a new circumstance that will constitute a “partial withdrawal,” thereby enhancing the ability of a multiemployer plan to assess liability against an employer when a covered facility is closed or the employer bargains out of the plan at a given location. The Act provides that a “partial withdrawal” occurs when an employer permanently ceases to have an obligation to contribute under one or more but fewer than all collective bargaining agreements that require contributions to a particular multiemployer pension plan, if the employer “transfers such work [i.e., work of the type for which contributions to the fund previously were made] … to an entity or entities owned or controlled by the employer.” Multiemployer plans may assert that only a minimal degree of ownership or control is required to cause the new definition of “partial withdrawal” to apply.
Cash Balance and Pension Equity Plans
The Act also includes a provision relating to the application of pre-existing sections of the Code and ERISA that prohibit reducing the rate of a participant’s benefit accrual based on age, a provision some courts have held is violated by the benefit formulas typically found in cash balance and pension equity plans. Under the Act, a plan generally will not be treated as violating these provisions merely because the accrued benefit of an otherwise similarly situated older worker under the plan is a smaller percentage of a normal retirement benefit at age 65 than the benefit accrual of a similarly situated younger worker, provided that the interest credit under the plan (or equivalent plan feature) does not exceed a market rate of interest (as determined by the Treasury Department). The Act also prohibits “wear away” under cash balance or pension equity benefit formulas adopted after June 29, 2005. In addition, Section 701(d) of the Act provides that the amendments made by Section 701 should not be construed “to create an inference” regarding the permissibility of benefit accruals under Section 4(i)(1) of the Age Discrimination in Employment Act or under various provisions of ERISA or the Code prior to the amendments adopted by the Act, which are effective as of June 29, 2005.
Employers with questions regarding the impact of the Pension Protection Act of 2006 should contact the Ogletree Deakins attorney with whom they normally work, a member of the Firm’s Employee Benefits Practice Group, or the Client Services Department at 866-287-2576 or via email at email@example.com.
Note: This article was published in the August 4, 2006 issue of the National eAuthority.