Legal Bulletins

After lengthy and contentious debate, Congress passed comprehensive pension reform legislation — the Pension Protection Act of 2006. President Bush is expected to sign the legislation.
A major objective of the Act is to shore up the funding of defined benefit (“DB”) pension plans. However, the Act also includes a broad array of new rules affecting defined contribution (“DC”) plans, including 401(k) and 403(b) plans. It also attempts to resolve long-standing controversies affecting cash balance plans and DB plans. Finally, the Act makes permanent a number of retirement provisions enacted under the 2001 tax law (“EGTRRA”) that were due to expire in 2010.
The most important provisions of the Act are summarized below. All changes take effect in 2008, unless otherwise noted.
Defined Benefit Plans
The Act more closely ties a DB plan’s required contribution to the plan’s funded status.
Generally, the required contribution for a plan year equals the present value of benefits expected to be earned during the year plus the amount needed to amortize any existing funding shortfall over seven years. A plan has a funding shortfall if its ratio of assets to benefit obligations is less than 100%. (Lower percentages apply for 2008-2010.)
Sponsors of underfunded plans are subject to tougher funding rules. Depending on the level of underfunding, companies may be restricted from increasing benefit amounts or paying lump sums and, in some cases, will be required to freeze benefits. Effective immediately, top executives in a company’s non-qualified deferred compensation plan face tax penalties if the plan is funded (through a rabbi trust or similar arrangement) while the company’s qualified DB plan is underfunded or the company is bankrupt.
The Act will require larger contributions for many plan sponsors. While proponents of the Act maintain that the new rules are necessary to strengthen existing plans and reduce the potential liability of the PBGC, critics predict that the law will only cause more DB plans to be frozen or terminated.
Extension of EGTRRA Provisions
The 2001 tax law (“EGTRRA”) added a number of rules designed to increase retirement savings, but those rules expire in 2011. The Act makes the rules permanent. Among the affected rules are:

• annual deferral limits under 401(k) and 403(b) plans, including over age 50 catch-up contribution limits, and IRA limits;
• annual Section 415 contribution limits under DC plans and benefit limits under DB plans; and
• limits on pay that can be taken into account under DB and DC plans.
  

Other Changes
There are other provisions of the Act that affect employee benefits. For example, beginning in 2007, non-spouse beneficiaries can rollover retirement plan distributions. In addition, there are new requirements for DB and DC plan benefit statements, and plan sponsors must make Form 5500 information more readily available to participants. The Act also expands use of excess pension assets to fund retiree medical benefits.