PPA makes automatic enrollment a retirement plan reality
Much has been written about the Pension Protection Act of 2006 (PPA) since its enactment last August, but it may be a while longer before manufacturers understand the full effects of its provisions.
Designed primarily to shore up ailing pension funds and ensure retirees’ benefits aren’t curtailed unexpectedly after they retire, the act also addresses nonpension retirement plans. How PPA will affect your company depends on what type of retirement plan you provide for your employees.
Simplifying automatic enrollment
If you’re like most employers today, you probably offer a 401(k) or comparable defined contribution plan. And fiduciary, legal and financial concerns may have made you reluctant to automatically enroll employees in that plan.
PPA makes it easier. Under the act, employees can’t sue you if the plan loses money, provided you offer reasonable investment options. Balanced funds, with investments in stocks and bonds or cash equivalents, are typically considered reasonable.
Additionally, PPA preempts state garnishment laws that require you to provide written notice to employees, or receive written permission from employees, before you deduct money from their paychecks.
You must, however, give employees 90 days to opt out of automatic enrollment and to receive any money deferred on their behalf. If they elect to take the money, it’s taxable income for the year but isn’t subject to the 10% early distribution penalty.
Another stumbling block to automatic enrollment has been nondiscrimination testing that limits total contributions made by highly compensated employees (those making more than $100,000) to a percentage of the total contributed by employees earning less money.
Under a safe harbor in PPA, you can adopt a qualified automatic contribution arrangement (QACA) that exempts you from meeting nondiscrimination requirements each year. Instead, you must match up to 3.5% of employees’ contributions, or make a nonelective contribution equal to 3% of compensation. In either case, your contribution must fully vest in two years.
Correcting your plan
If you choose not to adopt a QACA, you’ll be subject to nondiscrimination testing. If you fail the test, you must make corrections within 180 days after the end of the plan year. Current law provides only 90 days. You also must fund 100% of your plan’s total liabilities, rather than the 90% required under current law.
On the other hand, you also may maintain credit balances. If you currently have a credit balance, however, you must keep it separate from any credit balance that you may accumulate after 2008. You can use any credit balance to meet your minimum required contribution, but doing so also will reduce the value of your plan assets.
Other important provisions of PPA include:
Asset determination. You may average assets over three years to determine whether they’re sufficient to cover your plan’s liabilities, so long as the averaged value is between 90% and 110% of actual market value. Current law allows averaging over five years if the average value is between 80% and 120% of actual market value.
Liabilities. To determine your plan’s liabilities, you may use a modified yield curve being phased in over three years. You’ll use a different interest rate for plan liabilities due within five years, those due between six and 20 years, and those due in more than 20 years.
Vesting. All employer contributions for plan years beginning in 2007 must vest either at a three-year cliff (100% after three years) or a two- to six-year graded schedule (for example, 20% vested every year until 100% at six years).
Making a change
These and other provisions of PPA make automatic enrollment an advantage for you and your employees. Low participation in a 401(k) plan means not only that employees are at risk of not having enough money to live on when they retire, but also your highly compensated employees can’t contribute as much as they’d like to.
By automating the enrollment process for your retirement plan, you change the decision employees must make. Instead of deciding whether to participate, they must decide not to participate. With the changes being ushered in by PPA, now may be the time to take the initiative.
Sidebar: Remove the fear factor
One barrier to employee participation in a retirement plan is that many workers don’t feel qualified to make wise investment allocation choices. As of this year, you can help allay their fears.
The Pension Protection Act of 2006 (PPA) allows you to arrange investment advice for your employees as of 2007, without fear that you’ll be held liable for any subsequent losses in employees’ holdings. There are rules, though.
You can contract with a registered investment advisor such as an insurance company or bank to provide advice, but the advisor’s fees can’t vary according to the investment options people select.
Alternatively, you may offer advice using a computer model, so long as the program applies generally accepted investment theories, takes into account individual participants’ preferences and financial status, and considers all available options in determining the best balance of investments for each employee.
Also, note that you cannot offer both a computer model and individual consultations. You must decide which is best for your circumstances. Your financial professional can help you make the determination.
For more information about our services to inventory based businesses,
Contact: Mark Walker, Partner, Director of Inventory Based Businesses Practice at 817.882.7724.
The articles in this newsletter are general in nature and are not a substitute for accounting, legal, or other professional services. We assume no liability for the reader's reliance on this information. Before implementing any of the ideas contained in this publication, consult a professional advisor to determine whether they apply to your unique circumstances.