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Pension Protection Act Passes Congress

With the signing of the Pension Protection Act on August 17, 2006, by President Bush, significant legislation was put into effect with the intent of strengthening workers’ retirement security.  The Pension Protection Act changes defined benefit plan funding rules, legitimizes cash balance plans, encourages automatic enrollment in 401(k) plans, makes permanent the improvements in the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), and allows for the creation of a combination defined benefit and 401(k) plan, called the DB(k). The bill also extends the use of corporate bond rates for funding through 2006 and 2007.  Most changes are effective with plan years that begin in 2008.

Single Employer Plan Funding
The bill changes the current defined benefit funding rules after 2007 to require:

• A funding target of 100% of current liability. Plans that are fairly well funded can phase-in the 100% target from 2008-2010. Plans that are required to make a deficit reduction calculation in 2007 are not eligible for the phase-in.    
• The difference between current liability and assets to be amortized over 7 years.
• The current liability to be measured using a modified yield curve interest rate.

“At-Risk” Plans
A plan is considered “at risk” based on its funding status.  At-risk plans are subject to accelerated funding requirements.   Plans with fewer than 500 participants are exempt from the at-risk rules. 

Restrictions on Benefits
A plan’s funding status triggers the following:

• Below 80% funded – Prohibits amendments to increase benefits (unless certain conditions exist).
• Between 60% and 80% funded – Prohibits lump sum benefits generally in excess of 50% of the participant’s accrued benefit.
• Below 60% funded:
  • Freezes benefit accruals
  • Prohibits plant shutdown benefits
  • Prohibits lump sum benefits
  • Restricts nonqualified executive compensation arrangements

Modified Yield Curve
The yield curve is based on a 24-month average of the yield on AAA, AA, and A rated corporate bonds of varying maturities.  The modified yield curve interest rate for valuing liabilities includes three interest rates; for liabilities due in under 5 years, between 5 and 20 years, and in over 20 years.  The change in calculating a plan’s liabilities is phased in during 2008 and 2009. 

Other Defined Benefit (DB) Plan Changes
The bill includes the following DB plan changes:

• Makes substantial changes to the funding rules for multi-employer collectively bargained plans.
• Requires lump sum benefit payments to be based on the same yield-curve approach used for pension funding, phased in over five years beginning in 2008. 
• Increases disclosure requirements for all plans so that participants are better aware of the funding status of their employer’s plan.
• Clarifies that cash balance plans are not inherently age discriminatory, benefits must be fully vested in three years, interest credits cannot exceed a market rate of return, and pay credits cannot be lost. 

EGTRRA Permanency
The increased limits in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) were set to expire after 2010.  The bill makes the EGTRRA retirement plan changes and IRA changes, including the low-income Saver’s Credit, permanent.

Automatic Enrollment
The bill provides an automatic enrollment safe harbor design for 401(k), 403(b), and governmental 457 plans that gives relief from nondiscrimination and top heavy testing. It also gives relief from state tax withholding laws and directs the Department of Labor to issue fiduciary safe harbors for default investments.

Other Defined Contribution (DC) Plan Changes
The bill includes the following DC plan changes:

• Creates two new prohibitive transaction exemptions for giving investment advice to plan participants.
• Requires that plan participants have immediate diversification rights with respect to elective deferrals and employee contributions.   
• Allows taxpayers to direct the IRS to rollover the refund of their income tax directly into an IRA of the taxpayer’s choice.
• Permits non-spouse beneficiary tax-free rollovers between a qualified, 403(b), and governmental 457 plan and an IRA.

While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject covered and is provided with the understanding that The Principal is not rendering legal, accounting, or tax advice.  It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code.  You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements. 

Insurance products and plan administrative services are provided by Principal Life Insurance Company®
a member of the Principal Financial Group, Des Moines, IA 50392.

ZZ 22915
08/2006