The Pension Protection Act (PPA) of 2006 was signed by President George W. Bush on August 17, 2006. The PPA is the most significant legislation having to do with pension plans since the Employee Retirement Income Security Act of 1974 (ERISA). The PPA looks to strengthen the traditional private pension system by offering incentives to employers, as well as providing to employees a more stable path to retirement. As you examine more details about the PPA and how it might fit into your overall financial picture, consider a financial advisor who can provide hands-on guidance.
Before the PPA, many employers were finding ways to cut pension funding and skip payments to the Pension Benefit Guaranty Corporation (PBGC), which was created as part of ERISA to provide a safety net for participants in the event that their employer-sponsored defined benefit plans became insolvent. As more companies continued to skip payments, or abandon defined-benefit plans altogether, the PBGC fell more into debt. As a result, the PPA requires pension providers to fund their defined-benefit plans fully and requires those guilty of underfunding to pay higher premiums.
The PPA also made permanent the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) that were supposed to expire in 2011. Some of these provisions include:
- Increases in contribution limits to Individual Retirement Accounts (IRAs): Prior to EGTRRA, contributions to IRAs were limited to $2,000. EGTRRA provided new IRA limits, which increase in incremental amounts with cost-of-living increases (COLAs). This means that employers can contribute more to pension plans during prosperous times in order to make up for the possibility of lower payments when times are tough.
- Catch-up contributions: Employees who are 50 years or older may make additional contributions to their 401(k) accounts and/or IRAs.
- Allowing Roth contributions under 401(k) and 403(b) plans: Employers are allowed to add a Roth component to their 401(k) or 403(b) programs, which allows employees to designate their salary deferral contributions as after-tax Roth contributions. Unlike a Roth IRA, a Roth 401(k) does not have any income limits, so all employees can choose this account type regardless of their income level. Roth 401(k) contributions are made after-tax, but employees can withdraw both the contribution and the earnings on those contributions tax-free. This approach differs from the traditional 401(k) in which taxes on both contributions and earnings are not applied until withdrawal.
- Giving tax credits to employers for start-up costs and expenses incurred when establishing and/or administering employer-sponsored plans.
In addition to making the EGTRRA provisions permanent, the PPA also enacts new legislation that affects employers and employees, or plan participants. The following are some key changes the PPA has brought about.
Automatic Enrollment
The PPA makes it easier for employers to enroll employees into a 401(k) plan automatically. In the past, most 401(k) plans required employees to agree to put money into a 401(k) plan, whereas automatic enrollment allows the employer to withhold a percentage of employees’ pay and contribute it to the 401(k) plan, all while giving employees the option to opt out.
The PPA requires that employers who choose automatic enrollment plans explain that the employee has the right to change the rate of contribution to the 401(k), or to opt out of the plan altogether. The employer must also define the time periods for such decisions to be made. The percentage automatically withheld must be the same for all employees covered by the plan and cannot surpass 10% of salary, although the employee can choose to contribute more or less to the plan.
Diversifying
It is common for 401(k) plans to require that employer contributions to the plan be invested in employer stock. However, the employee stands to lose money if the stock value decreases by the time the employee retires. The PPA requires that in a defined contribution plan, the employer must provide at least three investment alternatives in the event that the stock loses value. Employees of three or more years have the option to transfer the value of the stock into mutual funds or other investments that the employer offers with the plan.
Survivor Annuity
The PPA requires that defined benefit pension plans offer 75% survivor annuity, in addition to a lesser option equaling at least a 50% survivor annuity in the event that the retiree passes away and leaves a spouse behind. The law states that the couple can choose to have all benefits paid to the retiree during his lifetime, leaving nothing to the surviving spouse. However, the couple can also choose to leave the surviving spouse a larger survivor’s benefit, meaning there would be a reduction in the retiree’s lifetime benefit.
Access to Information
The PPA requires employers to provide periodic benefit statements to employees, whereas in the past, employees had to request information in writing.
For traditional pension plans, employers must provide individualized benefit statements every three years. For retirement savings plans (such as 401(k) plans) for which employees have control over their investment choices, statements must be provided once every quarter.
The PPA requires that all defined benefit pension plans, whether funded or underfunded, single or multiemployer, release annual plan funding notices to all parties involved – including employers, employees, beneficiaries, labor organizations representing employees and the PBGC. Multiemployer plans must also provide information on whether the plan was in critical or endangered status (depending on the percentage by which the plan is underfunded). If at any point the plans are underfunded to the point of being in critical or endangered condition, these plans must adopt rehabilitative plans to increase funding levels.
Advisement
The PPA makes it easier for employees to seek objective information regarding the plan that will work best for them. Fiduciary advisors may be compensated for providing investment advice but are protected by conditions that state the compensation cannot change based on the investment option selected. A certified independent third-party computer model can also provide advice. The PPA also increases penalties for coercive interference with pension rights. Equal compensation and greater penalties regarding pension plans and rights ensure that employees are receiving unbiased information about the difference in plans.
Bottom Line
Overall, the Pension Protection Act of 2006 (PPA) is a law that aimed to strengthen pension funding rules, provide employees with more information about their plans and give employees more options and control over their own retirement plans. Legislators created the plan to safeguard retirement accounts and hold companies accountable if they were not sufficiently funding retirement plans. The PPA made permanent particular provisions from the Economic Growth and Tax Relief Reconciliation Act of 2001. In addition, the PPA boosted contribution limits for IRAs and increased 401(k) salary deferral contribution limits. In bolstering the pension system at large, the PPA reduced the reliance on the federal pension system and the Pension Benefit Guaranty Corporation.
Tips for Getting Ready for Retirement
- Whether or not your employer offers an attractive pension, consider talking to a financial advisor as you prepare for retirement. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
- As you explore your pension and 401(k) plan, or other retirement account options to consider, don’t forget to factor in Social Security as you plan for your golden years. Our Social Security calculator can help.
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