Defined Contribution Provisions Gain Traction as Pension Reform Moves Ahead

Defined benefit reform has dominated the 2005 legislative agenda, but defined contribution issues started gaining traction as pension reform moved through the House and the Senate. Defined contribution provisions are included in both the Pension Security and Transparency Act (PSTA, S.1783), approved by the Senate on November 16, and the Pension Protection Act (PPA, H.R.2830), approved by the House on December 15. But the House and Senate bills differ significantly, so negotiations will continue.

Automatic Enrollment
Many employers have adopted automatic enrollment arrangements, which have been around for years. Efforts to further encourage automatic enrollment in defined contribution plans gained bipartisan support during the 2005 legislative session (see Watson Wyatt Insider, June 2005). Such provisions appear in both the PSTA and the PPA, with some differences between them.

Under the PPA, companies adopting qualified automatic enrollment arrangements would enjoy a safe harbor that exempts them from the participation, nondiscrimination and top-heavy rules. To qualify for the safe harbor, the plan would have to enroll all new employees at a 3 percent salary deferral. The plan would then automatically increase employee deferrals by 1 percentage point annually until reaching 6 percent of compensation. Employees could change their contributions or opt out of the plan altogether. But for the employer to continue to qualify for the safe harbor, at least 70 percent of employees would have to continue their participation in the automatic enrollment arrangement.

In safe-harbor automatic enrollment arrangements, employers would have to match at least 50 percent of employee contributions up to 6 percent of compensation. Alternatively, employers could contribute 2 percent of salary for all employees. Employer contributions would vest after two years of service. Employers would have to notify employees of their rights and obligations, including their right to change their deferrals and to opt out of the plan. If the plan offered more than one investment option, the notice would also have to explain the default investment option. Notices would have to give employees a reasonable period of time in which to choose contribution levels and investments.

Under the automatic enrollment safe harbor in the PSTA, employers would have to enroll all employees who were not contributing at least 3 percent of compensation. The plan would automatically increase annual contributions by 1 percent until reaching 10 percent of compensation. Employers could choose between matching at least 50 percent of employees’ contributions up to 7 percent of compensation or contributing at least 3 percent of compensation for all employees.

The PPA and PSTA would preempt state laws that interfere with automatic enrollment arrangements, such as state wage withholding laws, and provide fiduciary protection for employers’ default investments.

Permanent EGTRRA Extension
The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made many important changes to employer-provided retirement plans (see Watson Wyatt Insider, July 2001). But the act will expire on December 31, 2010, unless Congress extends it. The PSTA would not extend EGTRRA.

The PPA would permanently extend EGTRRA’s retirement savings provisions, including the saver’s credit, which provides a tax credit for low- and moderate-income taxpayers who contribute to employer-provided retirement plans or IRAs. The saver’s credit would otherwise expire in 2007.

Extending the retirement savings provisions would be extremely expensive — $30 billion over a 10-year period, according to estimates released by Congress’ Joint Committee on Taxation. The high price tag could diminish the prospects for all the extensions. But there has been bipartisan support for extending the saver’s credit, so that provision may be singled out for inclusion in final pension reform.

Diversification of Employer Stock
Under the PSTA, employees would gain new investment choices. Similar legislation was active on the 2002 legislative agenda — following Enron’s bankruptcy in late 2001 and a series of corporate scandals — but the issue was later eclipsed by pension reform.

The act would grant employees immediate control over their elective deferrals. Employees could diversify employer-contributed employer stock after three years of service. Standalone employee stock ownership plans (ESOPs) would be exempt from these diversification requirements, and a three-year phase-in period would apply to stock held on the act's effective date.

The PSTA would require employers to issue benefit statements and provide investment information. If defined contribution plan participants direct their own investments, the employer would have to provide quarterly benefit statements. Otherwise, they would have to provide annual statements showing total assets, vested benefits (or the vesting date) and the value of employer stock. The notice would also have to explain any limits on participants’ rights to direct their investments. Defined benefit statements would be required as well.

Investment Education
Both the PPA and the PSTA would promote retirement investment advice, investment education and retirement planning.

Under the PSTA, employers would have to provide basic investment guidelines for employees, including the benefits of diversification; essential differences among stocks, bonds, mutual funds and other investments; and guidance on choosing investments that appropriately reflect the investor’s age and years until retirement.

The PPA would allow “fiduciary advisers” to offer specific investment advice to plan participants. Employers would be responsible for the prudent selection and periodic review of fiduciary advisers, who would have to meet notification and other requirements. Employers that met specified requirements would not be liable for advice provided by investment advisers. The House approved this provision several times in the past, but opponents claim a conflict of interest, because fiduciary advisers could recommend investments in which they have a financial interest.

The PSTA takes a different approach, providing a safe harbor for employers that hire independent investment advisers. In addition, under the PSTA, participants could pay up to $1,000 per year for qualified retirement planning services through pretax payroll deductions.

Additional PSTA Provisions
The PSTA includes a wider range of defined contribution provisions than the PPA. For example, the PSTA includes several provisions aimed at improving retirement account portability. It would allow participants to roll money from a qualified plan directly into a Roth IRA and would also facilitate non-spouse rollovers.

The PSTA would require faster vesting of employer nonelective contributions. It would impose three-year cliff vesting or a five-year graded vesting schedule — the same vesting requirements that currently apply to employer-matching contributions.

The PSTA would also lengthen the notice and consent period required before a distribution of benefits, direct the secretary of labor to issue regulations relating to subsequent qualified domestic relations orders (QDROs), require that retirement plans offer a 75 percent survivor annuity option, expand the period for distributing excess employee contributions and make other changes.

Next Steps
The House and the Senate have approved many of the provisions under discussion during past legislative sessions. And several newer provisions — including automatic enrollment — enjoy broad support. But there are many differences between the PPA and the PSTA, so a conference committee will have to decide which — if any — defined contribution provisions to include in final pension reform.