Pension Protection Act changes 401(k) provisions

Last updated on July 2nd, 2019 at 11:00 am

By Todd Barden, for SBT

On Aug. 17, President George W. Bush signed the Pension Protection Act of 2006 into law. The Pension Protection Act contains many beneficial changes for both defined contribution and defined benefit plans. This summary provides an overview of the provisions of the law in relation to 401(k) and other defined contribution plans we believe are most relevant to plan administration. For each change made by the law, we have provided a short summary of the current law, where applicable, followed by an overview of the new law and the effective date of the change.

I. EGTRRA retirement plan provisions permanent

Current Law: The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) made numerous changes affecting defined contribution retirement plans.  These provisions were to expire after 2010.

PPA:  The Act makes permanent all provisions of EGTRRA that relate to retirement plans and IRAs.

II. Automatic enrollment and default investments

Current Law:  In general, 401(k) plans must satisfy annual nondiscrimination tests on deferrals and other provisions.  Current law provides employers the ability to satisfy these nondiscrimination requirements under a “safe harbor” design in which the 401(k) plan must satisfy certain contribution, notice, and vesting requirements.

PPA: The Act provides for an additional nondiscrimination safe harbor for plans with a “qualified” automatic enrollment feature starting in 2008. Under the qualified automatic enrollment program, eligible employees automatically defer to the plan a certain stated percentage of compensation unless the employee affirmatively elects a different percentage or to forgo withholding altogether. Under PPA, plans that satisfy the new automatic enrollment safe harbor (1) would be deemed to satisfy the ADP and ACP tests; and (2) would not be subject to the top-heavy plan rules.

The Act provides that in order to satisfy the automatic enrollment safe harbor, the plan must provide for an initial automatic deferral rate of between 3 and 10 percent and additional deferrals in subsequent years.

Additionally, the employer must either match the first 1 percent of deferrals at 100 percent and the next 5 percent of deferrals at the rate of 50 percent. Alternatively, the employer may provide a 3 percent contribution to all eligible employees. Employer contributions may be subject to a vesting schedule.

III. Default investments

Current Law:  ERISA section 404(c) provides relief to fiduciaries to the extent participants direct the investment of their own accounts under the plan. Section 404(c) does not provide fiduciaries relief where a participant does provide investment direction and their accounts are invested in the plan’s “default” investment.

PPA:  As directed by PPA, the Department of Labor issued regulations providing safe harbor guidance on the designation of default investments under ERISA section 404(c). The default investments should include “a mix of asset classes consistent with capital preservation or long-term capital appreciation, or a blend or both.”

IV. Investment advice

Current Law: ERISA restricts fiduciaries from entering into specific “prohibited transactions” as provided under ERISA. Under current law, it is difficult for a party to provide investment advice to a plan participant without violating one or more of ERISA’s prohibited transactions if the adviser receives compensation from the investment provider. 

PPA: The new law provides an exemption to ERISA’s prohibited transaction rules for advice provided by a “fiduciary adviser” under an “eligible investment advice arrangement.” The exemption covers advice provided to a participant in the plan, but not advice to the plan. In order to qualify for the exemption, the eligible arrangement must either (1) provide that the fees or other compensation received by the fiduciary adviser do not vary depending on the investment option chosen or (2) use a computer model under an investment advice program meeting certain criteria. An independent fiduciary would need to approve the arrangement.

The fiduciary adviser also would be required to provide advice in a format designed to be reasonably understood by the average investor. Plan participants must receive notices regarding the fiduciary advisor’s relationship to the investment provider among other requirements. 

V. Rollovers by non-spouse beneficiaries

Current Law:  Non-spouse beneficiaries are not permitted to roll over distributions resulting from the participant’s death and, as a result, may incur an immediate tax liability upon distribution.

PPA:  Effective 2007, a non-spouse beneficiary may roll over the benefits they receive from a retirement plan to an IRA. The IRA would be treated as an inherited IRA and subject to the minimum distribution rules that apply to inherited IRAs.

VI. Reporting and disclosure

Current Law: A plan administrator must provide participants or beneficiaries with a benefit statement upon request, but only once during any 12-month period.

PPA:  Participants or beneficiaries who have the right to direct their investments in a defined contribution plan must be provided benefit statements on a quarterly basis. For participants or beneficiaries who do not have the right to direct their investments, a benefit statement must be provided on an annual basis. 

It is important to consider all of this information and discuss it with your personal attorney and tax advisor to understand how this will impact your personal plan.

Todd Barden is a certified financial planner (CFP) professional and is president of Great Lakes Retirement Advisors LLC (GLRA) in Milwaukee. He offers securities through AXA Advisors LLC, which is not affiliated with GLRA. He can be reached at (414) 278-1522 or by visiting his Web site at www.glrallc.com.

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