The objective of the Act is to require that most pension plans become fully funded over a seven-year period.  Prior law required only a 90% funding level and the transition to 100% funding under the Pension Protection Act is gradual, beginning in 2008.

The funded status of a plan is determined by comparing the value of the plan's assets on the valuation date to the present value of the plan's benefit obligations. 

Plan assets are generally valued at fair market value as of the valuation date, although some averaging to reduce the impact of market fluctuations is allowed.

The present value of the plan's benefit obligations is determined by the plan's actuary based on interest and mortality assumptions provided in the Act.

The ratio of plan assets to benefit obligations then determines the plan's funded status…whether the plan is fully funded, underfunded, overfunded or at risk.  The funded status is important because it determines the amount of the required contribution.

For each plan year, the employer must generally contribute a minimum of the plan's "target normal cost" plus a "shortfall amortization installment."

The "target normal cost" is the present value of the benefits expected to accrue during the plan year, assuming the actuarial assumptions required by the Act.

A "shortfall amortization installment" is required if a funding shortfall exists (i.e., if the ratio of plan assets to benefit obligations is less than a specified percentage).  For plans established prior to 2008, a funding shortfall exists if the ratio of plan assets to benefit obligations is less than 92% in 2008, 94% in 2009, 96% in 2010 and 100% thereafter.  If a funding shortfall exists, it is amortized in level annual installments over seven years and that amortized amount is added to the target normal cost to arrive at a plan's required minimum contribution for that plan year.

NOTE:  Pension plans of commercial passenger airlines and airline catering companies benefit from special funding rules that allow funding shortfalls to be amortized either over 10 years (instead of seven years) or amortized over 17 years if special rules are followed.

"At-risk" plans are subject to stricter funding requirements, resulting in higher contribution requirements. 

A plan will be considered at risk if (1) it is less than 80% funded without regard to the at-risk rule, or (2) it is less than 70% funded with regard to the at-risk rule.  The 80% threshold is, however, reduced to 65% for 2008, 70% for 2009 and 75% for 2010.

Liabilities under the at-risk rule are determined by assuming that all employees who are eligible to retire in the next 10 years will retire as early as possible and elect the retirement benefit with the highest present value. 

Additional funding will be required from at-risk plans in order to bring the plan out of at-risk status more rapidly. 

If a plan's funded status falls below specified levels, the Act imposes several limitations on benefits.

If less than 80% of a plan's benefit obligations are funded, the forms of accelerated distributions (e.g., lump sum distributions) are limited and the plan cannot be amended to increase benefits.

If less than 60% of a plan's benefit obligations are funded, there can be no accelerated distributions (e.g., lump sum distributions), benefit accruals are frozen and the plan cannot be amended to increase benefits.

Starting immediately on the date of enactment, the Pension Protection Act restricts the funding of and payouts from executive compensation plans if the employer's pension plan is at risk.

Under previous law, an employer generally could deduct contributions up to 100% of a plan's current liability.  Any contributions above that amount were subject to a 10% excise tax.

For 2006 and 2007, the Pension Protection Act increases the maximum deductible contribution from 100% to 150% of a plan's current unfunded liability, as calculated under prior law.

Beginning in 2008, deductible contributions may be made up to an amount equal to the normal cost for the year, plus (1) the amount necessary to fully fund the plan as of the beginning of the year, plus (2) 50% of the unfunded liability as of the beginning of the year, plus (3) a "cushion" based on anticipated benefit increases in future years.

The annual flat-rate PBGC premium of $30 per participant remains unchanged, with annual indexing for inflation starting in 2007.  The variable-rate PBGC premium, however, will be subject to new rules based on yield curve segment rates beginning in 2008.  In addition, the Act subjects pension plan sponsors who "dump" pension liabilities on the PBGC and then emerge from bankruptcy to termination premiums of $1,250 per participant.

In order to encourage cash balance "hybrid plans," the Act protects them against age discrimination challenges, so long as the plans meet specified standards, generally from June 29, 2005 and later.

In order to facilitate phased retirement, the Act allows for "in-service" pension plan distributions to plan participants who are age 62 or older, enabling them to become part-time employees and still receive pension benefits.

The Act makes it easier for companies to automatically enroll employees into their 401(k) plans by explicitly protecting automatic enrollment against state interference.  With automatic enrollment, employees' salary is automatically reduced to fund their 401(k) contributions unless or until an employee takes steps to opt-out of participating.

It has not been uncommon for 401(k) plans to require that employer contributions to the plan be invested in employer stock.  With the collapse of Enron illustrating the risks that employees run by being substantially invested in their employer's stock, the Act requires that any defined contribution plan holding publicly-traded employer securities allow plan participants to diversify their account balances invested in those securities.  At least three materially different investment alternatives must be available to plan participants.

In the past, ERISA rules inhibited the investment information that employers could provide to plan participants.  By creating a new prohibited transaction exemption, beginning in 2007 the Act permits plan fiduciaries to be compensated for providing plan participants with investment advice.  Generally speaking, an investment advice arrangement must either provide that any compensation received by the fiduciary advisor does not vary based on the investment option selected or the recommendations are based on a computer model certified by an independent third party.

In the case of IRAs, advice based on a computer model will qualify for the prohibited transaction exemption only if the model complies with guidelines to be developed by the Labor Department.

Beginning in 2010, companies with up to 500 employees can establish a combined defined benefit plan and automatic enrollment 401(k) plan with a single plan document and trust fund. 

Under the new law, defined contribution plan employer contributions other than matching contributions are subject to the faster vesting rules that currently apply to employer matching contributions only.  After 2006, all employer contributions to a defined contribution plan will have to vest under either a 3-year cliff vesting schedule or a 6-year graded vesting schedule.

For plan years beginning after 2007, the Act requires that defined benefit and money purchase pension plans offer a 75% survivor annuity, in addition to a lesser option equaling at least a 50% survivor annuity.

Currently, certain rollovers are either prohibited or require use of a conduit traditional IRA.  The Act simplifies rollovers in these situations:

• Currently, a spouse beneficiary may roll over his or her spouse's interest in a qualified retirement plan, government plan or 403(b) plan into an IRA and not be taxed until distributions are actually taken.  Beginning in 2007, the Act extends this special rollover treatment to non-spouse beneficiaries as well.
• A temporary rule allowing after-tax contributions to employer plans to be rolled over into IRAs has been made permanent.
• Direct rollovers will be allowed from retirement plans to Roth IRAs, beginning in 2008, assuming all conversion qualifications are met (e.g., income requirements).
• The IRS is granted the permanent authority to extend the 60-day rollover period when failure to roll funds over within 60 days is due to events beyond the reasonable control of the individual.

Originally set to expire after 2010, the availability of a Roth feature in 401(k) and 403(b) plans, which first became available in 2006, has been made permanent.

Within six months of enactment, the Treasury Department is to issue regulations allowing 401(k) and 403(b) plan hardship withdrawals with respect to any person named as a beneficiary of the plan participant.  Current rules limit hardship withdrawals to a participant's spouse and dependents only.

Reservists who are called to active military duty for at least 179 days between September 12, 2001 and December 30, 2007 are allowed to make penalty-free withdrawals from retirement plans and IRAs.  Service personnel are also given up to two years following the end of their active duty to avoid income tax on distributions by re-contributing the amounts they withdrew.

Public service personnel participating in a governmental pension plan may make penalty-free withdrawals following separation from service if they are age 50 or greater (previously age 55).

The higher dollar contributions to IRAs have been made permanent ($4,000 in 2006 - 2007, $5,000 in 2008 and inflation adjusted thereafter).  In addition, the additional $1,000 "catch-up" IRA contribution available to older workers (over age 50) is made permanent.

Also, beginning in 2007, taxpayers will be allowed to direct the IRS to deposit all or a portion of their tax refund into an IRA.

Finally, the income limits used for determining eligibility for Roth IRA contributions and deductions for contributions to traditional IRAs made by active participants in an employer's qualified plan will be indexed for inflation beginning in 2007.

The Saver's Credit, which allows lower- and middle-income taxpayers to claim a tax credit of up to $1,000 for contributions or deferrals to retirement plans and IRAs, was scheduled to expire at the end of 2006.  The Saver's Credit has been made permanent and, in addition, starting in 2007 the adjusted gross income limits used to calculate the amount of the credit will be adjusted for inflation.  The amount of the credit itself, however, is not indexed for inflation.

The maximum annual benefit a participant can receive from a defined benefit plan has been made permanent ($175,000 for 2006, as adjusted for inflation). 

In addition, defined benefit plan benefits will be reduced only if payments begin prior to age 62.  Prior to EGTRRA, benefits that began prior to Social Security retirement age were subject to reduction.

The higher dollar contributions to defined contribution plans, 401(k)/403(b) plan elective deferrals, 457 plan deferrals and SIMPLE plans, as well as the catch-up contributions that can be made by older workers, have been made permanent. 
 

 The higher maximum compensation on which defined contribution plan contributions can be based has been made permanent ($220,000 in 2006, as adjusted for inflation).  In addition:

• Rather than reverting to the pre-EGTRRA 25% limit, the limit on total contributions for a participant in a defined contribution plan will remain at 100% of compensation.
• The deduction limit for contributions to defined contribution plans remains at 25% of aggregate compensation, rather than reverting to the pre-EGTRRA limit of 15% for profit-sharing plans and 25% for money-purchase pension plans.
• The rule that makes 401(k) elective deferrals deductible in full, without any regard to deduction limitations, is made permanent.