Changes For Pensions Ahead
By Janet Novack
Wednesday, February 1, 2006
WASHINGTON, D.C. - If, like the majority of U.S. workers,
your only pension plan is a 401(k), you might not have paid
much notice to the pension reform bills the House and Senate
passed late last year.
After all, debate about these bills has focused on how
Congress can prevent more companies from dumping their
underfunded defined benefit pension plans into the Pension
Benefit Guaranty Corp.'s lap. The PBGC’s $23 billion
deficit is likely to grow if bankrupt carriers
Delta Air Lines
and Northwest Airlines
follow the lead of US
UAL abandon their plans to the government
insurer. (When United emerges from bankruptcy this week and
begins trading on Thursday on Nasdaq as UAUA, the PBGC will
own a big chunk.)
The PBGC’s woes should worry you as a taxpayer, but they
don’t affect your 401(k). There’s no government guarantee
for a 401(k) -- your losses are your problem.
Still, some big changes for “defined contribution” plans
will be on the table, too, when House and Senate negotiators
begin to hammer out a compromise pension bill, possibly in
late February. The final legislation could boost the number
of workers participating in 401(k)s, but reduce the amount
some employers contribute to workers’ accounts.
Here are some key issues:
Limits. The House bill, but not the Senate
version, would make permanent the low-income-savers credit
and the higher 401(k) and Individual Retirement Account
contribution limits that were part of the 2001 tax cut.
Under current law, the credit expires at the end of 2006 and
the higher contribution limits at the end of 2010. While
these tax breaks are popular, the $30 billion cost for
making them permanent means they aren’t a sure thing.
“By a magnitude of ten, permanency is the highest
priority,’’ for employers sponsoring 401(k)s, says Ed
Ferrigno, vice president for Washington Affairs of the
Profit Sharing/401k Council of America. “This could very
well be the best chance to get permanency,’’ he adds.
Both the House and Senate bills remove possible legal
barriers to “automatic enrollment” in 401(k)s and reward
employers who adopt automatic enrollment by chopping the
amount they must contribute to workers’ pensions to avoid
“nondiscrimination testing.” With automatic enrollment,
employees must opt out of the plan, rather than opting into
it. If they do nothing, some percentage of their pay -- at
least 3% -- is diverted into a 401(k) and invested in a mix
of funds or a balanced fund.
Automatic enrollment is a no-brainer; according to the
Retirement Security Project, it typically raises 401(k)
participation rates from 75% of eligible employees to 85% to
95%. That’s critical given that most of today’s younger
workers, even those employed by corporate giants, will have
only defined contribution 401(k)s and not traditional
pensions to fall back on. Just this month,
IBM announced it
will freeze its defined benefit plan and offer only 401(k)
What about nondiscrimination testing? It’s an arcane
business with a simple aim: to make sure managers have an
incentive to promote the 401(k) plan to lower-paid workers.
The test means that if lower-paid workers don’t save, highly
compensated employees (those earning $100,000 or more in
2006) can’t put as much money in the 401(k).
Under current law, a company can escape the
nondiscrimination test by contributing 3% of pay to every
employee’s retirement account, whether or not he saves, or
by offering to match the first 3% of salary a worker saves
dollar for dollar, and the next 2% at a 50% rate, for a
maximum 4% match. The House bill would allow an employer
who automatically enrolled new hires in the 401(k) to escape
the nondiscrimination test by putting just 2% of pay away
for all workers, or by offering just a 50% match on the
first 6% saved -- for a maximum 3%. (The Senate would allow
a somewhat lower match, too, but only if all employees --
not just new ones -- were automatically enrolled.)
“The legislation does enough to encourage employers to use
auto-enrollment without this unnecessary nondiscrimination
carrot,’’ says J. Mark Iwry, a senior fellow with the
Brookings Institution and leader of the Retirement Security
Project who oversaw pension policy at the Treasury until
The House, but not the Senate, would allow financial
services companies that administer 401(k)s, such as
Principal Financial Group,
Fidelity Investments and the Vanguard Group, to provide
participants with investment advice -- including
recommending their own funds.
The idea, pushed by House Education & the Workforce
Committee Chair John Boehner (R-Ohio), is opposed by
independent financial advisers, as well as consumer groups,
who worry about possible conflicts of interest and abuses.
Boehner argues that participants need access to more advice,
and any conflicts and fees would have to be disclosed up
front. But a whole mini-industry of separate advisers,
including mutual fund rater
already offering participants advice. Venture
capitalist-backed Invesmart, will even manage a
participant’s 401(k) for just $10 a month.
More than just management of 401(k)s is at stake here.
Cerulli Associates estimates that this year $221 billion in
401(k) money will roll over into IRAs, and that annual
rollovers will hit $387 billion in 2010. Moreover,
according to Cerulli, rollover money has been the biggest
source of cash for managed mutual fund accounts. If
financial service companies can advise employees on
investing their 401(k)s, that could give them the inside
track on some lucrative rollover business, too.