Now is the time for small business owners to bone up on a new law that makes big changes in employee retirement plans.
The Pension Protection Act of 2006, passed in August, rewrote many of the rules on pensions in an effort to aid owners and employees alike. While some changes won’t kick in for a year or two, others went into effect this month.
Keeping track is important because the law opens up new opportunities for savings and also holds potential pitfalls.
A major benefit: Business owners and key personnel, who had been limited in their own 401(k) savings, can now sock away more if the company enrolls employees automatically in its plan and contributes a required amount to each account.
Potential pitfalls include new rules that require more communication with employees. Quarterly statements are now required, for example. Until now, 401(k) statements weren’t technically required at all _ though many plans did issue some form of statement to stay in line with accepted industry practice.
For a small business without a designated pension person, staying on top of the new rules can be daunting. Many big financial firms that provide plans to employers are making a push to explain the changes, but business owners shouldn’t wait for that to happen, according to 401(k) advocates.
“Call your professionals and tell them that you’re ready when they want to talk to you,” said Dallas Salisbury, president and chief executive of the Employee Benefit Research Institute, in Washington. “Say, ‘We know we have to do something, so when you know what it is, tell us.”‘
The new law affects both defined-benefit plans — traditional pensions that pay out a fixed sum after retirement — and defined-contribution plans like 401(k)s. The changes to defined-benefit plans mostly involve funding requirements.
Among the most significant changes now in place is automatic enrollment, which lets an employer put all employees into the plan by default.
Auto enrollment has proven popular, according to Jack Stewart, a director in the consulting group at Principal Financial Group. Many who had wanted to use the option in the past were afraid of state laws that guard against garnishing wages.
“We’ve seen a fairly good uptick in clients that have gone into auto enrollment already,” said Stewart.
Auto enrollment lets business owners unlock savings for themselves and key personnel when they use it with a set of other practices; these include contributing 3 percent of salary into each employee’s account and increasing the amount by a required percentage each year for several years.
Taken together, the practices trigger a safe harbor in the law that lets owners and key personnel contribute their own maximum contributions, $15,500 for an individual this year, and an additional $5,000 for those over 50.
In the past, owner and executive contributions were often limited because a plan was deemed to discriminate against lower-paid employees. The new required contributions are intended to make plans fair to all.
“In general, the PPA will make establishing a retirement plan more attractive to more small business owners, and because of that, more of the rank and file employees will be covered by, and benefit from, an employer-sponsored retirement plan,” said Ray Shojinaga, president of Flynn, Shojinaga & Associates Inc., an independent actuarial consulting firm in Alameda, Calif.
Vesting schedules have also changed. Many plans were required this month to follow new rules that vest employees fully within three years. Alternately, plans can choose a graded schedule that vests fully after six years.
Vanguard, for one, is taking an active stance on provisions like vesting because the firm believes its clients look to it as the expert.
“We stepped up and partnered with plan sponsors to make sure the plans were in compliance,” said Dennis Simmons, a principal in the ERISA legal group at Vanguard. “For vesting, we said, ‘We’re making the change for you and it will be in place for 2007.”‘
Congress also weighed in on another big issue when it passed the law: The question of whether an employer should encourage employees to get professional advice on managing retirement savings.
The law encourages advice by saying that a plan sponsor won’t be held responsible for investment losses in the plan. This provision went into effect on Jan. 1, though the Department of Labor is still expected to issue guidance on it, according to Simmons.
Company stock in retirement plans is also affected by the law, which requires that employees be told of its presence in a plan, and informed that a heavy concentration can be risky. Employees are now free to sell company stock in the plan and replace it with another investment.
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