The new Pension Protection Act offers opportunities
for advisors, if you know where to dig.
President Bush signed into law the Pension
Protection Act of 2006 (PPA) last August. This legislation is the most
comprehensive reform to the retirement system since 1974's Employee
Retirement Income Security Act (ERISA).
The PPA, at least as it concerns defined
contribution plans (401(k)s, profit sharing plans, etc.), is based on
the premise that America's workers need help and encouragement to save
more for retirement. The provisions of ERISA were based on the premise
that "smarter and more educated" investors will better handle their own
retirement planning responsibilities.
The PPA abandons this methodology by adopting safe
harbors for employers and plan sponsors that provide acceptable
"default" savings rates and "default" investment options beyond money
market or guaranteed income investments. In order for employers and
plan sponsors to benefit from these safe harbor provisions, the new
investment options offered to employees must be approved life cycle,
asset allocation or balanced funds. In essence, once the provisions are
implemented within plans, employees will be required to opt out of the
contribution and investment plans provided by their employers as part
of the plan itself.
A key component of the default participation rules
is that the employee must be given the right to opt out within 90 days
without any penalty, and be entitled to a refund of all contributions
made on his/her behalf, subject to income tax. It should be noted that
these provisions are optional to plan sponsors, and do not become
effective until plan years beginning after December 31, 2007. The
Department of Labor (DOL) is in the process of issuing implementing
regulations regarding the qualifications for the default investment
options, but it is expected that these new rules will not be overly
restrictive in terms of meeting the definitions.
The Employer Stock Issue
For plans with employer stock, participants must be
given the option to diversify out of the stock and the plan must offer
at least three materially different investment alternatives. For
existing plans with employer stock, there is a three-year phase-in for
these provisions. Employees must also be given more liberal time
periods in which to sell employer stock and diversify into other
investment alternatives.
The Opportunity
The act also provides new opportunities and
safeguards for employers or plan sponsors who provide investment advice
to 401(k) or other plan participants. In light of the philosophical
change concerning overall plans, the offering of financial advice is
now encouraged and can be provided by employers and plan sponsors with
"safe harbor" protection.
In order to qualify for safe harbor protections, the
advice must be provided either by a fiduciary advisor or a
fiduciary-compliant "computer modeling" program offered by investment
managers, broker dealers, insurance companies or other select financial
service entities, including banks. In essence, qualified financial
advisors employed by these various entities, or independent advisors,
will be eligible to provide individual advice to plan participants for
a fee (paid by the plan or the participant) if the advisors acknowledge
their fiduciary status in writing, charge only a level fee (no
difference in fee levels based on investment selection) and fully
disclose their compensation arrangements as well as conflicts of
interest.
Important Consideration
Under prior interpretations, 12b-1 payments-even
though different among various mutual funds offered within the
plan-qualify as a level compensation plan since they are all
asset-based fees incorporated within the funds themselves. Plan
sponsors and employers also are protected from liability when they
provide approved computer modeling or portfolio planning programs to
their employees, provided the programs are created by an independent
and objective asset advisory firm (Ibbotson, Morningstar, Financial
Engines, etc).
The act introduces a new requirement for annual
audits of the computer-driven advice model mentioned earlier, and of
the services arrangement between the fiduciary advisor and the plan
sponsor. The details of the audits have yet to be defined, but they
likely will resemble the procedures an independent expert would use to
assess a fiduciary advisor 's asset allocation and optimization
procedures, and due diligence procedures for selecting investment
options, as well as investment-related fees and expense and monitoring.
It is anticipated that many of the broker-dealer and
plan sponsors of 401(k) plans will be offering these types of programs
bundled with their 401(k) plan offerings. It is interesting to note
that the PPA addresses the issue of providing advice to IRA
participants, but also states that the DOL is responsible for writing
new rules and regulations as to the applicability of the computer
modeling provisions to IRAs.
Permanent Limits
Additional important provisions of the PPA include
making permanent the contribution limits for various retirement plans,
including the catch-up provisions for those over 50, Roth provisions
for both IRAs and 401(k)s, as well as making permanent section 529
college saving plans. This provides certainty going forward and removes
a disincentive to adopt these beneficial plans in the future. It is
expected that many current 401(k) plans will now be adding permanent
Roth features to their plans, enhancing the opportunities for greater
estate and income tax savings in the future. A significant added
benefit of the PPA is the ability to roll over proceeds directly from a
qualified retirement plan to a Roth IRA (without going through a
traditional IRA).
This simplifies overall administration of retirement
plans and, with $3 trillion expected to be distributed from 401(k)
plans over the next 15 years, provides opportunities for financial
advisors. In addition, charitable contributions now can be made
directly from IRAs without first passing out of the IRA and through an
individual's adjusted gross income. This will have the result of
enabling more participants to qualify for a full charitable
contribution benefit since the adjusted gross income limits will no
longer apply. These contributions will also satisfy minimum withdrawal
requirements to the extent they apply for those IRA owners over the age
of 701/2.
PPA also deals directly and comprehensively with
defined benefit plans and the current funding challenges of those
plans, outlining time frames and procedures for companies and sponsors
to bring those plans up to funding compliance. Dues to the Pension
Benefit Guaranty Corporation (PBGC) are raised. New rules for
conversions to cash balance plans are also included in the legislation.
The law is new and far-reaching. It still is being
interpreted by commentators, and opportunities are still being
explored. Many of the implementing and interpreting regulations have
yet to be written, although some were due as early as December 31,
2006. More will be forthcoming later in 2007. For the time being, it is
worthwhile to monitor the promulgation of the rules and regulations by
the DOL and other administrative bodies, and consider how your service
offerings can be expanded. Stay tuned.
Quick-Read Summary Of The PPA
Providers can give you investment advice.
Preserves today's high savings limits in 401(k)s and IRAs.
Simplifies estate planning and helps you prevent overloading on company stock.
Employers can offer Roth 401(k) plans.
Makes tax-free withdrawals from 529 plans permanent.
Ken Ziesenheim, JD, LLM, CFP, is a
managing director of Thornburg Investment Management, president of
Thornburg Securities and a past chairman of the National Endowment for
Financial Education (NEFE). He also served as chairman of NEFE's
investment committee. He is the author of Understanding ERISA-A Compact
Guide to the Landmark Act, Marketplace Books, 2002.