The Association of U S West Retirees



Big 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 Airways and 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:

Employee Contribution 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.

Employer Contributions.  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) contributions.

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 2001.

Investment Advice.  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 Morningstar, is 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.