Pension reform: Boon for 401(k)s

The reform President Bush signed into law could mean increased worker savings. But it won't stop the move away from pensions.

By Jeanne Sahadi, senior writer

August 17 2006: 3:27 PM EDT

NEW YORK ( -- One of the most sweeping reforms of the retirement plan universe was signed into law by President Bush on Thursday afternoon, promising to bolster pension plan funding and increase workers' retirement savings.

Many provisions of the bill have received wide acclaim, notably those regarding 401(k)s. But critics say the legislation could accelerate the move away from traditional pension plans, that parts of the bill will benefit only high-income workers and that it does little to help the millions of workers whose companies don't offer retirement plans.

The 900-page Pension Protection Act of 2006 comes as the number of people covered by a defined-benefit pension has steadily declined and awareness has grown about the lack of adequate savings among Americans.

A majority of workers 45 and older have less than $50,000 in savings, according to a survey by the Employee Benefit Research Institute (EBRI). What's more, almost 40 percent of workers over 40 don't participate in a 401(k) when they are eligible.

The new legislation encourages companies to automatically enroll 401(k)-eligible employees and to automatically increase worker contributions every year. It also allows the plan provider chosen by the employer to offer investment advice to workers.

Automatic enrollment is expected to boost the participation rate in 401(k) plans beyond 90 percent.

In addition, the bill makes permanent what until now have been temporary increases in 401(k) and IRA contribution levels.

And it makes permanent the saver's tax credit to encourage low-income workers to save for retirement.

Critics note that the increased contribution limits won't do much to help lower- and middle-income employees but will primarily benefit high-income employees who can afford to save up to the maximum amounts allowed. And they are disappointed the bill does not extend the saver's credit to middle-income workers as well.

(See more on these and other 401[k] changes, including loosened restrictions on how long employees may be required to hold company stock.)

Several provisions in the bill are not related to retirement per se, including one that makes permanent the tax-free status of withdrawals from state-sponsored 529 college savings plans.

Away from pensions

On the pension plan front, the new law changes pension accounting rules, how much companies must contribute to their plans and how much they must pay in premiums to the Pension Benefit Guaranty Corp, which insures pension plans.

"The problem of underfunded pensions will not be eliminated overnight. This bill establishes sound standards for pension funding," President Bush said during the signing ceremony." But, he said - addressing companies with pension plans - "in the end the primary responsibility rests with employers to fund the pension promises as soon as they can."

Some analysts have suggested that the more stringent funding requirements will push some companies to freeze their pension plans and switch all their workers to a defined-contribution plan.

The trend toward a 401(k) environment isn't new. Some 44 million workers are still covered by pensions. But in the past two years alone, tens of thousands have learned that their companies are freezing their pension plans, meaning that workers will be entitled to the benefits they have accrued to date but no further benefits will accrue. Translation: they will need to save more to make up for lost accruals. (While freezes aren't welcome by employees, some may be able to profit from them. See more.)

For companies with pension plans that are less than 100 percent funded and that don't have enough cash to meet the increased contribution requirements, they may be more inclined to freeze their plans, said EBRI fellow and pension expert Jack VanDerhei. Or some companies already thinking about a freeze may use the bill's more stringent requirements as their way out.

For companies with plans that are fully funded, the pension bill won't chase them out of the pension business, VanDerhei said. But upcoming changes in accounting rules from the Financial Accounting Standards Board (FASB) just might, he added.

FASB is expected to change the way companies account for their pension assets on their income statements. Currently, a company on its income statement doesn't need to recognize gains or losses in its pension assets up to certain limits. FASB rules may require that they do, and that will introduce an element of volatility in the bottom line that corporations aren't likely to relish, VanDerhei said.

In that case, a company might be inclined not to freeze its plan but to terminate it altogether, VanDerhei said. When a plan is terminated, the existing assets are converted into annuities for the plan participants, and no further benefits accrue.