Retirement Planning: New Rules Help Small Business
The Pension Protection Act encourages wider participation and loosens restrictions on employers
Small business owners will find plenty to smile about in the new Pension Protection Act’s treatment of 401(k) and 403(b) defined contribution plans. Enacted chiefly to stave off a meltdown in the nation’s private pension plans, the act includes a range of tax benefits for the savings plans that have come to dominate small businesses retirement planning.
At more than 900 pages, the new Pension Protection Act (PPA) is the biggest retirement legislation in 30 years. As its name implies, the top goal is to address underfunding in approximately 30,000 traditional (defined benefit) pension plans. The Pension Protection Act will require most pension plans to be fully funded over a seven-year period, and those currently considered at risk (less than 80% funded) must boost their contributions. That will accelerate the ongoing shift in big business to defined benefit plans, says Glenn Sulzer, a senior tax analyst in the Chicago office of CCH Inc., an international provider of tax information.
| HIGHLIGHTS OF THE PENSION PROTECTION ACT OF 2006 | |||||||
|
Indeed, the bill also provides new rules to encourage savings in 401(k)s and other plans that are common in small business. “Assuming most small businesses aren’t maintaining defined benefit plans, the act is good for them,” says Sulzer.
For example, the act aims to simplify filing requirements. Beginning in 2007, a sole proprietor with a 401(k) plan covering the owner and a spouse will be exempt from filing IRS Form 5500 in all but the final filing year of a savings plan, so long as plan assets don’t exceed $250,000. The act also promises a simplified form 5500 for companies with fewer than 25 employees.
The list of significant changes in the PPA goes on:
Automatic-enrollment
Beginning in 2007, employers can automatically enroll employees in a defined contribution plan, such as a 401(k), unless the worker opts out. Many companies were already doing so, but the new law supersedes statutes in some states that had prevented the withholding of any compensation without the employee’s explicit consent.
If a sponsor uses auto-enrollment and meets certain standards for contributions by both the employer and employee and allows employees to vest within two years, he can qualify for guaranteed non-discrimination status. This will allow owners and highly-compensated employees to maximize their contributions without violating Dept. of Labor rules aimed at widespread participation. In the past if a plan were found to be “top-heavy,” sponsors would be forced to refund some contributions back to participants.
“This provides a means to comply with those tests, so employers will jump all over it,” Sulzer says. Employees must be notified annually of their enrollment and opt-out options, but automatic enrollment is expected to increase participation rates because signup is by default.
The PPA also allows employers to make default investment decisions for plan participants who don’t specify their wishes, and reduces fiduciary liability in doing so. In the past, if an employee did not make a clear designation, funds were often left in money-market funds that fared poorly, which occasionally prompted lawsuits against plan sponsors.
Advice and consent
The employer’s authority to make default investment decisions will likely lead to a greater variety and quality of funds geared to those accounts, says Kenny Landgraf, owner of Austin-based wealth management advisor Kenjol Capital Management LLC.
It was always unlikely that a single fund would be an appropriate default investment for both a 25-year-old and a 50-year-old participant employee, but the old fiduciary rules discouraged employers from giving too many choices. Now, they will feel safer in adding variations, such as lifestyle funds that automatically allocate investments based on how many years from retirement the participants are. “There are going to be stronger investment options in the plan,” he says.
Another big change is in the area of advice. Even though many employees were in desperate need of competent counsel in choosing investment funds, employers and their plan administrators could only provide educational information. Under the PPA, however, plan providers will now be able to provide personalized advice to plan participants, albeit with some limitations (for a more detailed story on this, see Registered Rep. magazine, October, 2006).
The sun never sets
Perhaps of greater interest to small business owners, the Pension Protection Act clarifies and extends what had been temporary tax benefits created by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Initially slated to sunset in 2010, the measures are intended to boost defined contribution retirement savings programs.
Most relevant to small employers is the deduction limit for defined contribution plans, which increased from 15% to 25% of eligible compensation, according to Tim Corle, COO of Tycor Benefit Administrators in Berwyn, Pa. Eligible compensation is the sum of compensation for all employees eligible to participate in a plan. “A 401(k) wasn’t practical” before EGTRRA, Corle says. “EGTRRA changed all that and opened the door for the small employers.”
Other EGTRRA benefits made permanent in the new law include: • Businesses with 100 or fewer employees can deduct 50% of retirement plan startup costs, up to $500, in each of a plan’s first three years. • Individuals age 701?2 and older can take up to $100,000 in tax-free deductions from an IRA to make charitable distributions. This also expires at the end of 2007.
Permanent Roth 401(k)
The PPA makes the Roth 401(k), introduced in 2006, permanent. While traditional 401(k)s use pretax dollars for funding and then tax distributions to retirees, a Roth plan does the opposite, using after-tax contributions and providing tax-free income in retirement. Despite their appeal, especially for small business owners (see earlier story in SBR), employers have been slow to adopt these plans because they were scheduled to disappear after 2010.
New notice requirements
Small business owners who want to take advantage of the new defined contribution provisions in the PPA must take the good with the bad: namely, a handful of notice requirements designed to keep plan participants and regulators apprised of investment performance.
Participant-directed plans now must provide account statements to participants each quarter, including notices of any restrictions on directing their investments, and a warning about concentrated risks. Previously the minimum requirement was annual statements. A change in fund options or providers now requires a notification to participants.
“Most qualified providers will be on top of these requirements,” Corle says. “If you’re unsure whether a notice applies to you, contact your plan provider.”
