A new law that makes big changes in employee retirement plans can benefit small business owners. While some aspects of it won't kick in for a year or two, others went into effect in January, so now is a good time to understand its ramifications.
The Pension Protection Act of 2006 (PPA), which was passed by Congress in August 2006, rewrote many of the rules on pensions in an effort to aid owners and employees alike. While the law opens up new opportunities for savings, it also holds potential pitfalls.
One major benefit is that it allows business owners and key personnel, who had been limited in their own 401(k) savings, to sock away more. This applies if the company enrolls employees automatically in its plan and contributes a required amount to each account.
Among the potential pitfalls are 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, although 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," says 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 applies to both defined benefit plans, which are traditional pensions that pay out a fixed sum after retirement, and to defined contribution plans, such as 401(k)s. The changes to defined benefit plans are centered primarily on funding requirements.
Among the most significant change already in place is automatic enrollment, which allows an employer to 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 companies that wanted to use the automatic enrollment option in the past, shied away from them because of state laws that guard against garnishing wages. "We've seen a fairly good up tick in clients that have gone into auto enrollment already," said Stewart.
Auto enrollment allows business owners to unlock savings for themselves and key personnel when they use it with a set of other practices. Those include a contribution of three 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. The maximum is $15,500 for an individual this year, and an additional $5,000 for those who are more than 50 years old.
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," says Ray Shojinaga, president of Flynn, Shojinaga & Associates Inc., an independent actuarial consulting firm in Alameda, CA.
Vesting schedules have also changed. Many plans were required to follow new rules that vest employees fully within three years. Alternately, plans can choose a graded schedule that vests employees fully after six years.
Congress also weighed in on another big issue when it passed the law. It is the question of whether an employer should encourage employees to get professional advice on managing retirement savings.
The law encourages obtaining advice by saying that a plan sponsor won't be held responsible for investment losses in the plan. This provision went into effect on January 1, but the Department of Labor is expected to soon issue guidance on it.
Under the law, company stock can be included in retirement plans as long as employees are told it is a component of the plan and are informed that a heavy concentration of company stock can be risky. In addition, employees are free to sell company stock in their retirement plan and replace it with another investment.
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