CRS Updates Report on Pension Protection Act

                            Funding Target

Valuation of Assets and Liabilities. Under current law, a plan sponsor can determine the value of a plan's assets using actuarial valuations, which can differ from the current market value of those assets. For example, in an actuarial valuation, the plan's investment returns may be averaged ("smoothed") over a five-year period, and the average asset value may range from 80% to 120% of the fair market value. This smoothing is permitted because pension plans are considered long-term commitments, and smoothing reduces volatility in the measurement of plan liabilities and assets that can be caused by year-to-year fluctuations in interest rates and the rate of return on investments. Smoothing of interest rates and asset values therefore reduces the year-to-year volatility in the plan sponsor's required minimum contributions to a defined benefit pension plan. H.R. 2830 would narrow the range for actuarial valuations to 90% to 110% of the fair market value of assets and reduce the maximum smoothing period from five years to three years.

Pension plan liabilities extend many years into the future. Determining whether the plan is adequately funded requires converting a long-term stream of pension payments into the amount that would be needed today to pay off those liabilities all at once. This amount -- the "present value" of the plan's liabilities -- is then compared with the value of the plan's assets. An underfunded plan is one in which the value of the plan's assets falls short of the present value of its liabilities by more than the percentage allowed under law. Converting a future stream of payments (or income) into a present value requires the future payments (or income) to be discounted using an appropriate interest rate. Other things being equal, the higher the interest rate, the smaller the present value of the future payments (or income), and vice versa.

Under the bill, plan sponsors would determine the funding target using three interest rates, which would be based on when the benefits are projected to be paid: in less than five years, in 5 to 20 years, or in more than 20 years. The Secretary of the Treasury would determine these rates, which would be derived from a "yield curve" of investment-grade corporate bonds.¹ Interest rates would be averaged over a three-year period under a formula using 50% of the rate from the most recent plan year, 35% of the rate from the previous plan year, and 15% from the plan year before that. The yield curve would be phased in during the 2006 and 2007 plan years, becoming fully effective in 2008. This methodology would permanently replace the four-year average of corporate bond rates established under P.L. 108-218, which expires after 2005.

Contribution Limits and Credit Balances. H.R. 2830 would allow plan sponsors to contribute more to their pension plans than they can under current law. It would set the maximum tax-deductible contribution at 150% of the plan's funding target.² Within certain limits, sponsors would be able to offset required current contributions with previous contributions. However, using these so- called "credit balances" to offset required contributions would be permitted only in plans that are at least 80% funded and only after subtracting pre-enactment credit balances from plan assets. Credit balances also would have to be adjusted for investment gains and losses since the date of the original contribution that created the credit balance.

Lump-Sum Distributions. By law, defined benefit pensions must offer participants the option to receive their accrued benefits in the form of an annuity -- a series of monthly payments guaranteed for life. Some defined benefit plans also offer participants the option to take their accrued benefits as a single lump sum at the time they separate from the employer. The amount of a lump-sum distribution from a defined benefit pension is inversely related to the interest used to calculate the present value of the benefit that has been accrued under the plan: the higher the interest rate, the smaller the lump-sum and vice versa. Under current law, lump-sum distributions are calculated using the average interest rate on 30- year Treasury bonds. The interest rate on long-term Treasury securities has historically been lower than the average interest rate on long-term investment-grade corporate bonds because bond markets generally consider U.S. Treasury securities to be free of the risk of default.

H.R. 2830 would require plan sponsors to calculate lump-sum distributions using three interest rates based on investment-grade corporate bonds. As a result, participants of different ages would have their lump-sum distributions calculated using different interest rates. Other things being equal, lump-sum distributions paid to workers nearer to retirement would be calculated using a lower interest rate than would be used for younger workers. As a result, all else being equal, an older worker would receive a larger lump-sum than a similarly situated younger worker. The interest rates used to calculate lump sums would be based on current bond rates rather than the three-year weighted average rate used to calculate the plan's funding target. The new rules for calculating lump sums would be phased-in over five years.

PBGC Premiums for Single-Employer Plans. The Pension Benefit Guaranty Corporation (PBGC) was established by the Employee Retirement Income Security Act of 1974 (ERISA) to insure pension benefits under defined benefit pension plans. The PBGC is funded by premiums paid by plan sponsors and investment returns on the assets held in its trust fund. It receives no appropriations from Congress. The PBGC does not have the legal authority to set its own premiums, which are set in law by Congress. The PBGC receives two types of premiums from plans sponsored by individual employers: a per-capita premium of $19 per year that is charged to all single-employer defined benefit plans, and a variable premium equal to $9 per $1,000 of underfunding (0.9%) charged to underfunded plans. Congress last raised the annual PBGC premiums in 1991.

H.R. 2830 would raise the base annual PBGC premium from $19 to $30 per participant. The $30 premium would be phased in beginning in 2007, on a schedule based on the plan's funded status. For plans that are at least 80% funded, the higher premium would be phased in over five years. In plans that are less than 80% funded, the higher premium would be phased in over three years. The premium then would be indexed to average national wage growth. Unlike current law, a plan would not be exempted from the variable-rate premium (to be renamed the "risk-based premium") of $9 per $1,000 of underfunding if it was not underfunded in any two consecutive years out of the previous three years. The risk-based premium would be assessed on all underfunded plans, regardless of the plan's funding status in earlier years.

Limits on Benefits in Underfunded Plans. H.R. 2830 would limit certain forms of benefit payments and the accrual of new benefits in underfunded plans. Plans funded at less than 80% could not pay lump-sum distributions and could not increase benefits without first fully funding the new benefits. In plans less than 60% funded, benefits would be "frozen" and no new benefits could be earned under the plan. Participants would have to be notified of these restrictions on benefits. An actuary would have to certify that the plan had re-attained funded status before new benefit accruals could begin. As introduced, these restrictions would have applied to plans that were under-funded after credit balances had been deducted from plan assets. As amended by the Education and Workforce Committee, the benefit restrictions would not apply if the plan's assets were at least 100% of plan liabilities before subtracting credit balances. In plans considered to be at risk of default, assets set aside in trust funds to pre-fund deferred compensation for highly compensated employees would be taxable as employee income.

Prohibition on "Shut-Down" Benefits. "Shutdown benefits" are pension payments made to long-service employees when a plant is shut down. These benefits typically are negotiated between employers and labor unions. Shutdown benefits usually are not prefunded. H.R. 2830 would prohibit shut-down benefits, effective in 2007.³

Disclosure Requirements. The bill would require plan administrators to provide an annual "funding notice" within 90 days of the close of the plan year to each participant and beneficiary and to any labor organization representing participants. The notice must include (1) identifying information; (2) the ratio of active to inactive participants; (3) the plan's assets and liabilities and the ratio of assets to liabilities; and (4) the plan's funding and asset allocation policies. Plan sponsors also would have to include more information on the Form 5500 that they file annually with the Internal Revenue Service, including an explanation of the actuarial assumptions used to project future retirements and asset allocations. Plans would have to provide participants a copy of the summary annual report (SAR) within 15 days of the deadline for filing the Form 5500.

Section 4010 of ERISA provides that plans underfunded by $50 million or more must file a report with the PBGC, but it prohibits the PBGC from releasing this information to the plan participants or the public. H.R. 2830 would require the plan sponsor to provide participants with a notice of their filing with the PBGC. The notice would include (1) the number of the sponsor's at-risk plans in which the ratio of assets to liabilities in the preceding plan year was less than 60%; (2) the value of the assets, the funding target, and the asset/liability ratio for each plan; and (3) the aggregate value of plan assets, plan funding targets (taking into account only vested benefits) and asset/liability ratios for all plans. The notice would have to be sent to participants no later than 90 days after the related notice is sent to PBGC. The PBGC notice is due 105 days after the close of the year. The disclosure requirements would be triggered if the plan were underfunded by $50 million or more; if the plan were less than 60% funded; or if the plan were less than 75% funded and sponsored by an employer in a financially troubled industry. Congress would also have to be given the same information sent to the PBGC.

Rules for Multiemployer Plans.⁴ Under H.R. 2830, multiemployer plans would have to amortize unfunded prior service liability over 15 years, rather than over 30 years as under current law. "Endangered" plans (those that are less than 80% funded) generally would be required to develop a plan to increase contributions, reduce or cease new benefit accruals, and adopt other plan amendments that can reasonably be expected to meet prescribed improvements in the plan's funded status within 10 years. Alternative schedules for improving solvency would apply to endangered plans that are less than 70% funded and to plans more than 70% funded but less than 80% funded. Employers currently contributing to severely underfundfed plans would be required to make 5% to 10% surcharge contributions until the next collective bargaining agreement is adopted. Multiemployer plans would be required to furnish actuarial and financial reports within 30 days of a request from a contributing employer or labor organization, and they would have to report the amount of an employer's withdrawal liability within 180 days of receiving a written request from a contributing employer. They also would have to identify the number of contributing employers and the number of workers for whom there is no contributing employer. The bill would increase the maximum tax-deductible contribution for multiemployer plans to 140% of current liability.

Investment Advice. H.R. 2830 would allow advisors or affiliates of investment funds offered in a § 401(k) plan to offer investment advice to plan participants. Eligible plans would be exempted from certain rules governing prohibited transactions under ERISA and the Internal Revenue Code. The adviser would have to meet disclosure and qualification requirements and would have to provide notice of fees, material affiliations, any limitation on the scope of advice, and services provided with respect to the advice. The notice would have to state that the participant or beneficiary could arrange third-party advice. The adviser would be acting as a fiduciary, subject to the terms of ERISA that apply to plan fiduciaries. The advisor would have to be either a registered investment adviser, a registered broker or dealer, or an affiliate, agent, or employee of a bank or insurance company. Fees would have to be reasonable and at least as favorable as an arm's length transaction, and the participant would have to make the actual investment and asset allocation decisions. The plan sponsor's fiduciary obligations would be limited to selecting and reviewing the adviser. The sponsor would have no duty to monitor investment advice given by the adviser and would not be liable for the advice given.

Cash Balance Plans and other Hybrid Pensions. The bill would establish principles for testing defined benefit plans for age discrimination and would clarify that "cash balance plans" do not ordinarily discriminate against older employees under federal law. It describes how cash balance plans and other "hybrid" pensions that have characteristics of both defined benefit and defined contribution plans would be tested for age discrimination, and clarifies that a defined benefit plan does not discriminate on the basis of age if a participant's entire accrued benefit, as defined under the plan's benefit formula, is no less than the accrued benefit of any worker similarly situated in every respect except for age. Pre-retirement indexing (for example, periodic adjustments that protect the economic value of the benefit against inflation prior to distribution) could be disregarded in making this determination. The bill also provides that in the case of cash balance plans, paying a lump sum equal to the participant's account balance would be sufficient to prevent a prohibited forfeiture of an accrued benefit, provided that the plan credits interest at a rate no greater than a market rate of interest. These provisions would apply to cash balance plans only prospectively.

Other Defined Contribution Plan Provisions. Several amendments to H.R. 2830 passed by the Committee on Ways and Means would affect defined contribution plans and Individual Retirement Accounts (IRAs). The higher annual contribution limits for IRAs and qualified retirement plans enacted in 2001 under P.L. 107-16 would be made permanent. A safe harbor for nondiscrimination testing would be established for employers who offer automatic enrollment in defined contribution retirement plans. Taxpayers could direct the Internal Revenue Service deposit part of a tax refund directly into an IRA. Workers who participate in tax-preferred flexible spending accounts (FSAs) could carry over as much as $500 annually in unused balances or transfer them to a health savings account. The Savers' Credit, a nonrefundable tax credit for low- and middle-income families, which is scheduled to expire after 2006, would be made permanent. The 10% early-distribution penalty would be waived for public safety employees who participate in pension plans with a "Deferred Retirement Option Plan" feature and for military reservists and national guardsmen who are called to active duty for at least 180 days. For members of the military, combat pay would be treated as earned income for purposes of IRA contributions. Tax-free rollovers would be permitted from the IRA or pension of a deceased individual to an IRA or pension of a designated beneficiary other than a spouse. Disabled persons could contribute to an IRA even if they had no earned income. Public safety officers who retire or become disabled could make tax-free distributions of up to $5,000 annually from governmental pension plans to purchase health or long-term care insurance.

² The bill would allow a plan sponsor to deduct for tax purposes a contribution equal to the greater of (1) 150% of current liability or (2) if the plan is not "at-risk," 100% of liability determined as if the plan were at-risk, plus the plan's normal cost, minus the value of plan assets.

³ In 2004, the 6^th U.S. Circuit Court of Appeals ruled that the PBGC could set a plan termination date that would prevent the agency from being liable for shutdown benefits. In March 2005, the U.S. Supreme Court declined to hear the case, leaving the Circuit Court's decision in place.

⁴ Multiemployer plans are common among workers covered by collective bargaining agreements.