New law offers lagging retirement accounts a shot in the armBIZ SPOTLIGHT – Tax Planning
Companies that want to enroll workers automatically in 401(k) plans now have free rein to do so under a federal law enacted in August. Known as the Pension Protection Act of 2006, the law also changed the rules for traditional pension plans.
Businesses in New Jersey will take advantage of their newfound freedom to opt workers into 401(k) plans, says Kenneth A. Bagner, a manager at accounting firm Sobel & Co. in Livingston. ÂI think it will be commonplace starting the year 2008,Â when automatic enrollment is first allowed.
Indeed, many companies already had been thinking about automatic enrollment, says Robert Abzug, an actuary and principal with Cohn Benefits Consulting in Garden City, N.Y. The company is an affiliate of accounting firm J.H. Cohn in Roseland.
What kept companies from acting in the past was fear of being held liable if a workerÂs involuntary 401(k) investments turned sour, Abzug says. In that case, an employee theoretically could sue his or her employer.
Now the Pension Protection Act has erased liability for companies that follow the actÂs rules for investing employee funds. In general, companies must put money into investments appropriate to the employeeÂs age.
Under the act, companies can deduct money from employee paychecks and invest it directly into a 401(k) plan without seeking permission. Employees who donÂt want their money in a 401(k) can choose to withdraw from the plan.
ÂAll the companies that were on the fence are likely to start doing that going forward,Â Abzug says. ÂOther companies that have done it are probably breathing a sigh of relief. They now have relief from any liability.Â
The act addresses widespread concerns that workers arenÂt saving enough for their own retirements, particularly as traditional pension plans are withering.
ÂIn too many places, the companies that sponsor 401(k) plans have not done enough of a cheerleading and educational effort to get their employees to participate in the 401(k) plans and save enough,Â says Bill Knox, a wealth manager and principal at RegentAtlantic Capital, an investment firm in Chatham.
About 61 percent of retirement assets are now held in 401(k) plans and individual retirement accounts, known as defined-contribution plans, according to the Employee Benefit Research Institute in Washington, D.C. These plans have a set amount that the worker and/or employer put in, but no set payout. The remaining 39 percent of retirement assets are in traditional pension plans, known as defined-benefit plans because they pay a fixed amount after someone retires.
ÂWe donÂt have defined-benefit plans for most people in this country anymore,Â Knox says.
Knox hopes the new law will boost savings in 401(k) plans if only because people will be unlikely to opt out. ÂInertia is just incredibly powerful,Â he says. ÂSo if people are enrolled, theyÂll stay enrolled.Â
More than two-thirds of workers, 69 percent, favor automatic enrollment, according to a survey conducted in January by the Employee Benefit Research Institute. Slightly less than two-thirds, 65 percent, favored automatically increasing the share of money saved when they get a raise.
Now that itÂs allowed, automatic enrollment is expected to boost 401(k) participation rates to 92 percent of those eligible, up from 66 percent, according to the institute.
The Pension Protection Act also sets new rules for traditional pension plans.
In general, the rules address the problem of underfunded plans, those that lack the money to support the retirement benefits theyÂve promised.
Nationwide, in part because of the turbulent stock market, employer pension plans collectively are about $23 billion short, according to the Government Accountability Office.
Taxpayers typically have to bail out plans that fail. A federal agency, the Pension Benefit Guaranty Corp., makes good on at least some of the benefits promised by defunct plans.
The agency protects the pensions of about 1.2 million New Jersey workers and retirees. It has taken over 193 Garden State plans and, last year, paid out more than $61.5 million to more than 15,000 retirees and other beneficiaries.
Companies with traditional pension plans need to evaluate their funding levels now so they are prepared when new rules takes effect in 2008, says Steven Schenkel, director of the audit practice at J.H. Cohn.
ÂThe first thing you want to do is avoid significant underfunding,Â he suggests.
The new rules, for example, give companies less time to make good on any shortfalls and apply penalties to those missing the mark. The penalties include freezing separate benefit plans for top executives and managers.
Some small businesses have maintained traditional defined-benefit plans because they allow people to save more money toward retirement than defined-contribution plans, Schenkel says.
Meanwhile, for businesses with fewer than 500 workers that have both a 401(k) and a defined-benefit pension, the new law allows for combining the two types of plans. That provision should save companies money on auditing and other administrative requirements, accountants say.
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