Americans have waited a long time for pension reform,
and it finally arrived with the Pension Protection Act of 2006,
a law signed by President Bush this month and designed to enhance
retirement security. Will it accomplish its mission?
Many of the provisions are positive changes, particularly
those pertaining to the "defined-contribution
plans" for which workers assume all responsibility. I'm
talking about 401(k) plans for workers in the private sector, 403(b)
plans for nonprofit employees and educators, and 457 plans for government
employees. For the most part, workers use their own money to fund
these plans and bear all investment risk.
The Pension Protection Act of 2006 will enable many
Americans to better shore up their own funds for retirement -- even
those who are oblivious.
But will it help companies shore up funds for traditional
pension plans? Employers assume all responsibility for these "defined-benefit
plans," and this legislation is supposed to strengthen
these plans for workers. But many folks are dubious about the new
law's effectiveness for this type of plan.
No question: Defined-contribution plans have increased in popularity
over the last 25 years while the old-style pensions have waned.
In some ways that's a better fit for a mobile work force. Workers
who sign up for these plans get tax breaks and the opportunity to
build a nice nest egg.
Still, lots of workers don't elect to defer part of their pay into a 401(k) plan due to "inertia" -- a euphemism for "laziness."
The law sets new guidelines designed to encourage
more companies to automatically enroll workers into their plans.
Workers can opt out. It's their money, after all. They're entitled
to sabotage their retirement if they wish. But the same force that
prevents workers from signing up for plans is expected to keep them
from opting out of auto-enrollment plans. Studies show that participation
increases by as much as 35 percentage points when they are offered.
So that's a good thing. The result: Americans will
be better prepared for their retirements even if they didn't consciously
plan to be. It's a forced mechanism we should all welcome.
So sign up already
But while companies are encouraged to adopt it, they're not required to do so. If your company continues to demand its employees to sign up, just do it.
Companies that do adopt the auto-enrollment feature
must defer between 3 percent and 10 percent of a worker's salary
but no less than 4 percent in the second year. The salary deferral
amounts increase by at least a percentage point each year, so that
6 percent at a minimum is deferred in the fourth year and thereafter.
In addition, companies must provide at least a 3-percent match (assuming
a 5-percent deferral rate) or a 3-percent profit sharing contribution,
and these contributions must be vested after no longer than two
years. Woo-hoo! These are big positives.