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ERISA and PPA
Congressional efforts to cushion the nest egg over the years
By Shelia Watson
Contributing Writer
The Employee Retirement Income Security Act of 1974, which set minimum standards for most voluntarily established pension and health plans in private industry, was created to protect the interests of employees and their beneficiaries regarding their pension plans.
ERISA does not require employers to establish plans or provide insurance, but it does regulate the manner in which benefit plans operate.
Before ERISA, some plans contained vesting rules that took decades. There was a risk of working up to retirement only to lose all benefits because the worker was one day from vesting. That risk, combined with long vesting periods, made retirement benefits insecure.
Vesting contributions
ERISA required that sponsors of pension plans vest contributions either in defined contribution plans of 100% after five years (which, by definition, are fully funded at the start even if the employee has yet to invest, and 100% of employee contributions are 100% vested throughout) or in 20% graded increments after three years, so that 40% is vested after four years, 60% vested in five years, 80% vested after six years and full vesting after seven years in the graded schedule.
ERISA was amended several times to deal with concerns about the funding and vesting of defined benefit pension plans. Some of the amendments include the Consolidated Omnibus Budget Reconciliation Act, better known as COBRA, and the Health Insurance Portability and Accountability Act, also known as HIPPA.
Those amendments allow workers and family members the right to continue coverage for a period of time after leaving employment and allow employees the ability to obtain coverage with pre-existing conditions in some circumstances when moving from one plan to another, respectively.
New legislation
Even with the extensive ground ERISA and its amendments cover, a series of recent events eventually prompted new legislation in the form of the Pension Protection Act of 2006. Those events include: the stock market slump of 2000-2003, a low interest rate environment, the Sept. 11 terrorist attacks and subsequent economic slowdowns, airline failures, severe weather disasters such as Hurricanes Katrina and Rita and, most notably covered in the press, corporate corruption cases such as Enron.
The PPA, signed into law in August 2006, includes a number of charitable reforms and incentives. The legislation requires companies to more accurately analyze their pension plans’ obligations and closes many loopholes some companies previously took to underfund their plans.
Pre-PPA rules
Before the PPA, the funding rules required that pension plans keep a “funding standard account,” and keeping that account balanced entailed adding credits for employer contributions and charges for liabilities.
The pre-PPA rules were more flexible, allowing plans 30 years to amortize past service liabilities, which were based on time worked before the plan was instituted.
Beginning in 2008, when the PPA funding rules go into effect, the funding standard account will be eliminated and plans will be required to stay fully funded or make up the difference in seven years.
Interest rates rules
There are also changes in the rules regarding interest rates.
Under the PPA, pension plans can use interest rates only from AAA-grade corporate bonds or better, whereas previously, BBB-grade corporate bonds could be used.
The lower the grade of the bond, the higher the interest rate, which requires less cash. Conversely, a higher-grade bond means more cash is required, and the new interest rate rules allow only 24 months of interest rate averaging. This means pension plans are much more subject to the volatility of the market. Pre-PPA rules allowed smoothing over five years.
Nevertheless, the PPA is considered a boost for ensuring greater retirement security for American workers. According to the Department of Labor, the PPA contains provisions to help American workers who save for retirement through defined contribution plans such as IRAs And 401(k)s.
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