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Pension law may eventually improve defined benefit system

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Nine months after Congress passed the most extensive pension reform legislation in three decades, it remains unclear whether the law will breathe new life into defined benefit plans.

The Pension Protection Act responded to worries that pension funding rule loopholes left the federal agency that protects plan participants' benefits exposed to massive losses.

Both congressional leaders and the Bush administration were concerned that the Pension Benefit Guaranty Corp. could be bankrupted by terminations of massively underfunded pension plans, with a taxpayer-funded government bailout needed to prevent the PBGC from defaulting on its benefit guarantees to hundreds of thousands of participants.

In response, federal lawmakers stiffened pension plan funding rules. Lawmakers reduced to seven years from 30 the maximum amount of time to fund liabilities. They also eliminated a big loophole that allowed companies with severely underfunded plans to boost benefits, and tied the interest rates employers use to value plan liabilities to plan demographics.

But there are positives from an employer perspective in the new law, with the biggest being protection from age discrimination suits for those with cash balance plans. The law protects new plans set up after June 29, 2005, from such suits, but left it to the courts to resolve some two dozen suits filed against existing plans.

With cash balance plans' legality no longer in doubt, at least two major employers—MeadWestvaco Corp., a Richmond, Va.-based pulp paper and office supplies manufacturer, and SunTrust Banks Inc., a big Atlanta-based bank—converted traditional pension plans to cash balance plans. A third employer, package delivery giant FedEx Corp. in Memphis, Tenn., is expanding an existing cash balance plan.

Some experts say it will only be a matter of time before other employers follow, thanks to the protection afforded by the PPA.

"It took the PPA to restart the engine for hybrid plans after being stalled for a long, long time," said Larry Sher, principal and director of retirement policy at Buck Consultants L.L.C. in New York.

Still, there is plenty of uncertainty for employers, the chief issue being the lack of Treasury Department regulations to help employers comply with the many new requirements of the law. With many provisions due to kick in next year, pension experts say the effective date should be pushed back a year to give regulators more time to develop rules.

"We're not going to be comfortable with Treasury just issuing guidance," said Lynn Dudley, vp and senior counsel with the American Benefits Council in Washington. "We need to take time to do it right."

At a hearing earlier this month before the House Education and Labor Committee, Scott Macey, senior vp and director of government affairs for Aon Consulting in Somerset, N.J., asked to delay tougher funding rules until 2009 to avoid having more employers freezing their plans.

"Businesses cannot absorb that type of sudden increase in costs," Mr. Macey said at the hearing. "In the current defined benefit plan environmentÖthe reaction to that type of surprise would be swift and decisive in many cases: All new benefit accruals would likely cease and the plan would be frozen in order to control costs."

Even with short-term uncertainty caused by the lack of regulatory guidance, some observers say the federal law and its anticipated regulations will eventually improve the defined benefit system. Whether its strength will translate into more traditional defined benefit growth is unclear.

"Change is always tough," said Kyle Brown, an attorney at Watson Wyatt Worldwide in Arlington, Va. "Employers will come back to the system. It isn't a matter of when but to what degree."

New combination plan

Tucked within the massive federal pension reform measure is language allowing for a new hybrid pension plan that is both defined benefit and defined contribution. Starting in 2010, the eligible combined DB(k) would be available for companies with 500 or fewer employees.

The DB(k) is a defined benefit plan that accepts 401(k) contributions. On the 401(k) side, employees would be enrolled automatically and defer 4% of pay, of which employers would match at least 50%. The defined benefit portion would provide at least 1% of final pay for up to 20 years of service and employees would be 100% vested after three years' service. Employers could also structure the defined benefit plan component as a cash balance plan in which pay-related credits would increase with employee age.

Employers offering a DB(k) would face reduced filing requirements. In certain situations, they would be exempt from rules that restrict the amount of benefits available to a company's top executives.

DB(k) interest may rise closer to its availability date and after some of the more pressing issues arising from the federal law have been resolved, consultants agreed.

Many small employers that offered a defined contribution plan were reluctant to add a defined benefit plan, mostly because of the administrative setup work, said Rick Lawson, vp of federal government relations at Principal Financial Group in Washington. With DB(k) plans, employers "can do it all in one document," he said.

On a related front, legislation was introduced earlier this month in the House and in March in the Senate. The proposed Retirement Security for Life Act of 2007 would create tax incentives for individuals to invest a percentage of their retirement savings in annuities. Specifically, retirees could exclude 50% of annuity income—up to $40,000—from their taxable income. Both measures have been referred to committee.