Defined Contribution Reform Dependent on Defined Benefit Reform

If any changes to defined contribution legislation will be made before the 2006 elections, they will be riding on the tail of reform of the defined benefit system.

With Social Security reform largely off the agenda, probably for at least four years, the only urgent retirement-related business facing Congress at the moment is resolving outstanding private sector defined benefit plan issues, including conversions to cash balance plans.

With a number of corporations, especially in the airlines industry, using the bankruptcy process to unload large pension liabilities onto the federal government, Congress is feeling a great deal of pressure to reform the system. Additionally, there is significant concern about the ability of the Pension Benefit Guaranty Corporation to operate within the existing premium rate structure. However, as with most issues facing the Hill, there is wide disagreement on the government’s role.

The crowded legislative agenda, including hurricane damage relief, Supreme Court nominations and completing budget authorizations, may push consideration of the retirement agenda into 2006. Other issues like the CIA leak investigation and the war in Iraq, are also having an impact on the progress of legislation.

Just before the Thanksgiving recess, the Senate approved its version of the pension legislation. The House leadership promised to bring up its version after legislators return from their brief break. But that’s hardly the end of the story. President Bush has indicated he would veto the Senate version, so major changes may be made when the two versions are sent to the reconciliation committee. What emerges may or may not meet the approval of the Senate or the House

If anything is passed affecting public sector defined contribution plans, here are the likely areas of change:

• Adding 401(k) plans — New 401(k) plans adoptions have been prohibited for governmental entities since 1986. Sen. Craig Thomas (R-WY) has added an amendment to the Senate defined benefit reform bill that would open them up again. This proposal appears to have some chance of passage as part of the defined benefit reform legislation. At the opposite extreme, President Bush’s tax reform commission proposed the replacement of all retirement plans with a new system. This proposal does not appear to have much support at present.
• Automatic Enrollment — There is a great deal of sentiment on Capitol Hill to pass legislation providing employers greater confidence that they could automatically enroll new employees in their retirement plans, unless the employee affirmatively elects to not participate. Additional legislation would resolve issues on automatic increases in contributions, acceptable default options and withdrawal options.
  • There is some concern that the language currently being considered does not help public employers, because of current approaches to removing roadblocks may not apply to public sector plans. ICMA-RC is working with interested groups to develop an approach that includes public sector employees.
• Financial Advice — Both Democrats and Republicans appear to agree on the importance of providing incentives and protections for employers who offer their employees financial advice from a qualified investment advisor.
• Various Other Provisions — A number of other changes have been proposed. They include:
  • An exception to the 10 percent early distribution tax for distributions to public safety employees to the extent they are attributable to a “DROP Benefit” (sec. 905).
  • Tax-free distributions from 457, 403(b), and governmental 401(a) plans (up to $5,000) to eligible retired public safety officers to be used to pay for qualified health insurance premiums.
  • Making permanent the EGTRRA pension and IRA provisions
  • Providing for $500 flexible spending account carry-forwards or rollovers to an HSA.

As 2005 comes to a close, legislators will be working against the clock to complete their business. Any legislation that was introduced in 2005 remains active in 2006.

However, with Congressional elections looming next November, the odds of cooperation between the parties diminishes, making progress on controversial legislation all the more difficult.

It seems likely that some retirement reform legislation will reach the President’s desk, but not nearly the ambitious reform that was anticipated a year ago.