What You Should Know About the New Pension Law
The most sweeping changes in 30 years were signed recently by President Bush. They may come too late to save the ailing corporate system, but workers will get better tools to save for their own retirement.
By Mary Beth Franklin, Senior Editor, Kiplinger's Personal Finance
August 16, 2006
Advertisement
The new Pension Reform Act that President Bush signed on August 17 attempts to avert a meltdown of the traditional pension system while giving workers expanded tools to save for their own retirement. The mammoth piece of legislation, nearly 1,000 pages long, represents the most comprehensive changes in retirement-plan rules in more than 30 years.
RELATED LINKS | |||
 |
Am I Saving Enough for Retirement? | ||
|
|
Pensions Go Into the Deep Freeze | ||
|
|
Fresh Ideas for Retiring Rich | ||
|
|
How Much Will My 401(k) Grow? | ||
But some pension experts, including Alicia Munnell, director of the Center for Retirement Research at Boston College, worry that the law's requirement to boost pension funding from the current 90% of liabilities to 100% by 2008 will prompt more employers to freeze their pension plans, continuing a trend that has been going on for years. The new law will also prevent severely underfunded pension plans from making promises of future benefits that they may not be able to keep. And it boosts the insurance premiums paid to the Pension Benefit Guaranty Corp., the federal agency that takes over pension payments to current and future retirees when an employer goes bankrupt.
Although the costly new rules may hasten the death of traditional pensions, the new law may breathe new life into cash-balance plans. These hybrids are funded by employers as they would a pension, but the money is held in separate accounts for employees, much like a 401(k). Cash-balance plans have been stymied by legal challenges since 2003, but the new pension law, plus a recent appeals- court ruling rejecting allegations of discrimination against older workers, clears the way for broader adoption.
The new law also reflects the real-world shift in the risk and responsibility of saving for retirement from employers to employees. It allows you to save more money for your own retirement. And, beginning next year, you can get personal advice from your plan provider on how to invest it.
Automatic contributions
To boost 401(k) participation and protect procrastinators from themselves, the new law encourages companies to automatically enroll workers in their 401(k) plan. Although employees can choose to opt out, most probably won't -- turning the inertia associated with retirement savings to their advantage. The Employee Benefit Research Institute estimates that automatic enrollment would increase 401(k) participation from about 66% of eligible workers today to more than 90%.
Beginning in 2008, employers can designate that 3% of a worker's pay be automatically deposited in the 401(k), and increase contributions each year until they reach 6%. The Labor Department is expected to issue guidelines allowing target-date retirement funds -- which invest in a balanced portfolio of mutual funds that grow more conservative as you near retirement -- as an appropriate default investment.
Higher savings limits
One of the most significant provisions of the new law makes permanent the higher contribution levels for IRAs and 401(k)s that were scheduled to disappear after 2010. The higher limits also apply to other workplace-based retirement plans, such as 403(b)s for teachers and 457 plans for government workers.
The maximum contribution limit to an IRA, currently $4,000, will rise to $5,000 in 2008 and be indexed to inflation after that. Employee contributions to 401(k) plans, currently $15,000, had been scheduled to drop back to $10,000 after 2010. Now the higher level will remain until inflation triggers future increases in $500 increments.
Catch-up contributions for workers 50 and older are also here to stay. That means older workers can continue to add an extra $1,000 to their IRAs and an additional $5,000 to their 401(k) plans.
And those contributions can really add up. Consider an employee who began maxing out his 401(k) at age 40 in 2002, when contribution limits were raised. He could accumulate more than $1.1 million by age 65, assuming an 8% average annual rate of return. If the higher limits and catch-up contributions (which begin at age 50) had been allowed to expire, the account would be worth only $888,000, according to the Investment Company Institute. So our 40-year-old is guaranteed an additional $215,000. (Use our calculator to see how quickly your contributions can add up.)