Pension Protection Act of 2006 (P.L. 109-280)

IV. Budget Effects of the Bill

VII. Dissenting Views

For plan years beginning in 2006, the bill applies the law as in effect for 2005, including the use of an interest rate based on long-term corporate bond rates to measure pension liabilities. For plan years beginning after 2006, the bill replaces the present-law two-tiered funding rules for single-employer plans with a single set of rules. Under the new rules, employers must generally contribute: (1) the amount needed to amortize unfunded liabilities attributable to previously earned benefits (the plan's "funding shortfall") over seven years, plus (2) the amount needed to fund benefits earned in the current year (the plan's "normal cost"). For this purpose, liabilities are measured using a modified interest rate yield curve based on a three-year weighted average of corporate bond rates. The modified yield consists of three "segment" rates based on the time when benefits are expected to be paid from the plan (within five years, between six and 20 years, and after 20 years). The bill also specifies a general mortality table to be used in valuing liabilities and permits the use of a plan-specific mortality table in certain cases. Special assumptions must be used in measuring liabilities of "at-risk" plans (i.e., plans that are less than 60-percent funded). Several phase-in rules apply in measuring liabilities and determining a plan's funding shortfall. The bill also modifies the rules relating to the use of credit balances, so that credit balances are adjusted to reflect gains and losses on plan assets, credit balances can be used to reduce required contributions only if a plan is at least 80-percent funded, and, subject to certain exceptions, the value of plan assets is reduced by any credit balances in determining required contributions and a plan's funded status.

Benefit limitations under single-employer plans

Under the bill, a single-employer defined benefit pension plan may not provide benefits payable solely as a result of a plant shutdown or other unpredictable contingent event. In addition, benefit increases generally are not permitted if a plan is less than 80-percent funded unless the liability attributable to such increases is currently funded, lump-sums and other accelerated forms of distribution may not be made if a plan is less than 80-precent funded, and benefit accruals must be frozen if a plan is less than 60-percent funded. These provisions are generally effective after December 31, 2006, with a delayed effective date for plans maintained pursuant to collective bargaining agreements.

Modification of transition rule to pension funding requirements

The bill extends to 2006 special rules for determining required contributions and variable rate premiums in the case of a single-employer plan sponsored by a company engaged primarily in interurban or interstate passenger bus service and meeting certain other requirements and modifies the special rules for years after 2006 when the new single-employer funding rules become effective.

Treatment of nonqualified deferred compensation plan when employer defined benefit plan is in at-risk status

Effective after December 31, 2005, if a defined benefit pension plan is in at-risk status (i.e., the plan is less than 60-percent funded), certain arrangements involving nonqualified deferred compensation are treated as property transferred in connection with the performance of services, resulting in current income inclusion and, in some cases, interest and a 20-percent additional tax. This treatment applies if assets are set aside (directly or indirectly) in a trust or other arrangement as determined by the Secretary of the Treasury, or transferred to such a trust or other arrangement, for purposes of paying nonqualified deferred compensation when the defined benefit pension plan is in at-risk status. The rule does not apply in the case of assets that are set aside before the defined benefit pension plan is in at-risk statute. The treatment also applies if a nonqualified deferred compensation plan provides that assets will be restricted to the provision of benefits under the plan in connection with the at-risk status (or other similar financial measure determined by the Secretary of Treasury) of any defined benefit pension plan of the employer or assets are so restricted.

Under the bill, for plan years beginning after December 31, 2006, in the case of multiemployer plans, the amortization periods attributable to past service liabilities and gains or losses from changes in actuarial assumptions are 15 years, rather than 30 years. The bill also modifies the rules relating to extensions of amortization periods and the interest rate applicable in the case of a funding waiver or amortization extension.

Additional funding rules for multiemployer plans in endangered or critical status

The bill provides (1) criteria for identifying underfunded multiemployer plans that pose the risk of a funding deficiency or insolvency, and (2) procedures for developing a plan to improve funding status, effective for plan years beginning after December 31, 2005.

Measures to forestall insolvency of multiemployer plans

The bill increases the likelihood of anticipating future insolvencies by requiring multiemployer plans in reorganization status to make projections of possible insolvency over a longer period, effective for plan years beginning after December 31, 2005.

In the case of single-employer plans, the bill applies an interest rate based on long-term corporate bonds for purposes of determining current liability for plan years beginning in 2006.

Interest rate assumption for determination of lump-sum distributions

Under the bill, the minimum present value of certain forms of benefit, such as lump sums, is determined using three-segment rates, based on a yield curve of interest rates on investment-grade corporate bonds, and a specified mortality table. The changes to the statutory assumptions are phased in over five years beginning in 2007.

Interest rate assumption for applying benefit limitations to lump-sum distributions

Under the bill, effective for distributions in years beginning after December 31, 2005, the interest rate used in applying the limits on benefits to certain forms of distributions, such as lump sums, is not less than the greatest of (1) 5.5 percent, (2) the rate that provides a benefit of not more than 105 percent of the benefit that would be provided using the statutory rate in determining minimum present value, and (3) the rate specified under the plan.

Distributions during working retirement

Effective for distributions in plan years beginning after December 31, 2005, a pension plan does not fail to be a qualified retirement plan solely because in-service distributions are made to participants who have attained age 62.

Effective in 2006, the bill allows employers to make deductible contributions (1) to single-employer plans in an amount based on 150 percent of the plan's funding target and (2) to multiemployer plans in an amount based on 140 percent of the plan's current liability.

Updating rules for combination of plans

Effective 2006, in applying the combined limit on deductible contributions to defined benefit and defined contribution plans, only contributions to defined contribution plans exceeding six percent of compensation are taken into account.

Under the bill, the EGTRRA sunset for years beginning after December 31, 2010, does not apply to the pension and IRA provisions of EGTRRA. Thus, these provisions are made permanent.

Saver's credit made permanent

The bill makes the saver's credit permanent and provides for the direct deposit of the credit to an IRA or plan that accepts such amounts.

Increasing participation through automatic enrollment contribution arrangements

The bill provides nondiscrimination safe harbors for elective deferrals and matching contributions made under a qualified automatic contribution arrangement, which is an arrangement that provides that participants are treated as having elected to make elective deferrals at certain scheduled rates (unless they elect otherwise). The provision is effective for plan years beginning after December 31, 2005.

Penalty-free withdrawals from retirement plans for individuals called to active duty for at least 179 days

The bill provides an exception to the 10-percent early withdrawal tax for distributions from an IRA or attributable to elective deferrals in the case of a reservist called to active duty on or after September 11, 2001, and before September 12, 2007, for at least 180 days or an indefinite period. Such amounts may be recontributed to an IRA within two years of the end of active duty. The statute of limitations for claiming a refund with respect to such a distribution is extended to one year after the date of enactment of the provision.

Waiver of 10-percent early withdrawal penalty tax on certain distributions of pension plans for public safety employees

Effective for distributions after the date of enactment, the 10-percent early withdrawal tax does not apply to certain benefits under a deferred retirement option plan ("DROP") feature of a governmental defined benefit pension plan to qualified public safety employees.

Combat zone compensation taken into account for purposes of determining limitation and deductibility of contributions to individual retirement plans

Effective for years beginning after December 31, 2005, compensation as defined for IRA purposes includes combat pay that is excludible from gross income.

Direct payment of tax refunds to retirement plans

The Secretary of the Treasury is directed to develop forms under which all or a portion of taxpayer refunds for taxable years beginning after December 31, 2006, can be deposited directly into IRAs.

IRA eligibility for the disabled

Effective for years beginning after December 31, 2005, the bill allows IRA contributions to be made by disabled individuals who have no compensation.

Rollovers by nonspouse beneficiaries

The bill allows a nonspouse beneficiary who inherits an interest in an employer-sponsored retirement plan to roll the interest over to an IRA, effective for distributions after December 31, 2005. The bill does not change the application of the minimum distribution rules for nonspouse beneficiaries.

The bill provides rules for long-term care insurance coverage provided by a rider on or as part of an annuity contract and modifies the rules for long-term care insurance coverage provided by a rider on or as part of a life insurance contract. The provision is generally effective after December 31, 2006.

Disposition of unused health benefits in cafeteria plans and flexible spending arrangements

Effective for years beginning after December 31, 2005, the bill allows up to $500 in unused health benefits under a health flexible spending account to be carried over to the next year or, in the case of an employee eligible for contributions to a health savings account ("HSA"), contributed to an HSA.

Distributions from governmental retirement plans for health and long-term care insurance for public safety officers

Effective for years beginning after December 31, 2005, the bill provides an exclusion of up to $5,000 for amounts distributed from an employer-sponsored governmental retirement plan in order to pay accident or health or long-term care insurance premiums for retired public safety officers.

The bill also contains provisions that will increase the tax-favored savings opportunities for Americans. For example, the bill makes permanent the retirement savings provisions that were part of the Economic Growth and Tax Relief Reconciliation Act of 2001.

The bill also takes steps to make health care, including long-term care, more affordable.

H.R. 2830 was introduced on June 9, 2005, and was referred to the Committee on Education and the Workforce and in addition to the Committee on Ways and Means, for a period to be determined by the Speaker, in each case for consideration of such provisions as fall within the jurisdiction of the committee concerned.

The Committee on Education and the Workforce marked up the bill on June 29, 2005, and order the bill, as amended, favorably reported. See H.R. Rpt. 109-232, Part I, for the bill as reported by the Committee on Education and the Workforce.

Committee action

The Committee on Ways and Means marked up the bill on November 9, 2005, and ordered the bill, as amended, favorably reported.

Committee hearings

Matters addressed by the bill have been the subject of Committee review in the current as well as preceding Congresses.

The following full Committee and Subcommittee hearings related to matters in the bill have been held during the 109th Congress.

• Hearing on funding rules for multiemployer defined benefit plans in H.R. 2830, the "Pension Protection Act of 2005" (June 28, 2005, Subcommittee on Select Revenue Measures)

• Hearing on retirement policy challenges and opportunities of our aging society (May 19, 2005, Full Committee)

• Hearing on long-term care (April 19, 2005, Subcommittee on Health)

• Hearing on the President's proposal for single-employer pension funding reform (March 8, 2005, Subcommittee on Select Revenue Measures)

• Joint hearing on examining pension security and defined benefit plans, the Bush Administration's proposal to replace the 30-year Treasury rate (July 15, 2003; Subcommittee on Select Revenue Measures).

• Challenges facing pension plan funding (April 30, 2003; Subcommittee on Select Revenue Measures).

• Hearing on the President's fiscal year 2004 budget (February 5, 2003, Full Committee).

• Hearing on the President's fiscal year 2004 budget (February 4, 2003, Full committee).

A number of provisions in the bill as reported have previously passed the House, including the provisions relating to investment advice, treating combat pay as compensation for purposes of the IRA rules, providing for qualified reservist distributions, and allowing the rollover of unused amounts in a flexible spending arrangement.

Single-employer defined benefit pension plans are subject to minimum funding requirements under the Employee Retirement Income Security Act of 1974 ("ERISA") and the Internal Revenue Code (the "Code").¹ The amount of contributions required for a plan year under the minimum funding rules is generally the amount needed to fund benefits earned during that year plus that year's portion of other liabilities that are amortized over a period of years, such as benefits resulting from a grant of past service credit. The amount of required annual contributions is determined under one of a number of acceptable actuarial cost methods. Additional contributions are required under the deficit reduction contribution rules in the case of certain underfunded plans. No contribution is required under the minimum funding rules in excess of the full funding limit (described below).

As an administrative aid in the application of the funding requirements, a defined benefit pension plan is required to maintain a special account called a "funding standard account" to which specified charges and credits are made for each plan year, including a charge for normal cost and credits for contributions to the plan. Other charges or credits may apply as a result of decreases or increases in past service liability as a result of plan amendments, experience gains or losses, gains or losses resulting from a change in actuarial assumptions, or a waiver of minimum required contributions.

In determining plan funding under an actuarial cost method, a plan's actuary generally makes certain assumptions regarding the future experience of a plan. These assumptions typically involve rates of interest, mortality, disability, salary increases, and other factors affecting the value of assets and liabilities. If the plan's actual unfunded liabilities are less than those anticipated by the actuary on the basis of these assumptions, then the excess is an experience gain. If the actual unfunded liabilities are greater than those anticipated, then the difference is an experience loss. Experience gains and losses for a year are generally amortized as credits or charges to the funding standard account over five years.

If the actuarial assumptions used for funding a plan are revised and, under the new assumptions, the accrued liability of a plan is less than the accrued liability computed under the previous assumptions, the decrease is a gain from changes in actuarial assumptions. If the new assumptions result in an increase in the accrued liability, the plan has a loss from changes in actuarial assumptions. The accrued liability of a plan is the actuarial present value of projected pension benefits under the plan that will not be funded by future contributions to meet normal cost or future employee contributions. The gain or loss for a year from changes in actuarial assumptions is amortized as credits or charges to the funding standard account over ten years.

If minimum required contributions are waived (as discussed below), the waived amount (referred to as a "waived funding deficiency") is credited to the funding standard account. The waived funding deficiency is then amortized over a period of five years, beginning with the year following the year in which the waiver is granted. Each year, the funding standard account is charged with the amortization amount for that year unless the plan becomes fully funded.

If, as of the close of a plan year, the funding standard account reflects credits at least equal to charges, the plan is generally treated as meeting the minimum funding standard for the year. If, as of the close of the plan year, charges to the funding standard account exceed credits to the account, then the excess is referred to as an "accumulated funding deficiency." Thus, as a general rule, the minimum contribution for a plan year is determined as the amount by which the charges to the funding standard account would exceed credits to the account if no contribution were made to the plan. For example, if the balance of charges to the funding standard account of a plan for a year would be $200,000 without any contributions, then a minimum contribution equal to that amount would be required to meet the minimum funding standard for the year to prevent an accumulated funding deficiency.

Credit balances

If credits to the funding standard account exceed charges, a "credit balance" results. A credit balance results, for example, if contributions in excess of minimum required contributions are made. Similarly, a credit balance may result from large net experience gains. The amount of the credit balance, increased with interest at the rate used under the plan to determine costs, can be used to reduce future required contributions.

Funding methods and general concepts

A defined benefit pension plan is required to use an acceptable actuarial cost method to determine the elements included in its funding standard account for a year. Generally, an actuarial cost method breaks up the cost of benefits under the plan into annual charges consistingof two elements for each plan year. These elements are referred to as: (1) normal cost; and (2) supplemental cost.

The plan's normal cost for a plan year generally represents the cost of future benefits allocated to the year by the funding method used by the plan for current employees and, under some funding methods, for separated employees. Specifically, it is the amount actuarially determined that would be required as a contribution by the employer for the plan year in order to maintain the plan if the plan had been in effect from the beginning of service of the included employees and if the costs for prior years had been paid, and all assumptions as to interest, mortality, time of payment, etc., had been fulfilled. The normal cost will be funded by future contributions to the plan: (1) in level dollar amounts; (2) as a uniform percentage of payroll; (3) as a uniform amount per unit of service (e.g., $1 per hour); or (4) on the basis of the actuarial present values of benefits considered accruing in particular plan years.

The supplemental cost for a plan year is the cost of future benefits that would not be met by future normal costs, future employee contributions, or plan assets. The most common supplemental cost is that attributable to past service liability, which represents the cost of future benefits under the plan: (1) on the date the plan is first effective; or (2) on the date a plan amendment increasing plan benefits is first effective. Other supplemental costs may be attributable to net experience losses, changes in actuarial assumptions, and amounts necessary to make up funding deficiencies for which a waiver was obtained. Supplemental costs must be amortized (i.e., recognized for funding purposes) over a specified number of years, depending on the source. For example, the cost attributable to a past service liability is generally amortized over 30 years.

Normal costs and supplemental costs under a plan are computed on the basis of an actuarial valuation of the assets and liabilities of a plan. An actuarial valuation is generally required annually and is made as of a date within the plan year or within one month before the beginning of the plan year. However, a valuation date within the preceding plan year may be used if, as of that date, the value of the plan's assets is at least 100 percent of the plan's current liability (i.e., the present value of benefit liabilities under the plan, as described below).

For funding purposes, the actuarial value of plan assets may be used, rather than fair market value. The actuarial value of plan assets is the value determined under a reasonable actuarial valuation method that takes into account fair market value and is permitted under Treasury regulations. Any actuarial valuation method used must result in a value of plan assets that is not less than 80 percent of the fair market value of the assets and not more than 120 percent of the fair market value. In addition, if the valuation method uses average value of the plan assets, values may be used for a stated period not to exceed the five most recent plan years, including the current year.

In applying the funding rules, all costs, liabilities, interest rates, and other factors are required to be determined on the basis of actuarial assumptions and methods, each of which is reasonable (taking into account the experience of the plan and reasonable expectations), or which, in the aggregate, result in a total plan contribution equivalent to a contribution that would be obtained if each assumption and method were reasonable. In addition, the assumptions are required to offer the actuary's best estimate of anticipated experience under the plan.²

Under special funding rules (referred to as the "deficit reduction contribution" rules),³ an additional charge to a plan's funding standard account is generally required for a plan year if the plan's funded current liability percentage for the plan year is less than 90 percent.⁴ A plan's "funded current liability percentage" is generally the actuarial value of plan assets as a percentage of the plan's current liability.⁵ In general, a plan's current liability means all liabilities to employees and their beneficiaries under the plan, determined on a present-value basis.

The amount of the additional charge required under the deficit reduction contribution rules is the sum of two amounts: (1) the excess, if any, of (a) the deficit reduction contribution (as described below), over (b) the contribution required under the normal funding rules; and (2) the amount (if any) required with respect to unpredictable contingent event benefits. The amount of the additional charge cannot exceed the amount needed to increase the plan's funded current liability percentage to 100 percent (taking into account any expected increase in current liability due to benefits accruing during the plan year).

The deficit reduction contribution is the sum of (1) the "unfunded old liability amount," (2) the "unfunded new liability amount," and (3) the expected increase in current liability due to benefits accruing during the plan year.⁶ The "unfunded old liability amount" is the amount needed to amortize certain unfunded liabilities under 1987 and 1994 transition rules. The "unfunded new liability amount" is the applicable percentage of the plan's unfunded new liability. Unfunded new liability generally means the unfunded current liability of the plan (i.e., the amount by which the plan's current liability exceeds the actuarial value of plan assets), but determined without regard to certain liabilities (such as the plan's unfunded old liability and unpredictable contingent event benefits). The applicable percentage is generally 30 percent, but decreases by .40 of one percentage point for each percentage point by which the plan's funded current liability percentage exceeds 60 percent. For example, if a plan's funded current liability percentage is 85 percent (i.e., it exceeds 60 percent by 25 percentage points), the applicable percentage is 20 percent (30 percent minus 10 percentage points (25 multiplied by .4)).⁷

A plan may provide for unpredictable contingent event benefits, which are benefits that depend on contingencies that are not reliably and reasonably predictable, such as facility shutdowns or reductions in workforce. The value of any unpredictable contingent event benefit is not considered in determining additional contributions until the event has occurred. The event on which an unpredictable contingent event benefit is contingent is generally not considered to have occurred until all events on which the benefit is contingent have occurred.

Required interest rate and mortality table

Specific interest rate and mortality assumptions must be used in determining a plan's current liability for purposes of the special funding rule. For plans years beginning before January 1, 2004, the interest rate used to determine a plan's current liability must be within a permissible range of the weighted average ⁸ of the interest rates on 30-year Treasury securities for the four-year period ending on the last day before the plan year begins. The permissible range is generally from 90 percent to 105 percent (120 percent for plan years beginning in 2002 or 2003).⁹ The interest rate used under the plan generally must be consistent with the assumptions which reflect the purchase rates which would be used by insurance companies to satisfy the liabilities under the plan.¹⁰

Under the Pension Funding Equity Act of 2004 ("PFEA 2004"),¹¹ a special interest rate applies in determining current liability for plan years beginning in 2004 or 2005.¹² For these years, the interest rate used must be within a permissible range of the weighted average of the rates of interest on amounts invested conservatively in long-term investment-grade corporate bonds during the four-year period ending on the last day before the plan year begins. The permissible range for these years is from 90 percent to 100 percent. The interest rate is to be determined by the Secretary of the Treasury on the basis of two or more indices that are selected periodically by the Secretary and are in the top three quality levels available.

The Secretary of the Treasury is required to prescribe mortality tables and to periodically review (at least every five years) and update such tables to reflect the actuarial experience of pension plans and projected trends in such experience.¹³ The Secretary of the Treasury has required the use of the 1983 Group Annuity Mortality Table.¹⁴

No contributions are required under the minimum funding rules in excess of the full funding limitation. The full funding limitation is the excess, if any, of (1) the accrued liability under the plan (including normal cost), over (2) the lesser of (a) the market value of plan assets or (b) the actuarial value of plan assets.¹⁵ However, the full funding limitation may not be less than the excess, if any, of 90 percent of the plan's current liability (including the current liability normal cost) over the actuarial value of plan assets. In general, current liability is all liabilities to plan participants and beneficiaries accrued to date, whereas the accrued liability under the full funding limitation may be based on projected future benefits, including future salary increases.

TIMING OF PLAN CONTRIBUTIONS

In general, plan contributions required to satisfy the funding rules must be made within 8-1/2 months after the end of the plan year. If the contribution is made by such due date, the contribution is treated as if it were made on the last day of the plan year.

In the case of a plan with a funded current liability percentage of less than 100 percent for the preceding plan year, estimated contributions for the current plan year must be made in quarterly installments during the current plan year.¹⁶ The amount of each required installment is 25 percent of the lesser of (1) 90 percent of the amount required to be contributed for the current plan year or (2) 100 percent of the amount required to be contributed for the preceding plan year.¹⁷

The IRS is authorized to require security to be granted as a condition of granting a waiver of the minimum funding standard if the sum of the plan's accumulated funding deficiency and the balance of any outstanding waived funding deficiencies exceeds $1 million.

If the total of the contributions the employer fails to make (plus interest) exceeds $1 million and the plan's funded current liability percentage is less than 100 percent, a lien arises in favor of the plan with respect to all property of the employer and the members of the employer's controlled group. The amount of the lien is the total amount of the missed contributions (plus interest).

The Committee believes that the current defined benefit pension system does not contain appropriate funding rules to ensure that pension plans are properly funded. The Committee believes that comprehensive funding rule changes are needed in order to address the systematic pension underfunding crisis that continues to threaten the financial security of millions of participants. In addition, the present-law single-employer defined benefit plan funding rules, including the existence of a dual set of rules, are overly complex.

It is the view of the Committee that present-law pension funding rules permit underfunded plans to make up funding shortfalls over too long a period of time, putting workers at risk of having their plans terminate without adequate funding. The Committee believes that present-law funding rules should be modified to ensure that employers are required to make sufficient and consistent contributions to ensure that plans ultimately meet a 100 percent funding target.

The Committee believes that liabilities should be measured more precisely than required under present law. The Committee believes that the comprehensive pension reforms must include permanent interest rate reforms that generally reflect the timing of when liabilities are to be paid out. The Committee believes that the general matching of discount rates of differing maturities to pension obligations is the most accurate and practical way to measure the cost of meeting pension obligations and that a yield curve concept should be used. The Committee understands that use of a yield curve to measure other types of financial liabilities, such as car loans, mortgages, and certificates of deposit, is a common and prudent business practice.

The Committee believes that accuracy in measuring pension liabilities and providing plan sponsors the ability to predict and budget for pension contributions are both important considerations. The Committee believes that the present-law rules do not appropriately balance these concerns, and that slightly reducing the smoothing periods under present law would improve accuracy while maintaining predictability. Thus, the Committee bill incorporates smoothing techniques in applying the modified yield curve and in determining asset values.However, the bill also generally reduces by one year the period over which smoothing is permitted.

The Committee also believes that the mortality table required to be used under present law in calculating plan liabilities is outdated and may cause certain plans to appear to be better funded with fewer liabilities. Thus, the Committee believes that it is appropriate to update the mortality table required to be used and to allow the use of plan-specific mortality tables upon approval of Secretary of the Treasury.

The present-law rules relating to credit balances have been identified as contributing to plan underfunding. Under present law, a credit balance is increased each year based on an assumed rate of interest, even if plan assets have failed to earn that rate of return or suffered losses. In addition, credit balances can be used to offset required contributions, even in the case of a seriously underfunded plan, thus slowing plan funding. Indeed, as benefits continue to accrue, using credit balances to offset required contributions causes funded status to deteriorate further. The PBGC has noted that in some large plan terminations, the use of credit balances allowed a "funding holiday" for several years before plan termination, at which time the plans were significantly underfunded. Because credit balances were perceived as having such a harmful effect on funding, the Administration proposal would have eliminated the credit balances accumulated under present law, as well as prohibited new balances from accumulating. The bill does not adopt the strict approach of the Administration proposal. Rather, the bill both preserves the ability to use present-law balances, as well as permits new balances to accumulate. However, use of new balances is more limited to counteract some of the harmful effects associated with credit balances under present law.

The Committee is also concerned about seriously underfunded plans as such plans present a risk to employees, as well as to the PBGC insurance program and to other PBGC premium payors. If the PBGC does not remain solvent, there may be increased pressures for guaranteed benefits to be paid from general revenues, thus imposing additional burdens on American taxpayers generally. The Committee believes that it is appropriate to require underfunded plans to use certain additional assumptions and loading factors in determining their funding obligations.

For plan years beginning after December 31, 2005, and before January 1, 2007, the provision applies the present-law funding rules, with an extension of the interest rate applicable in determining current liability for plan years beginning in 2004 and 2005. Thus, in determining current liability for funding purposes for plan years beginning in 2006, the interest rate used must be within the permissible range (90 to 100 percent) of the weighted average of the rates of interest on amounts invested conservatively in long-term investment-grade corporate bonds during the four-year period ending on the last day before the plan year begins.

The minimum required contribution for a plan year, based on the value of plan assets (reduced by any prefunding balance and funding standard carryover balance) compared to the funding target, is shown in the following table:

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The provision specifies the interest rates and mortality table that must be used in determining a plan's target normal cost and funding target, as well as certain other actuarial assumptions, including special assumptions if the value of a plan's assets (reduced by any prefunding and funding standard carryover balances) for the preceding year was less than 60 percent of the plan's funding target (an "at-risk" plan).

Target normal cost

Under the provision, the minimum required contribution for a plan year generally includes the plan's target normal cost for the plan year. A plan's target normal cost is the present value of all benefits expected to accrue or be earned under the plan during the plan year (the "current" year). For this purpose, an increase in any benefit attributable to services performed in a preceding year by reason of a compensation increase during the current year is treated as having accrued during the current year.

If the value of a plan's assets (reduced by any funding standard carryover balance and prefunding balance) exceeds the plan's funding target for a plan year, for purposes of determining the minimum required contribution for the plan year, normal cost is reduced by the excess.

Funding target and shortfall amortization charges

A shortfall amortization base is determined for a plan year based on the plan's funding shortfall for the plan year, that is, the amount by which the plan's funding target for the year exceeds the value of the plan's assets (reduced by any funding standard carryover balance and prefunding balance). The shortfall amortization base is the excess of (1) the funding shortfall, over (2) the present value of (a) the aggregate shortfall amortization installments for the plan year and the five succeeding plan years that have been determined with respect to any shortfall amortization bases for each of the six preceding plan years and (b) the aggregate waiver amortization installments (discussed below) for the plan year and the four succeeding plan years that have been determined with respect to any waived funding deficiency for each of the five preceding plan years. Under a special rule, a shortfall amortization base does not have to be established for a year if the value of a plan's assets (reduced by any prefunding balance, but only if the employer elects to use the prefunding balance to reduce required contributions for the year) is at least equal to the plan's funding target for a plan year.

A transition rule applies with respect to certain plans in determining a shortfall amortization base for a plan year beginning after 2006 and before 2011. The transition rule applies to a plan that is subject to the present-law funding rules for the 2006 plan year, but is not subject to the present-law deficit reduction contribution rules for that year (either because of the plan's funded status or because the plan covers no more than 100 participants). Under the transition rule, for purposes of determining a shortfall amortization base for a plan year, the plan's funding shortfall is calculated by reference to the applicable percentage of the plan's funding target as shown in the following table:

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Waiver amortization charges

The provision retains the present-law rules under which the Secretary of the Treasury may waive all or a portion of the contributions required under the minimum funding standard for a plan year (referred to as a "waived funding deficiency").²² If a plan has a waived funding deficiency for a plan year or any of the four preceding plan years, the minimum required contribution for the plan year is increased by the waiver amortization charge for the plan year.

The waiver amortization charge for a plan year is the aggregate of the waiver amortization installments for the plan year with respect to any waiver amortization bases for the five preceding plan years. The waiver amortization installments with respect to a waiver amortization base for a plan year are annual installments determined as the amount needed to amortize the waiver amortization base in level annual installments over the five-year period beginning with the following plan year. The waiver amortization installments for a plan year are determined using the appropriate segment interest rates for the plan year (discussed below). The waiver amortization base for a plan year is the amount of the waived funding deficiency (if any) for the plan year.

If a plan's funding shortfall for a plan year is zero (i.e., the value of the plan's assets, reduced by any funding standard carryover balance and prefunding balance, is at least equal to the plan's funding target for the year), any waiver amortization bases for preceding plan years are eliminated. In that case, for purposes of determining any waiver amortization charges for that year and succeeding years, the waiver amortization base for preceding years is zero.

Actuarial assumptions used in determining a plan's target normal cost and funding target

The corporate bond yield curve used for this purpose is to be prescribed on a monthly basis by the Secretary of the Treasury, reflecting a three-year weighted average of yields on investment grade corporate bonds with varying maturities. The three-year weighted average is an average determined using a methodology under which the most recent year is weighted 50 percent, the preceding year is weighted 35 percent, and the second preceding year is weighted 15 percent.

The Secretary of the Treasury is directed to publish each month the corporate bond yield curve and each of the segment rates for the month. In addition, such Secretary is directed to publish a description of the methodology used to determine the yield curve and segment rates, which is sufficiently detailed to enable plans to make reasonable projections regarding the yield curve and segment rates for future months, based on a plan's projection of future interest rates.

Under the provision, the present value of liabilities under a plan is determined using the segment rates for the "applicable month" for the plan year. The applicable month is the month that includes the plan's valuation date for the plan year, or, at the election of the plan sponsor, any of the four months preceding the month that includes the valuation date. An election of a preceding month applies to the plan year for which it is made and all succeeding plan years unless revoked with the consent of the Secretary of the Treasury.

The provision provides a transition rule for plan years beginning in 2007 and 2008.²³ Under this rule, for plan years beginning in 2007, the first, second, or third segment rate with respect to any month is the sum of: (1) the product of the segment rate otherwise determined for the month, multiplied by 33-1/3 percent; and (2) the product of the applicable long-term corporate bond rate,²⁴ multiplied by 66-2/3 percent. For plan years beginning in 2008, the first, second, or third segment rate with respect to any month is the sum of: (1) the product of the segment rate otherwise determined for the month, multiplied by 66-2/3 percent; and (2) the product of applicable long-term corporate bond rate multiplied by 33-1/3 percent.

Under the provision, certain amounts are determined using the plan's "effective interest rate" for a plan year. The effective interest rate with respect to a plan for a plan year is the single rate of interest which, if used to determine the present value of the liabilities taken into account in determining the plan's funding target for the year, would result in an amount equal to the plan's funding target (as determined using the first, second, and third segment rates).

The Secretary of the Treasury is directed to make revisions at least every 10 years in any tables in effect under the provision to reflect the actual experience of pension plans and projected trends in such experience.

The provision also provides for the use of a different mortality table with respect to a plan, as requested by the plan sponsor and approved by the Secretary of Treasury. In order for the table to be used, the Secretary must determine that the table (1) reflects the actual experience of the pension plan and projected trends in such experience and (2) is significantly different from the table otherwise required to be used. Such a table may generally be used for up to 10 years. However, the table shall no longer apply if the plan's actuary determines that the table no longer meets the applicable criteria. A mortality table submitted to the Secretary for approval under the provision is treated as in effect for the succeeding plan year unless the Secretary, within the 180-day period beginning on the date of the submission, disapproves of the table and provides the reasons that the table fails to meet the applicable criteria.

The provision generally does not require other specified assumptions to be used in determining the plan's target normal cost and funding target except in the case of at-risk plans (discussed below). However, similar to present law, the determination of present value or other computation must be made on the basis of actuarial assumptions and methods, each of which is reasonable (taking into account the experience of the plan and reasonable expectations), and which, in combination, offer the actuary's best estimate of anticipated experience under the plan.²⁶

Special assumptions for at-risk plans

The provision applies special rules in determining the funding target and normal cost of a plan in at-risk status. A plan is in at-risk status for a plan year if the plan's funding target attainment percentage for the preceding year was less than 60 percent. A plan's funding target attainment percentage for a plan year is the ratio, expressed as a percentage, that the value of the plan's assets (reduced by any funding standard carryover balance and prefunding balance) bears to the plan's funding target for the year. For this purpose, the plan's funding target is determined using the actuarial assumptions for plans that are not at-risk.

The funding target of a plan in at-risk status for a plan year is generally the sum of: (1) the present value of all liabilities to participants and beneficiaries under the plan for the plan year, determined using (in addition to the normally required assumptions) an assumption that all participants will elect benefits at the times and in the forms that will result in the highest present value of liabilities, plus (2) a loading factor. The loading factor is the sum of (1) $700 times the number of participants in the plan, plus (2) four percent of the funding target determined without regard to the loading factor.²⁷

The target normal cost of a plan in at-risk status for a plan year is generally the sum of: (1) the present value of benefits expected to accrue or be earned under the plan during the plan year, determined using (in addition to the normally required assumptions) an assumption that all participants will elect benefits at the times and in the forms that will result in the highest present value, plus (2) a loading factor. The loading factor is four percent of the target normal cost determined without regard to the loading factor.²⁸

If a plan has been in at-risk status for fewer than five consecutive plan years, the amount of a plan's funding target for a plan year is the sum of: (1) the amount of the funding target determined without regard to the at-risk rules, plus (2) the transition percentage for the plan year of the excess of the amount of the funding target determined under the at-risk rules over the amount determined without regard to the at-risk rules. Similarly, if a plan has been in at-risk status for fewer than five consecutive plan years, the amount of a plan's target normal cost for a plan year is the sum of: (1) the amount of the target normal cost determined without regard to the at-risk rules, plus (2) the transition percentage for the plan year of the excess of the amount of the target normal cost determined under the at-risk rules over the amount determined without regard to the at-risk rules. The transition percentage is the product of 20 percent times the number of consecutive plan years for which the plan has been in at-risk status.

Funding standard carryover balance or prefunding balance

Under the bill, if the value of a plan's assets (reduced by any prefunding balance) is at least 80 percent of the plan's funding target (determined without regard to the at-risk rules) for the preceding plan year, the plan sponsor may elect to credit all or a portion of the funding standard carryover balance or prefunding balance against the minimum required contribution for the current plan year (determined after any funding waiver), thus reducing the amount that must be contributed for the current year.

The value of plan assets is generally reduced by any prefunding balance or funding standard carryover balance for purposes of determining minimum required contributions. However, the plan sponsor may elect to reduce the prefunding balance or funding standard carryover balance, so that the value of plan assets is not required to be reduced by that amount in determining the minimum required contribution for the plan year. Any reduction of the prefunding balance or funding standard carryover balance applies before determining the balance that is available for crediting against minimum required contributions for the plan year.

For subsequent years (i.e., as of the valuation date for each plan year beginning after 2007), the funding standard carryover balance of a plan is decreased (but not below zero) by the sum of: (1) any amount credited to reduce the minimum required contribution for the preceding plan year, plus (2) any amount elected by the plan sponsor as a reduction in the funding standard carryover balance (thus reducing the amount by which the value of plan assets must be reduced in determining minimum required contributions).

For subsequent years (i.e., as of the valuation date for each plan year beginning after 2007 (the "current" plan year)), the prefunding balance of a plan is increased by the amount elected by the plan sponsor, not to exceed: (1) the excess (if any) of the aggregate total employer contributions for the preceding plan year, over (2) the minimum required contribution for the preceding plan year. For this purpose, the minimum required contribution for the preceding plan year is increased by interest, at the plan's effective rate for the preceding plan year, on any portion of the required contribution remaining unpaid as of the valuation date for the current plan year, for the period beginning with the first day of the preceding plan year and ending on the date that the unpaid portion of the contribution is made.

As of the valuation date for each plan year beginning after 2007, the prefunding balance of a plan is decreased (but not below zero) by the sum of: (1) any amount credited to reduce the minimum required contribution for the preceding plan year, plus (2) any amount elected by the plan sponsor as a reduction in the prefunding balance (thus reducing the amount by which the value of plan assets must be reduced in determining minimum required contributions). As discussed above, if the prefunding balance is used to reduce a minimum required contribution, the value of plan assets must be reduced by the prefunding balance in determining whether a shortfall amortization base must be established for the plan year (i.e., whether the value of plan assets for a plan year is less than the plan's funding target for the plan year). Thus, the prefunding balance may not be included in the value of plan assets in order to avoid a shortfall amortization base for a plan year and also used to reduce the minimum required contribution for the same year.

To the extent that a plan has a funding standard carryover balance of more than zero for a plan year, none of the plan's prefunding balance may be credited to reduce a minimum required contribution, nor may an election be made to reduce the prefunding balance for purposes of determining the value of plan assets. Thus, the funding standard carryover balance must be used for these purposes before the prefunding balance may be used.

Any election relating to the prefunding balance and funding standard carryover balance is to be made in such form and manner as the Secretary of the Treasury prescribes.

Other rules and definitions

If a required contribution for a preceding plan year is made after the valuation date for the current year, the contribution is taken into account in determining the value of plan assets for the current plan year. For plan years beginning after 2007, the contribution is taken into account in the amount of its present value as of the valuation date for the current plan year, determined using the plan's effective rate of interest for the preceding plan year. In addition, any required contribution for the current plan year is not taken into account in determining the value of planassets. If a required contribution for the current plan year is made before the valuation date, the value of plan assets is reduced for interest on the contribution for the period from the time of contribution to the valuation date, determined using the plan's effective rate of interest for the current plan year.

(sec. 113(a) of the bill and new sec. 436 of the Code)

Defined benefit pension plans are not permitted to provide "layoff" benefits (i.e., severance benefits).³² However, defined benefit pension plans may provide subsidized early retirement benefits, including early retirement window benefits.³³

An amendment of a qualified retirement plan may not decrease the accrued benefit of a plan participant.³⁴ This restriction is sometimes referred to as the "anticutback" rule and applies to benefits that have already accrued. In general, an amendment may reduce the amount of future benefit accruals, provided that, in the case of a significant reduction in the rate of future benefit accrual, certain notice requirements are met.

For purposes of the anticutback rule, an amendment is also treated as reducing an accrued benefit if, with respect to benefits accrued before the amendment is adopted, the amendment has the effect of either (1) eliminating or reducing an early retirement benefit or a retirement-type subsidy, or (2) except as provided by Treasury regulations, eliminating an optional form of benefit.

Under the provision, a plan does not fail to meet the requirements of the anti-cutback rule solely by reason of the adoption of a plan amendment necessary to meet the requirements of the provision.

In the case of a plan maintained pursuant to one or more collective bargaining agreements between employee representatives and one or more employers ratified before the date of enactment of the provision, the provision does not apply to plan years beginning before the earlier of: (1) the later of (a) the date on which the last collective bargaining agreement relating to the plan terminates (determined without regard to any extension thereof agreed to after the date of enactment), or (b) the first day of the first plan year to which the provision would otherwise apply; or (2) January 1, 2009. For this purpose, any plan amendment made pursuant to a collective bargaining agreement relating to the plan that amends the plan solely to conform to any requirement under the provision is not to be treated as a termination of the collective bargaining agreement.

2. Funding-based limits on benefits and benefit accruals

(sec. 113(b) of the bill and new sec. 437 of the Code)

Under present law, various restrictions may apply to benefit increases and distributions from a defined benefit pension plan, depending on the funding status of the plan.

Limitation on certain benefit increases while funding waivers in effect

Within limits, the IRS is permitted to waive all or a portion of the contributions required under the minimum funding standard for a plan year.³⁵ A waiver may be granted if the employer responsible for the contribution could not make the required contribution without temporary substantial business hardship for the employer (and members of the employer's controlled group) and if requiring the contribution would be adverse to the interests of plan participants in the aggregate.

If a funding waiver is in effect for a plan, subject to certain exceptions, no plan amendment may be adopted that increases the liabilities of the plan by reason of any increase in benefits, any change in the accrual of benefits, or any change in the rate at which benefits vest under the plan.³⁶

Security for certain plan amendments

In the case of a single-employer defined benefit pension plan, if a plan amendment increasing current liability is adopted and the plan's funded current liability percentage is less than 60 percent (taking into account the effect of the amendment, but disregarding any unamortized unfunded old liability), the employer and members of the employer's controlled group must provide security in favor of the plan.³⁷ The amount of security required is the excess of: (1) the lesser of (a) the amount by which the plan's assets are less than 60 percent of current liability, taking into account the benefit increase, or (b) the amount of the benefit increase and prior benefit increases after December 22, 1987, over (2) $10 million. The amendment is not effective until the security is provided.

The security must be in the form of a bond, cash, certain U.S. government obligations, or such other form as is satisfactory to the Secretary of the Treasury and the parties involved. The security is released after the funded liability of the plan reaches 60 percent.

Prohibition on benefit increases during bankruptcy

Subject to certain exceptions, if an employer maintaining a single-employer defined benefit pension plan is involved in bankruptcy proceedings, no plan amendment may be adopted that increases the liabilities of the plan by reason of any increase in benefits, any change in the accrual of benefits, or any change in the rate at which benefits vest under the plan.³⁸

Restrictions on benefit payments due to liquidity shortfalls

In the case of a single-employer plan with a funded current liability percentage of less than 100 percent for the preceding plan year, estimated contributions for the current plan year must be made in quarterly installments during the current plan year. If quarterly contributions are required with respect to a plan, the amount of a quarterly installment must also be sufficient to cover any shortfall in the plan's liquid assets (a "liquidity shortfall"). In general, a plan has a liquidity shortfall for a quarter if the plan's liquid assets (such as cash and marketable securities) are less than a certain amount (generally determined by reference to disbursements from the plan in the preceding 12 months).

If a quarterly installment is less than the amount required to cover the plan's liquidity shortfall, limits apply to the benefits that can be paid from a plan during the period of underpayment. During that period, the plan may not make any prohibited payment, defined as: (1) any payment in excess of the monthly amount paid under a single life annuity (plus any social security supplement provided under the plan) in the case of a participant or beneficiary whose annuity starting date occurs during the period; (2) any payment for the purchase of an irrevocable commitment from an insurer to pay benefits (e.g., an annuity contract); or (3) any other payment specified by the Secretary of the Treasury by regulations.³⁹

Prohibition on reductions in accrued benefits

An amendment of a qualified retirement plan may not decrease the accrued benefit of a plan participant.⁴⁰ This restriction is sometimes referred to as the "anticutback" rule and applies to benefits that have already accrued. In general, an amendment may reduce the amount of future benefit accruals, provided that, in the case of a significant reduction in the rate of future benefit accrual, certain notice requirements are met.

For purposes of the anticutback rule, an amendment is also treated as reducing an accrued benefit if, with respect to benefits accrued before the amendment is adopted, the amendment has the effect of either (1) eliminating or reducing an early retirement benefit or a retirement-type subsidy, or (2) except as provided by Treasury regulations, eliminating an optional form of benefit.

Under the provision, in the case of an underfunded single-employer defined benefit pension plan, limitations may apply with respect to: (1) plan amendments increasing benefit liabilities; (2) certain forms of distribution; and (3) benefit accruals.

Limitations on plans less than 80-percent funded

The limitation ceases to apply with respect to any plan year, effective as of the first day of the plan year (or, if later, the effective date of the amendment), if the plan sponsor makes a contribution (in addition to any minimum required contribution for the plan year), equal to: (1) if the plan's funding target attainment percentage is less than 80 percent, the amount of the increase in the plan's funding target for the plan year attributable to the amendment; or (2) if the plan's funding target attainment percentage would be less than 80 percent taking into account the amendment, the amount sufficient to result in a funding target attainment percentage of 80 percent. In addition, the limitation does not apply to a plan for the first five years the plan (or a predecessor plan) is in effect.

Additional limitation on benefit accruals for plans less than 60-percent funded

A plan must provide that, if the plan's funding target attainment percentage is less than 60 percent for a plan year, all future benefit accruals under the plan must cease as of the valuation date for the plan year. However, this limitation does not apply to a plan for the first five years the plan (or a predecessor plan) is in effect.

Funding target attainment percentage

The term "funding target attainment percentage" means the ratio, expressed as a percentage, that the value of the plan's assets (reduced by the plan's funding standard carryover balance and prefunding balance) bears to the plan's funding target for the year (i.e., the present value of liabilities under the plan).⁴² For this purpose, the plan's funding target is determined using the actuarial assumptions for plans that are not at-risk. However, under a special rule, if a plan's funding target attainment percentage is at least 100 percent, determined by not reducing the value of the plan's assets by the plan's funding standard carryover balance and prefunding balance, such reductions do not apply for this purpose.

Determining funding levels

Under the provision, certain presumptions apply in determining whether limitations apply with respect to a plan, subject to certification of the plan's funding target attainment percentage by the plan's enrolled actuary. If a plan was subject to a limitation for the preceding year, the plan's funding target attainment percentage for the current year is presumed to be the same as the preceding year until the plan actuary certifies the plan's actual funding target attainment percentage for the current year. If (1) a plan was not subject to a limitation for the preceding year, but its funding target attainment percentage for the preceding year was not more than 10 percentage points greater than the threshold for a limitation, and (2) as of the first day of the fourth month of the current plan year, the plan actuary has not certified the plan's actual funding target attainment percentage for the current year, the plan's funding target attainment percentage is presumed to be reduced by 10 percentage points as of that day and that day is deemed to be the plan's valuation date for purposes of applying the benefit limitation. As a result, the limitation applies as of that date until the actuary certifies the plan's actual funding target attainment percentage. In any other case, if the plan actuary has not certified the plan's actual funding target attainment percentage by the first day of the tenth month of the current plan year, for purposes of the limitations, the plan's funding target attainment percentage is conclusively presumed to be less than 60 percent as of that day and that day is deemed to be the valuation date for the current plan year.

A special rule applies in applying the presumption rules in 2007. Under the special rule, the plan's "modified current liability percentage" for 2006 is substituted for the plan's funding target attainment percentage for the preceding plan year. Modified funding current liability percentage is the plan's funded current liability percentage for 2006, determined by reducing the value of the plan's assets by any credit balance if the plan's funded current liability percentage (before such a reduction) is less than 100 percent.

Anticutback relief

Under the provision, a plan does not fail to meet the requirements of the anti-cutback rule solely by reason of the adoption of a plan amendment necessary to meet the requirements of the provision.

Restoration of benefits

If a limitation on distributions or accruals applies with respect to a plan year (other than because of a presumption as to the plan's funding target attainment percentage) and the limitation ceases to apply for a subsequent year, the plan may provide for the resumption of such distributions or accruals only by means of the adoption of a plan amendment after the valuation date for the subsequent plan year.

In the case of a plan maintained pursuant to one or more collective bargaining agreements between employee representatives and one or more employers ratified before the date of enactment of the provision, the provision does not apply to plan years beginning before the earlier of: (1) the later of (a) the date on which the last collective bargaining agreement relating to the plan terminates (determined without regard to any extension thereof agreed to after the date of enactment), or (b) the first day of the first plan year to which the provision would otherwise apply; or (2) January 1, 2009. For this purpose, any plan amendment made pursuant to a collective bargaining agreement relating to the plan that amends the plan solely to conform to any requirement under the provision is not to be treated as a termination of the collective bargaining agreement.

The PBGC insures benefits under most single-employer defined benefit pension plans in the event the plan is terminated with insufficient assets to pay for plan benefits. The PBGC is funded in part by a flat-rate premium per plan participant, and a variable rate premium based on the amount of unfunded vested benefits under the plan. A specified interest rate and a specified mortality table apply in determining unfunded vested benefits for this purpose.

A special rule modifies the minimum funding requirements in the case of certain plans. The special rule applies in the case of plans that (1) were not required to pay a variable rate PBGC premium for the plan year beginning in 1996, (2) do not, in plan years beginning after 1995 and before 2009, merge with another plan (other than a plan sponsored by an employer that was a member of the controlled group of the employer in 1996), and (3) are sponsored by a company that is engaged primarily in interurban or interstate passenger bus service.

The special rule generally treats a plan to which it applies as having a funded current liability percentage of at least 90 percent for plan years beginning after 1996 and before 2004 if for such plan year the funded current liability percentage is at least 85 percent. If the funded current liability of the plan is less than 85 percent for any plan year beginning after 1996 and before 2004, the relief from the minimum funding requirements generally applies only if certain specified contributions are made.

For plan years beginning in 2004 and 2005, the funded current liability percentage of the plan is treated as at least 90 percent for purposes of determining the amount of required contributions (100 percent for purposes of determining whether quarterly contributions are required). As a result, for these years, additional contributions and quarterly contributions are not required with respect to the plan. In addition, for these years, the mortality table used under the plan is used in determining the amount of unfunded vested benefits under the plan for purposes of calculating PBGC variable rate premiums.

For plan years beginning after 2005 and before 2010, the funded current liability percentage generally will be deemed to be at least 90 percent if the actual funded current liability percentage is at least at certain specified levels. The relief from the minimum funding requirements generally applies for a plan year beginning in 2006, 2007, or 2008 only if contributions to the plan for the plan year equal at least the expected increase in current liability due to benefits accruing during the plan year.

Under the provision, for the plan year beginning in 2006, a plan's funded current liability percentage of a plan is treated as at least 90 percent for purposes of determining the amount of required contributions (100 percent for purposes of determining whether quarterly contributions are required). As a result, for the 2006 plan year, additional contributions and quarterly contributions are not required with respect to the plan. In addition, the mortality table used under the plan is used in determining the amount of unfunded vested benefits under the plan for purposes of calculating PBGC variable rate premiums.

Under the provision, for plan years beginning after 2006, the mortality table used under the plan is used in determining: (1) any present value or making any computation under the minimum funding rules applicable to the plan; and (2) the amount of unfunded vested benefits under the plan for purposes of calculating PBGC variable rate premiums. Under a special phase-in, for purposes of determining the plan's funding shortfall for plan years beginning after 2006 and before 2012, the applicable percentage of the plan's funding shortfall is the following: 90 percent for 2007, 92 percent for 2008, 94 percent for 2009, 96 percent for 2010, and 98 percent for 2011.⁴³ In addition, in determining minimum required contributions for plan years beginning after 2006, the value of plan assets is reduced only by the plan's prefunding balance (i.e., not by the plan's funding standard carryover balance) if, pursuant to a written agreement with the PBGC entered into before January 1, 2007, the funding standard carryover balance is not available to reduce the minimum required contribution for the plan year. Moreover, for purposes of the quarterly contributions requirement, the plan is treated as not having a funding shortfall for any plan year. As a result, quarterly contributions are not required with respect to the plan.

In the case of assets set aside in a trust (or other arrangement) for purposes of paying nonqualified deferred compensation, such assets are treated as property transferred in connection with the performance of services under Code section 83 at the time set aside if such assets (or trust or other arrangement) are located outside of the United States or at the time transferred if such assets (or trust or other arrangement) are subsequently transferred outside of the United States. A transfer of property in connection with the performance of services under Code section 83 also occurs with respect to compensation deferred under a nonqualified deferred compensation plan if the plan provides that upon a change in the employer's financial health, assets will be restricted to the payment of nonqualified deferred compensation.

While rank-and-file employees have little control over a company's decision to fund its pension plans, executives often have control in determining how nonqualified deferred compensation plans will be operated. In addition, executives who are covered by a nonqualified deferred compensation plan may also be instrumental in deciding how much to contribute to the defined benefit pension plan, thus determining the funded status of the pension plan.

The Committee believes that nonqualified deferred compensation plans covering executives should not be funded unless the employer's qualified pension plan is adequately funded.

If a nonqualified deferred compensation plan of an employer provides that assets will be restricted to the provision of benefits under the plan in connection with the at-risk status (or other similar financial measure determined by the Secretary of Treasury) of any defined benefit pension plan of the employer, or assets are so restricted, such assets are treated as property transferred in connection with the performance of services (whether or not such assets are available to satisfy the claims of general creditors) under Code section 83.

Any subsequent increases in the value of, or any earnings with respect to, transferred or restricted assets are treated as additional transfers of property. Interest at the underpayment rate plus one percentage point is imposed on the underpayments that would have occurred had the amounts been includible in income for the taxable year in which first deferred or, if later, the first taxable year not subject to a substantial risk of forfeiture. The amount required to be included in income is also subject to an additional 20-percent tax.

For years before 2007, the provision applies if the modified funded current liability percentage of the defined benefit pension plan for the preceding plan year is less than 60 percent. The modified funded current liability percentage is the funded current liability percentage reduced by any credit balance.

A multiemployer plan is a plan to which more than one unrelated employer contributes, which is established pursuant to one or more collective bargaining agreements, and which meets such other requirements as specified by the Secretary of Labor. Multiemployer plans are governed by a board of trustees consisting of an equal number of employer and employee representatives. In general, the level of contributions to a multiemployer plan is specified in the applicable collective bargaining agreements, and the level of plan benefits is established by the plan trustees.

Defined benefit multiemployer plans are subject to the same general minimum funding rules as single-employer plans, except that different rules apply in some cases. For example, different amortization periods apply for some costs in the case of multiemployer plans. In addition, the deficit reduction contribution rules do not apply to multiemployer plans.

Funding standard account

As an administrative aid in the application of the funding requirements, a defined benefit pension plan is required to maintain a special account called a "funding standard account" to which specified charges and credits are made for each plan year, including a charge for normal cost and credits for contributions to the plan. Other credits or charges or credits may apply as a result of decreases or increases in past service liability as a result of plan amendments or experience gains or losses, gains or losses resulting from a change in actuarial assumptions, or a waiver of minimum required contributions.

If, as of the close of the plan year, charges to the funding standard account exceed credits to the account, then the excess is referred to as an "accumulated funding deficiency." For example, if the balance of charges to the funding standard account of a plan for a year would be $200,000 without any contributions, then a minimum contribution equal to that amount would be required to meet the minimum funding standard for the year to prevent an accumulated funding deficiency. If credits to the funding standard account exceed charges, a "credit balance" results. The amount of the credit balance, increased with interest, can be used to reduce future required contributions.

Funding methods and general concepts

Charges and credits to the funding standard account

Funding waivers and amortization of waived funding deficiencies

Within limits, the Secretary of the Treasury is permitted to waive all or a portion of the contributions required under the minimum funding standard for the year (a "waived funding deficiency"). In the case of a multiemployer plan, a waiver may be granted if 10 percent or more of the number of employers contributing to the plan could not make the required contribution without temporary substantial business hardship and if requiring the contribution would be adverse to the interests of plan participants in the aggregate. The minimum funding requirements may not be waived with respect to a multiemployer plan for more five out of any 15 consecutive years.

If a funding deficiency is waived, the waived amount is credited to the funding standard account. In the case of a multiemployer plan, the waived amount is then amortized over a period of 15 years, beginning with the year following the year in which the waiver is granted. Each year, the funding standard account is charged with the amortization amount for that year unless the plan becomes fully funded. In the case of a multiemployer plan, the interest rate used for purposes of determining the amortization on the waived amount is the rate determined under section 6621(b) of the Internal Revenue Code (relating to the Federal short-term rate).

Extension of amortization periods

Amortization periods may be extended for up to 10 years by the Secretary of the Treasury if the Secretary finds that the extension would carry out the purposes of ERISA and would provide adequate protection for participants under the plan and if such Secretary determines that the failure to permit such an extension would (1) result in a substantial risk to the voluntary continuation of the plan or a substantial curtailment of pension benefit levels or employee compensation, and (2) be adverse to the interests of plan participants in the aggregate. The interest rate with respect to extensions of amortization periods is the same as that used with respect to waived funding deficiencies.

Alternative funding standard account

As an alternative to applying the rules described above, a plan which uses the entry age normal cost method may satisfy an alternative minimum funding standard. Under the alternative, the minimum required contribution for the year is generally based on the amount necessary to bring the plan's assets up to the present value of accrued benefits, determine using the actuarial assumptions that apply when a plan terminates. The alternative standard has been rarely used.

The provision provides that in applying the funding rules, all costs, liabilities, interest rates, and other factors are required to be determined on the basis of actuarial assumptions and methods, each of which is reasonable (taking into account the experience of the plan and reasonable expectations). In addition, as under present law, the assumptions are required to offer the actuary's best estimate of anticipated experience under the plan.

The provision provides that, upon application to the Secretary of the Treasury, the Secretary is to grant an extension of the amortization period with respect to any unfunded past service liability, investment loss, or experience loss if the Secretary determines that (1) absent the extension, the plan would have an accumulated funding deficiency in any of the next ten plan years, (2) the plan sponsor has adopted a plan to improve the plan's funding status, and (3) taking into account the extension, the plan is projected to have sufficient assets to timely pay its expected benefit liabilities and other anticipated expenditures. The extension may not exceed five years.

The Secretary of the Treasury may also grant an additional extension of such amortization periods for an additional five years. The standards for determining whether such an extension may be granted are the same as under present law.

As under present law, these extensions do not apply unless the applicant demonstrates to the satisfaction of the Treasury Secretary that notice of the application has been provided to each affected party (as defined in ERISA section 4001(a)(21)).

The provision modifies the interest rate applicable to waived funding deficiencies and extensions of amortization periods so that it is the greater of (1) 150 percent of the Federal mid-term rate, or (2) the rate of interest used under the plan in determining costs.

Subject to certain requirements, a multiemployer plan in reorganization status may also be amended to reduce or eliminate accrued benefits in excess of the amount of benefits guaranteed by the PBGC.⁴⁸ In order for accrued benefits to be reduced, at least six months before the beginning of the plan year in which the amendment is adopted, notice must be given that the plan is in reorganization status and that, if contributions to the plan are not increased, accrued benefits will be reduced or an excise tax will be imposed on employers obligated to contribute to the plan. The notice must be provided to plan participants and beneficiaries, any employer who has an obligation to contribute to the plan, and any employee organization representing employees in the plan.

In the case of multiemployer plans, the PBGC insures plan insolvency, rather than plan termination. A plan is insolvent when its available resources are not sufficient to pay the plan benefits for the plan year in question, or when the sponsor of a plan in reorganization reasonably determines, taking into account the plan's recent and anticipated financial experience, that the plan's available resources will not be sufficient to pay benefits that come due in the next plan year.⁴⁹ An insolvent plan is required to reduce benefits to the level that can be covered by the plan's assets. However, benefits cannot be reduced below the level guaranteed by the PBGC.⁵⁰ If a multiemployer plan is insolvent, the PBGC guarantee is provided in the form of loans to the plan trustees. If the plan recovers from insolvency status, loans from the PBGC can be repaid. Plans in reorganization status are required to compare assets and liabilities to determine if the plan will become insolvent in the future.

The provision provides additional funding rules for multiemployer defined benefit plans that are in endangered or critical status. The present-law reorganization and insolvency rules continue to apply.

Within 90 days after the first day of the plan year, the plan actuary must certify to the Secretary of the Treasury whether or not the plan is in endangered or critical status for the plan year. If the certification is not made within this period, the plan is presumed to be in critical status until the plan actuary makes a contrary certification. In making the determination whether a plan is in endangered or critical status, the plan actuary must make projections for the current and succeeding plan years, using reasonable actuarial assumptions and methods, of the current value of plan assets and the present value of liabilities under the plan for the current year as of the beginning of the year, based on the actuarial statement for the preceding plan year. Any actuarial projection of plan assets must assume (1) reasonably anticipated employer and employee contributions for the current and succeeding plan years, assuming that the terms of one or more collective bargaining agreements pursuant to which the plan is maintained for the current plan year continue in effect for the succeeding plan years, or (2) that employer andemployee contributions for the most recent plan year will continue indefinitely, but only if the plan actuary determines that there have been no significant demographic changes that would make continued application of such terms unreasonable.

If a plan is certified to be in endangered status or enters into critical status, notice must be provided within 30 days after the date of certification or entry to the participants and beneficiaries, the bargaining parties, the PBGC, the Secretary of the Treasury and the Secretary of Labor.

Endangered status

A multiemployer plan is in endangered status if the plan's funded percentage for the plan year is less than 80 percent, or the plan has an accumulated funding deficiency for the plan year or is projected to have an accumulated funding deficiency in any of the six succeeding plan years (taking into account amortization extensions). A plan's funded percentage is the percentage of plan assets over accrued liability of the plan.

Within 240 days after a plan is certified as endangered (if no funding improvement plan is in effect for the plan year), the plan sponsor must amend the multiemployer plan to include a funding improvement plan approved by the bargaining parties. The funding improvement plan must provide that during the funding improvement period, the plan will have a certain required increase in the funded percentage and no accumulated funding deficiency for any plan year during the funding improvement period, taking into account amortization extensions (the "benchmarks").

The provision requires that the plan's funded percentage increase such that the difference between 100 percent and the plan's funded percentage for the last year of the funding improvement plan is not more than two-thirds of the difference between 100 percent and the plan's funded percentage for the first year of the funding improvement plan. Thus, the difference between 100 percent and the plan's funded percentage must be reduced by at least one-third during the funding improvement period. The funding improvement period is the 10-year period beginning on the earlier of (1) the second anniversary of the date of adoption of the funding improvement plan, or (2) the first day of the first plan year following the year (after certification of endangered status) in which the collective bargaining agreements covering at least 75 percent of active participants have expired.

In the case in which the funded percentage of a plan is 70 percent or less, the provision requires that the plan's funded percentage increase such that the difference between 100 percent and the plan's funded percentage for the last year of the funding improvement plan is not more than four-fifths of the difference between 100 percent and the plan's funded percentage for the first year of the funding improvement plan. Thus, the difference between 100 percent and the plan's funded percentage must be reduced by at least one-fifth during the funding improvement period. In addition, a 15-year funding improvement period is used. If the plan year is prior to the first day of the first plan year following the plan year in which occurs the first date (after the day of the certification) as of which collective bargaining agreements covering at least 75 percent of active participants in the multiemployer plan have expired, the same requirements apply in the case of a plan in which the funded percentage is more than 70 percent, but less than 80 percent, if the plan actuary certifies within 30 days after certification of endangered status that the plan is not able to attain the funding percentage increase otherwise required by the provision (i.e., the difference between 100 percent and the plan's funded percentage must be reduced by at least one-third during the funding improvement period) over the funding improvement period. For subsequent years for such plans, if the plan actuary certifies that the plan is not able to attain the increase generally required under the provision, a 15-year funding improvement period is used.

Within 90 days after a plan is certified as endangered, the plan sponsor must provide to the bargaining parties alternative provisions for revised benefit structures, contribution structures, or both, which if adopted as amendments to the plan may be reasonably expected to meet the benchmark requirements for the funding improvement plan. The provisions must include (1) at least one provision for reductions in the amount of future benefit accruals necessary to achieve the benchmarks, assuming no amendments increasing contributions under the plan (other than amendments increasing contributions necessary to achieve the benchmarks after amendments have reduced future benefit accruals to the maximum extent permitted by law) and (2) at least one provision for increases in contributions necessary to achieve the benchmarks assuming no amendments reducing future benefit accruals under the plan. Upon request of any bargaining party who employs at least five percent of the active participants, or represents as an employee organization at least five percent of the active participants, the plan sponsor must provide information on other combinations of increases in contributions and reductions in future benefit accruals which would result in achieving the benchmarks. The plan sponsor may provide additional information as it deems appropriate.

Pending approval of the funding improvement plan, the plan sponsor must take all reasonable actions (consistent with the terms of the plan and present law) necessary to ensure an increase in the plan's funded percentage and a postponement of an accumulated funding deficiency for at least one additional plan year. These actions include applications for extensions of amortization periods, use of the shortfall funding method in making funding standard account computations, amendments to the plan's benefit structure, reductions in future benefit accruals, and other reasonable actions.

In addition, pending approval of a funding improvement plan, the plan may not be amended to provide (1) a reduction in the level of contributions for participants who are not in pay status; (2) a suspension of contributions with respect to any period of service; or (3) any new or indirect exclusion of younger or newly hired employees from plan participation. Pending approval of a funding improvement plan, restrictions apply on lump sum and other similar distributions. If the present value of participant's accrued benefit exceeds $5,000, the benefit may not be distributed as an immediate distribution or in any other accelerated form. In addition, except in the case of amendments required as a condition of qualification under the Internal Revenue Code, no amendment may be adopted which increases liabilities of the plan by reason of any increase in benefits, any change in accrual of benefits, or any change in the rate at which benefits become nonforfeitable.

If no plan is adopted by the end of the 240-day period after a plan is certified as endangered, the plan enters into critical status as of the first day of the succeeding plan year. Notice must be provided to participants and beneficiaries, the bargaining parties, the PBGC, the Secretary of Treasury and the Secretary of Labor within 30 days after the plan enters critical status.

A summary of any funding improvement plan and any modifications, together with annual updates regarding the funding ratio of the plan, must be included in the plan's annual report and summary annual report.

Upon adoption of a funding improvement plan, the plan may not be amended to be inconsistent with the funding improvement plan, or to increase future benefit accruals, unless the plan actuary certifies in advance that, after taking into account the proposed increase, the plan is reasonably expected to meet the benchmarks.

Critical status

There are several ways that a multiemployer plan can be in critical status for a plan year. A multiemployer plan is in critical status for a plan year if:

If a plan is in critical status for a plan year (and no rehabilitation plan is currently in effect for the plan year), the plan must be amended within 240 days after the plan enters critical status to include a rehabilitation plan. A plan is treated as entering into critical status as of the date that the plan is certified to be in critical status, is presumed to be in critical status because no certification is made, or enters into critical status because the requirements of endangered status are not satisfied.

A rehabilitation plan must consist of (1) amendments to the plan providing for measures, agreed to by the bargaining parties, to increase contributions, reduce plan expenditures, or reduce future benefit accruals, or to take any combination of such actions, determined necessary to cause the plan to cease to be in critical status during the rehabilitation period, or (2) reasonable measures to forestall possible insolvency if the plan sponsor determines that upon exhaustion of all reasonable measures, the plan would not cease to be in critical status during the rehabilitation period.

The rehabilitation period is the 10-year period beginning on the earlier of (1) the second anniversary of the date of adoption of the rehabilitation plan or (2) the first day of the first plan year following the year (after entry into critical status) in which the collective bargaining agreements covering at least 75 percent of active participants have expired.

Within 90 days after the date of entry into critical status the plan sponsor must propose to all bargaining parties a range of alternative schedules of increases in contributions and reductions in future benefit accruals that would carry out a rehabilitation plan. One schedule must show the reductions in future benefit accruals that would be necessary to cause the plan to cease to be in critical status if there were no further increases in rates of contribution to the plan. If the plan sponsor determines that the plan will not cease to be in critical status during the rehabilitation period unless the plan is amended to provide for an increase in contributions, one schedule must show the increases in contribution rates that would be necessary to cause the plan to cease to be in critical status if future benefit accruals were reduced to the maximum extent permitted by law. Upon request of any bargaining party who employs at least five percent of the active participants, or represents as an employee organization for purposes of collective bargaining at least five percent of the participants, the plan sponsor must include among the proposed schedules such schedules of increases in contributions and reductions in future benefit accruals as may be specified by the bargaining parties.

Any schedule including reductions in future benefit accruals forming part of a rehabilitation plan is applicable with respect to any group of active participants who are employed by any bargaining party in proportion to the extent to which increases in contributions under the schedule apply to such bargaining party. Any proposed schedule cannot reduce the rate of future accruals below the lower of (1) a monthly benefit equal to one percent of the contributions required to be made with respect to a participant or the equivalent standard accrual rate for a participant or group of participants under the collective bargaining agreements in effect as of the first day of the plan year in which the plan enters critical status, or (2) the accrual rate under the plan. The equivalent standard accrual rate is determined by the trustees based on the standard or average contribution base units that they determine to be representative for active participants and such other factors they determine to be relevant.

Pending approval of a rehabilitation plan, the plan may not be amended to provide (1) a reduction in the level of contributions for participants who are not in pay status; (2) a suspension of contributions with respect to any period of service; or (3) any new or indirect exclusion of younger or newly hired employees from plan participation. Pending approval of a funding improvement plan, restrictions apply on lump sum and other similar distributions. If the present value of participant's accrued benefit exceeds $5,000, the benefit may not be distributed as an immediate distribution or in any other accelerated form. In addition, pending approval of a rehabilitation plan, except in the case of amendments required as a condition of qualification under the Internal Revenue Code, no amendment may be adopted which increases liabilities of the plan by reason of any increase in benefits, any change in accrual of benefits, or any change in the rate at which benefits become nonforfeitable.

Upon adoption of a rehabilitation plan, the plan may not be amended to be inconsistent with the rehabilitation plan or to increase future benefit accruals, unless the plan actuary certifies in advance, that after taking into account the proposed increase, the plan is reasonably expected to cease to be in critical status.

Upon the adoption of a schedule of increases in contributions or reduction in future benefit accruals as part of a rehabilitation plan, the plan sponsor may, no more than once in any three-year period, amend the plan to update the schedule to adjust for any experience of the plan contrary to past actuarial assumptions. A summary of the rehabilitation plan and any modifications, together with annual updates regarding the funding ratio of the plan, must be included in the annual report and summary annual report for the plan year.

The failure of an employer to make contributions in compliance with the rehabilitation schedule may, at the discretion of the plan sponsor, be treated as a complete or partial withdrawal from the plan.

If the rehabilitation plan is not adopted within the 240-day period after entry into critical status, the plan must be amended to implement the schedule proposed by the plan sponsor that shows the reductions in future benefit accruals that would be necessary to cause the plan to cease to be in critical status if there were no further increases in rates of contributions to the plan.

In order to anticipate future insolvencies, at the end of the first plan year in which a plan is in reorganization and at least every three plans year thereafter, the plan sponsor must compare the value of plan assets for the plan year with the total amount of benefit payments made under the plan for the plan year.⁵¹ Unless the plan sponsor determines that the value of plan assets exceeds three times the total amount of benefit payments, the plan sponsor must determine whether the plan will be insolvent for any of the next three plan years.

A defined benefit pension plan must specify the actuarial assumptions that will be used in determining optional forms of benefit under the plan in a manner that precludes employer discretion in the assumptions to be used. For example, a plan may specify that a variable interest rate will be used in determining actuarial equivalent forms of benefit, but may not give the employer discretion to choose the interest rate.

Statutory assumptions must be used in determining the minimum value of certain optional forms of benefit, such as a lump sum.⁵² That is, the lump sum payable under the plan may not be less than the amount of the lump sum that is actuarially equivalent to the life annuity payable to the participant, determined using the statutory assumptions. The statutory assumptions consist of an applicable mortality table (as published by the IRS) and an applicable interest rate.

The applicable interest rate is the annual interest rate on 30-year Treasury securities, determined as of the time that is permitted under regulations. The regulations provide various options for determining the interest rate to be used under the plan, such as the period for which the interest rate will remain constant ("stability period") and the use of averaging.

The Committee recognizes that an immediate change in the interest rate used to calculate lump-sum benefits will in some cases reduce the amount of these benefits, which may cause participants to terminate employment in order to avoid any possible reduction. The Committee believes that a deferred effective date followed by a phase-in period of the yield-curve rates will mitigate any potential effect on participants and will provide participants with time to evaluate the impact of the change in interest rates on their benefits.

The mortality table that must be used for calculating lump sums is based on the mortality table required for minimum funding purposes (i.e., the RP-2000 Combined Mortality Table, using Scale AA, as published by the Society of Actuaries, as in effect on the date of enactment of the bill and revised from time to time) modified as appropriate by the Secretary of the Treasury. It is intended that the Secretary will prescribe gender-neutral tables for use in determining minimum lump sums.

The provision provides that minimum lump-sum values are to be calculated using the adjusted first, second, and third segment rates as applied under the funding rules, with certain modifications, for the month before the date of distribution or such other time as the Secretary of the Treasury may prescribe by regulation. The adjusted first, second, and third segment rates are derived from a corporate bond yield curve prescribed by the Secretary of the Treasury for such month which reflects the yields on investment grade corporate bonds with varying maturities (rather than a three-year weighted average, as under the minimum funding rules). Thus, the interest rate that applies depends upon how many years in the future a participant's annuity payment will be made. Typically, a higher interest rate applies for payments made further out in the future.

A transition rule applies for distributions in 2007 through 2010. For distributions in 2007 through 2010, lump-sum values are determined as the weighted average of two values: (1) the value of the lump sum determined under the methodology under present law (the "old" methodology); and (2) the value of the lump sum determined using the methodology applicable for 2007 and thereafter (the "new" methodology). For distributions in 2007, the weighting factor is 80 percent for the lump-sum value determined under the old methodology and 20 percent for the lump-sum determined under the new methodology. For distributions in 2008, the weighting factor is 60 percent for the lump-sum value determined under the old methodology and 40 percent for the lump-sum determined under the new methodology. For distributions in 2009, the weighting factor is 40 percent for the lump-sum value determined under the old methodology and 60 percent for the lump-sum determined under the new methodology. For distributions in 2010, the weighting factor is 20 percent for the lump-sum value determined under the old methodology and 80 percent for the lump-sum determined under the new methodology.

The provision also provides that a plan amendment requiring the use of the prescribed table and interest rate will not result in a violation of the rule that accrued benefits may not be decreased by plan amendment.

Under proposed regulations, in the case of a phased retirement program, a pension plan is permitted to pay a portion of a participant's benefits before attainment of normal retirement age.⁵⁶ A phased retirement program is a program under which employees who are at least age 59-1/2 and are eligible for retirement may reduce (by at least 20 percent) the number of hours they customarily work and receive a pro rata portion of their retirement benefits, based on the reduction in their work schedule.

The minimum funding requirements permit an employer to fund defined benefit plan benefits over a period of time. Thus, it is possible that a plan may be terminated at a time when plan assets are not sufficient to provide all benefits accrued by employees under the plan. In order to protect plan participants from losing retirement benefits in such circumstances, the Pension Benefit Guaranty Corporation ("PBGC"), a corporation within the Department of Labor, was created in 1974 under ERISA to provide an insurance program for benefits under most defined benefit plans maintained by private employers.

Termination of single-employer defined benefit plans

An employer may voluntarily terminate a single-employer plan only in a standard termination or a distress termination. The PBGC may also involuntarily terminate a plan (that is, the termination is not voluntary on the part of the employer).

A standard termination is permitted only if plan assets are sufficient to cover benefit liabilities. If assets in a defined benefit plan are not sufficient to cover benefit liabilities, the employer may not terminate the plan unless the employer (and members of the employer's controlled group) meets one of four criteria of financial distress.⁵⁷

The PBGC may institute proceedings to terminate a plan if it determines that the plan in question has not met the minimum funding standards, will be unable to pay benefits when due, has a substantial owner who has received a distribution greater than $10,000 (other than by reason of death) while the plan has unfunded nonforfeitable benefits, or may reasonably be expected to increase PBGC's long-run loss unreasonably. The PBGC must institute proceedings to terminate a plan if the plan is unable to pay benefits that are currently due.

Guaranteed benefits

When an underfunded plan terminates, the amount of benefits that the PBGC will pay depends on legal limits, asset allocation, and recovery on the PBGC's employer liability claim. The PBGC guarantee applies to "basic benefits." Basic benefits generally are benefits accrued before a plan terminates, including (1) benefits at normal retirement age; (2) most early retirement benefits; (3) disability benefits for disabilities that occurred before the plan was terminated; and (4) certain benefits for survivors of plan participants. Generally only that part of the retirement benefit that is payable in monthly installments (rather than, for example, lump-sum benefits payable to encourage early retirement) is guaranteed.⁵⁸

Retirement benefits that begin before normal retirement age are guaranteed, provided they meet the other conditions of guarantee (such as that before the date the plan terminates, the participant had satisfied the conditions of the plan necessary to establish the right to receive the benefit other than application for the benefit). Contingent benefits (for example, subsidized early retirement benefits) are guaranteed only if the triggering event occurs before plan termination.

For plans terminating in 2005, the maximum guaranteed benefit for an individual retiring at age 65 is $3,698.86 per month or $44,386.32 per year.⁵⁹ The dollar limit is indexed annually for wage inflation. The guaranteed amount is reduced for benefits starting before age 65.

In the case of a plan or a plan amendment that has been in effect for less than five years before a plan termination, the amount guaranteed is phased in by 20 percent a year.⁶⁰

PBGC premiums

In determining the amount of unfunded vested benefits, the interest rate used is generally 85 percent of the interest rate on 30 year Treasury securities for the month preceding the month in which the plan year begins (100 percent of the interest rate on 30 year Treasury securities for plan years beginning in 2002 and 2003). Under the Pension Funding Equity Act of 2004, in determining the amount of unfunded vested benefits for plan years beginning after December 31, 2003, and before January 1, 2006, the interest rate used is 85 percent of the annual rate of interest determined by the Secretary of the Treasury on amounts invested conservatively in long term investment-grade corporate bonds for the month preceding the month in which the plan year begins.

Changes to the variable rate premium are also appropriate to better reflect the risk that underfunded plans present to the pension insurance system. Under present law, employers of some underfunded plans may avoid paying the variable rate premium if the plan is at the full funding limitation, even though the plan poses a greater risk than better funded plans. This possibility is eliminated under the bill. In addition, the Committee bill modifies the base for the premium to conform to the funding targets under the funding provisions of the bill.

The Committee has noted that there is increasing use of bankruptcy reorganizations as a means of eliminating an employer's liability for pension benefits and shifting that liability to the PBGC pension insurance system. The Committee believes employers that terminate their plans on an underfunded basis (other than in bankruptcy liquidation proceedings) should continue to bear some financial responsibility for pension benefits following reorganization. Thus, the Committee bill requires additional premiums specifically related to such plan terminations. The Committee also believes that further action in this area is needed and that the bankruptcy laws should be reformed to prevent employers from shedding pension liabilities and shifting them to others.

Beginning in 2006, the provision phases in an increase of the flat rate premium to $30 as adjusted for years after 2006 based on increases in average wages as defined under the Social Security Act.⁶¹ The rate of the phase-in depends on the funded status of the plan. In general, the flat rate premium for a single-employer plan is determined under the following table:

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Variable rate premium

For 2006, the provision extends the present-law rule under which, in determining the amount of unfunded vested benefits for variable rate premium purposes, the interest rate used is 85 percent of the annual rate of interest determined by the Secretary of the Treasury on amounts invested conservatively in long term investment-grade corporate bonds for the month preceding the month in which the plan year begins.

Beginning in 2007, the determination of unfunded vested benefits for purposes of the variable rate premium is modified to conform to the funding rules of the provision. Thus, under the provision, unfunded vested benefits are equal to the amount which would be the plan's funding shortfall for the year⁶² if plan assets were valued at fair market value and only vested benefits were taken into account.⁶³ In valuing unfunded vested benefits the interest rate is the first, second, and third segment rates which would be determined under the funding rules of the provision, if the segment rates were based on the yields of corporate bond rates, rather than a three-year average of such rates. Under the bill, deductible contributions are no longer limited by the full funding limit; thus, the rule providing that no variable rate premium is required if contributions for the prior plan year were at least equal to the full funding limit no longer applies under the provision.

Premium for certain terminating plans

The provision imposes a per-participant premium of $1,250 for each applicable 12-month period following certain plan terminations (called the "termination premium"). The termination premium applies if the plan is terminated by the PBGC or in a distress termination by reason of (1) reorganization in bankruptcy (or similar State proceeding), (2) the inability of the employer to pay its debts when due, or (3) a determination that termination is necessary to avoid unreasonably burdensome pension costs caused solely by a decline in the employer's work force.

The applicable 12-month period is generally the 12-month period beginning with the month after the date in which the termination occurs and the next two 12-month periods. In the case of a termination due to reorganization, the liability for the termination premium does not arise until the employer is discharged from the reorganization proceeding (and the first 12-month period does not start until such discharge).

The PBGC may assess a penalty for a failure to provide the required information in the amount of up to $1,000 a day for each day the failure continues.⁶⁵

Under the provision, any person submitting to the PBGC section 4010 information with respect to a plan must provide notice thereof within 90 days to participants and beneficiaries under the plan (and under all plans maintained by members of the controlled group of each contributing sponsor of the plan). The notice must set forth: (1) the number of single-employer plans insured by the PBGC that are in at-risk status and maintained by contributing sponsors of the plan (and by members of their controlled groups) with respect to which the funding target attainment percentage for the preceding plan year is less than 60 percent; (2) the value of the assets of each plan for the plan year, the funding target for the plan year, and the funding target attainment percentage of each plan for the plan year and (3) taking into account all single-employer plans maintained by the contributing sponsor and the members of its controlled group, the aggregate total values of the assets of the plans as of the end of the plan year, the aggregate total of the funding targets of the plans (taking into account only vested benefits), and the aggregate funding targets attainment percentage (as defined above) with respect to the contributing sponsor for the preceding plan year.

For purposes of the notice requirement, a plan is in "at-risk status" for a plan year if the plan's funding target attainment percentage for the preceding year was less than 60 percent. A plan's "funding target attainment percentage" means the ratio, expressed as a percentage, that the value of the plan's assets (reduced by any funding standard carryover balance and prefunding balance) bears to the plan's funding target for the year (determined without regard to the special assumptions that apply to at-risk plans). A plan's funding target for a plan year is the present value of the liabilities to participants and beneficiaries under the plan.

Any notice required to be provided under the provision may be provided in written, electronic, or other appropriate form to the extent such form is reasonably available to the persons to whom the information is required to be provided. A person is not entitled to receive more than one notice during any 12-month period. The person required to provide the notice may make a reasonable charge to cover copying, mailing, and other costs of furnishing the notice, subject to a maximum amount that may be prescribed by the PBGC.

Concurrent with the provision of notice as required under the provision, notice must also be provided to the House Committees on Education and the Workforce and Ways and Means and the Senate Committees on Health, Education, Labor, and Pensions and Finance, which shall be treated as materials provided in executive session.

The present-law authority of the PBGC to impose a penalty for failure to provide section 4010 information applies to a failure to provide the notice required under the provision.

Prohibited transactions include (1) the sale, exchange or leasing of property, (2) the lending of money or other extension of credit, (3) the furnishing of goods, services or facilities, (4) the transfer to, or use by or for the benefit of, the income or assets of the plan, (5) in the case of a fiduciary, any act that deals with the plan's income or assets for the fiduciary's own interest or account, and (6) the receipt by a fiduciary of any consideration for the fiduciary's own personal account from any party dealing with the plan in connection with a transaction involving the income or assets of the plan. However, certain transactions are exempt from prohibited transaction treatment, for example, certain loans to plan participants.

Under ERISA, the Secretary of Labor may assess a civil penalty against a person who engages in a prohibited transaction, other than a transaction with a plan covered by the prohibited transaction rules of the Code. The penalty may not exceed five percent of the amount involved in the transaction for each year or part of a year that the prohibited transaction continues. If the prohibited transaction is not corrected within 90 days after notice from the Secretary of Labor, the penalty may be up to 100 percent of the amount involved in the transaction. Under the Code, if a prohibited transaction occurs, the disqualified person who participates in the transaction is subject to a two-tier excise tax. The first level tax is 15 percent of the amount involved in the transaction. The second level tax is imposed if the prohibited transaction is not corrected within a certain period and is 100 percent of the amount involved.

Under the provision, certain requirements must be met in order for the exemption to apply. When initially providing advice about a security or other property, the fiduciary adviser must provide to the recipient of the advice, on a reasonably contemporaneous basis, written notification of specified information (discussed below) as well as any disclosure required in connection with the investment transaction under any applicable securities laws. In addition, the investment transaction must occur solely at the direction of the recipient of the advice; the compensation received by the adviser and its affiliates in connection with the investment transaction must be reasonable; and the terms of the investment transaction must be at least as favorable as an arm's length transaction would be.

The written notification required to be provided by the fiduciary adviser must include information about the following: (1) all fees or compensation to be received by the adviser or any affiliate (including from a third party) in connection with the advice or the investment transaction; (2) any material affiliation or contractual relationship of the adviser or its affiliates in the security or other property involved in the investment transaction; (3) any limitation to be placed on the scope of the investment advice to be provided by the fiduciary adviser with respect to an investment transaction; (4) the types of services provided by the adviser in connection with the provision of investment advice; (5) the adviser's status as a fiduciary of the plan in connection with the provision of the advice; and (6) the ability of the recipient of the advice separately to arrange for the provision of advice by another adviser that could have no material affiliation with and receive no fees or other compensation in connection with the security or other property. In addition, in connection with the initial advice or subsequent advice, the required information must be maintained in currently accurate form and must be provided to a recipient of investment advice (without charge) at least annually and also when requested by the recipient of the advice or when there is a material change in the information. In the event of a material change in the information, currently accurate information must be provided to the recipient at a time reasonably contemporaneous to the change.

The written notification can be provided electronically. Any notification (or currently accurate information) must be written in a clear and conspicuous manner, calculated to be understood by the average plan participant, and be sufficiently accurate and comprehensive so as to reasonably apprise participants and beneficiaries of the required information. The Secretary of Labor is directed to issue a model form for the disclosure of fees and other compensation as required by the provision.

The fiduciary adviser must maintain for at least six years any records necessary for determining whether the requirements for the prohibited transaction exemption were met. A prohibited transaction will not be considered to have occurred solely because records were lost or destroyed before the end of six years due to circumstances beyond the adviser's control.

For purposes of the provision, "fiduciary adviser" is defined as a person who is a fiduciary of the plan by reason of the provision of investment advice to the plan, a participant or beneficiary and who is also: (1) registered as an investment adviser under the Investment Advisers Act of 1940 or under State laws; (2) a bank, a similar financial institution supervised by the United States or a State, or a savings association (as defined under the Federal Deposit Insurance Act), but only if the advice is provided through a trust department that is subject to periodic examination and review by Federal or State banking authorities; (3) an insurance company qualified to do business under State law; (4) registered as a broker or dealer under the Securities Exchange Act of 1934; (5) an affiliate of any of the preceding; or (6) an employee, agent or registered representative of any of the preceding who satisfies the requirements of applicable insurance, banking and securities laws relating to the provision of advice. "Affiliate" means an affiliated person as defined under section 2(a)(3) of the Investment Company Act of 1940. "Registered representative" means a person described in section 3(a)(18) of the Securities Exchange Act of 1934 or a person described in section 202(a)(17) of the Investment Advisers Act of 1940.

Subject to certain requirements, the employer or other person who is a plan fiduciary, other than a fiduciary adviser, is not treated as failing to meet the prohibited transaction requirements (or the fiduciary requirements of ERISA), solely by reason of the provision of investment advice as permitted under the provision or of contracting for or otherwise arranging for the provision of the advice. This rule applies if: (1) the advice is provided under an arrangement between the employer or plan fiduciary and the fiduciary adviser for the provision of investment advice by the fiduciary adviser as permitted under the provision; (2) the terms of the arrangement require compliance by the fiduciary adviser with the requirements of the provision; and (3) the terms of the arrangement include a written acknowledgement by the fiduciary adviser that the fiduciary adviser is a plan fiduciary with respect to the provision of the advice. The fiduciary responsibility requirements of ERISA must also be met in connection with the provision of investment advice.

The provision does not exempt the employer or a plan fiduciary from fiduciary responsibility under ERISA for the prudent selection and periodic review of a fiduciary adviser with whom the employer or plan fiduciary has arranged for the provision of investment advice. The employer or plan fiduciary does not have the duty to monitor the specific investment advice given by a fiduciary adviser.

The provision also provides that nothing in the fiduciary responsibility provisions of ERISA is to be construed to preclude the use of plan assets to pay for reasonable expenses in providing investment advice.

In December 2002, the IRS issued proposed regulations that dealt with the application of the age discrimination rules.⁶⁸ The proposed regulations included rules for applying the age discrimination rules with respect to accrued benefits, optional forms of benefit, ancillary benefits, and other rights and features provided under a plan. Under the proposed regulations, for purposes of applying the prohibition on age discrimination to defined benefit pension plans, an employee's rate of benefit accrual for a year is generally the increase in the employee's accrued normal retirement benefit (i.e., the benefit payable at normal retirement age) for the plan year. In the preamble to the proposed regulations, the IRS requested comments on other approaches to determining the rate of benefit accrual, such as allowing accrual rates to be averaged over multiple years (for example, to accommodate plans that provide a higher rate of accrual in earlier years) or, in the case of a plan that applies an offset, determining accrual rates before application of the offset. As discussed below, in June 2004, the IRS announced the withdrawal of the proposed regulations.

Under a cash balance plan, benefits are determined by reference to a hypothetical account balance. An employee's hypothetical account balance is determined by reference to hypothetical annual allocations to the account ("pay credits") (e.g., a certain percentage of the employee's compensation for the year) and hypothetical earnings on the account ("interest credits"). Cash balance plans are generally designed so that, when a participant receives a pay credit for a year of service, the participant also receives the right to future interest on the pay credit, regardless of whether the participant continues employment (referred to as "front-loaded" interest credits). That is, the participant's hypothetical account continues to be credited with interest after the participant stops working for the employer. As a result, if an employee terminates employment and defers distribution to a later date, interest credits will continue to be credited to that employee's hypothetical account.

Another type of hybrid plan is a pension equity plan (sometimes referred to as a "PEP"). Under a pension equity plan, benefits are generally described as a percentage of final average pay, with the percentage determined on the basis of points received for each year of service, which are often weighted for older or longer service employees. Pension equity plans commonly provide interest credits for the period between a participant's termination of employment and commencement of benefits.

Because of the front-loaded nature of accruals under cash balance plans, there is a longer time for interest credits to accrue on a pay credit to the account of a younger employee. Thus, a pay credit received at a younger age may provide a larger annuity benefit at normal retirement age than the same pay credit received at an older age. A similar effect may occur with respect to other types of hybrid plan designs, including pension equity plans.

Prior to the decision in the case of Cooper v. IBM Personal Pension Plan,⁶⁹ described below, discussions regarding hybrid plans typically did not question the ability of the basic hybrid plan design to satisfy the age discrimination rules. IRS consideration of cash balance plans began in the early 1990s.⁷⁰ At that time, the focus was on the question of whether such plans satisfied the nondiscrimination requirements under section 401(a)(4), which requires that benefits or contributions not discriminate in favor of highly compensated employees. Treasury regulations issued in 1991 under section 401(a)(4) provided a safe harbor for cash balance plans that provide frontloaded interest credits and meet certain other requirements. In connection with the issuance of these regulations, Treasury spoke to the cash balance age discrimination issue. The preamble to the final regulations stated "[t]he fact that interest adjustments through normal retirement age are accrued in the year of the related hypothetical allocation will not cause a cash balance plan to fail to satisfy the requirements of section 411(b)(1)(H), relating to age-based reductions in the rate at which benefits accrue under a plan." ⁷¹ Many interpreted this language as Treasury's position that cash balance plan designs do not violate the prohibitions on age discrimination. The IRS has not to date asserted that hybrid plan formulas result in per se violations of age discrimination requirements. The December 2002 proposed regulations, noted above, provided that an employee's rate of benefit accrual for a year is generally the increase in the employee's accrued normal retirement benefit (i.e., the benefit payable at normal retirement age) for the plan year. However, the proposed regulations provided a special rule under which an employee's rate of benefit accrual under a cash balance plan meeting certain requirements (an "eligible" cash balance plan) was based on the rate of pay credit provided under the plan. Thus, under the proposed regulations, an eligible cash balance plan would not violate the prohibition on age discrimination solely because pay credits for younger employees earn interest credits for a longer period.

Section 205 of the Consolidated Appropriations Act, 2004 (the "2004 Appropriations Act"), enacted January 24, 2004, provides that none of the funds made available in the 2004 Appropriations Act may be used by the Secretary of the Treasury, or his designee, to issue any rule or regulation implementing the 2002 proposed Treasury age discrimination regulations or any regulation reaching similar results.⁷² The 2004 Appropriations Act also required the Secretary of the Treasury within 180 days of enactment to present to Congress a legislative proposal for providing transition relief for older and longer-service participants affected by conversions of their employers' traditional pension plans to cash balance plans. The Treasury Department complied with this requirement by including in the President's budget for fiscal year 2005 a proposal relating to cash balance and other hybrid plans that specifically addresses conversions to such plans, the application of the age discrimination rules to such plans, and the determination of minimum lump sums under such plans.⁷³ In June 2004, the IRS announced the withdrawal of the proposed age discrimination regulations, including the special rules for eligible cash balance plans.⁷⁴ According to the Announcement, "[t]his will provide Congress an opportunity to * * * address cash balance and other hybrid plan issues through legislation."

The application of the age discrimination rules to hybrid plans has been the subject of litigation. This issue was first addressed in Eaton v. Onan Corporation.⁷⁵ In that case, the court considered how the rate of an employee's benefit accrual is determined for purposes of the age discrimination rules and concluded that the statute does not require the rate of benefit accrual to be measured solely by the value of a participant's annuity payable at normal retirement age. The court found that, in the case of a cash balance plan, the rate of benefit accrual should be defined as the change in the employee's cash balance account from one year to the next. The court held that a cash balance plan does not violate the prohibition on reducing the rate of benefit accrual because of age. This analysis has also been applied in two other cases, Tootle v. ARINC Inc.,⁷⁶ and Register v. PNC Financial Services Group, Inc.,⁷⁷ in which the courts found the Eaton v. Onan Corporation decision persuasive, rather than the Cooper v. IBM Personal Pension Plan decision.⁷⁸

Only in Cooper v. IBM Personal Pension Plan has a court required the age discrimination requirements to be applied to a cash balance plan on the basis of the benefit payable in the form of an annuity commencing at normal retirement age, which was age 65 under the plan.⁷⁹ For this purpose, the court required interest credits to be projected and valued as an age 65 annuity. The court noted that, in terms of an age 65 annuity, interest credits will always be more valuable for a younger employee than for an older employee. Thus, the court concluded that an employee's rate of benefit accrual declines as the employee gets older, in violation of the age discrimination rules. Although Eaton v. Onan Corporation had been decided in 2000, the court did not discuss the analysis in that case.

Calculating minimum lump-sum distributions under hybrid plans

Defined benefit pension plans, including cash balance plans and other hybrid plans, are required to provide benefits in the form of a life annuity commencing at a participant's normal retirement age. If the plan permits benefits to be paid in certain other forms, such as a lump sum, minimum present value rules apply, under which the alternative form of benefit cannot be less than the present value of the life annuity payable at normal retirement age, determined using certain statutorily prescribed interest and mortality assumptions.⁸⁰

Most cash balance plans are designed to permit a lump-sum distribution of a participant's hypothetical account balance upon termination of employment. This raises an issue as to whether a distribution of a participant's hypothetical account balance satisfies the minimum present value rules. In 1996, the IRS issued proposed guidance (Notice 96-8) on the application of the minimum present value rules to lump-sum distributions under cash balance plans and requested public comments in anticipation of proposed regulations incorporating the proposed guidance.⁸¹

Under the proposed guidance, a lump-sum distribution from a cash balance plan cannot be less than the present value of the benefit payable at normal retirement age, determined using the statutory interest and mortality assumptions. For this purpose, a participant's normal retirement benefit under a cash balance plan is generally determined by projecting the participant's hypothetical account balance to normal retirement age by crediting to the account future interest credits at the plan rate, the right to which has already accrued, and converting the projected account balance to an actuarially equivalent life annuity payable at normal retirement age, using the interest and mortality assumptions specified in the plan. The proposed guidance also included rules under which cash balance plans can provide lump-sum distributions in the amount of participants' hypothetical account balances if the rate at which interest credits are provided under the plan is not greater (or is assumed not to be greater) than the statutory interest rate.

Under the approach in the proposed guidance, a difference in the rate of interest credits provided under the plan, which is used to project the account balance forward to normal retirement age, and the statutory rate used to determine the lump-sum value (i.e., present value) of the accrued benefit can cause a discrepancy between the value of the minimum lump-sum and the employee's hypothetical account balance. This effect is sometimes referred to as "whipsaw." In particular, if the plan's interest crediting rate is higher than the statutory interest rate, then the resulting lump-sum amount will generally be greater than the hypothetical account balance.

Several courts, but not all, have applied an approach similar to the approach in the proposed guidance in cases involving the determination of lump sums under cash balance plans.⁸² Regulations addressing the application of the minimum present value rules to cash balance plans have not been issued.⁸³

The Committee is aware that some conversions of traditional defined benefit plans to hybrid plans raised some concern. The Committee also notes, however, that the IRS did not challenge the basic hybrid plan design and that, until the decision in Cooper v. IBM Personal Pension Plan, the legality of the basic hybrid plan design was not called into question. The court in that case found that the plan discriminated on the basis of age because the hypothetical accounts of younger workers accrue interest over a longer period of time, resulting in higher account balances. In effect, the court's decision found that plans that reflect the time value of money are age discriminatory. This result could potentially call into question other types of plan designs under more traditional defined benefit plans. The Committee does not believe that a plan design is age discriminatory merely because the benefits reflect the time value of money. The Committee is aware that some employers have already responded to the uncertainty raised by this decision by freezing their hybrid plans whether or not their plan was converted from a traditional plan. Thus, the situation being faced by many employees is not whether they will have a traditional defined benefit plan or a hybrid plan, but whether they will be covered by any pension plan.

With respect to the whipsaw issue, the Committee does not view the position taken by the IRS in Notice 96-8 to be a correct interpretation of present law. The Committee notes that this position has never been finalized in regulations and understands that the Treasury has been reviewing this position. The President's proposal would take an approach similar to that in the Committee bill. The Committee also notes that the approach taken in Notice 96-8 could harm plan participants. In response to the Notice, some employers have reduced the level of interest credits under their cash balance plans. In addition, the approach in the Notice provides a larger benefit for a participant who takes a distribution before normal retirement age. Thus, it penalizesemployees who wait for their benefits until retirement, which is a perverse result for a retirement plan.

The Committee believes that the uncertainty that exists with respect to certain aspects of hybrid plans (as well as other defined benefit pension plan designs) should be resolved by clarifying that the law accommodates the nature and design of these plans. Thus, the Committee bill adopts age discrimination standards that may be applied to all defined benefit plans, including hybrid plans, and also resolves other issues, such as the calculation of lump-sum benefits.

In adopting these rules, the Committee is aware that our private pension system is a voluntary system that must accommodate various concerns, including those of employers and employees. In order to maintain a viable private pension system, the Committee believes that employers should have the ability to make plan design changes on a prospective basis without undue restriction or mandates with respect to future benefit levels.

The Committee bill applies on a prospective basis because certain issues addressed by the bill are the subject of on-going litigation. However, the Committee views the provision as a clarification; the action of the Committee in clarifying the law should not cast any negative inference on the legality of hybrid plans.

Under the provision, a plan is not treated as violating the prohibition on age discrimination if a participant's entire accrued benefit, as determined as of any date under the formula for determining benefits as set forth in the text of the plan documents, would be equal to or greater than that of any similarly situated, younger individual. For this purpose, an individual is similarly situated to a participant if the individual and the participant are (and always have been) identical in every respect (including period of service, compensation, position, date of hire, work history, and any other respect) except for age. In addition, in determining a participant's entire accrued benefit for this purpose, the subsidized portion of any early retirement benefit (including any early retirement subsidy that is fully or partially included or reflected in an employee's opening balance or other transition benefits) is disregarded. In some cases the value of an early retirement subsidy may be difficult to determine; it is therefore intended that a reasonable approximation of such value may be used for this purpose. The provision is intended to apply to hybrid plans, including pension equity plans.

In addition, under the provision, plans do not violate the prohibition on age discrimination solely because of the following plan designs or features:

Calculating minimum lump-sum distributions under hybrid plans

The provision provides a special rule for determining minimum lump-sum benefits under a defined benefit pension plan under which the accrued benefit payable upon distribution (or any portion thereof) is expressed as the balance of a hypothetical account maintained for the participant. Under the provision, such a plan is not treated as violating the minimum present value rules solely because of the amount actually made available for distribution under the terms of the plan, in any case in which the applicable interest rate that would be used under the terms of the plan to project the amount of the participant's account balance to normal retirement age is not greater than a market rate of return. The Secretary of the Treasury is given regulatory authority relating to: (1) the calculation of a market rate of return for this purpose; and (2) permissible methods of crediting interest to the account (including variable interest rates) resulting in effective rates of return not greater than a market rate of return.

Employer contributions to qualified retirement plans are deductible subject to certain limits.⁸⁵

In the case of a defined benefit pension plan (including both single-employer and multiemployer plans), the employer generally may deduct the greater of: (1) the amount necessary to satisfy the minimum funding requirement of the plan for the year; or (2) the amount of the plan's normal cost for the year plus the amount necessary to amortize certain unfunded liabilities over 10 years, but limited to the full funding limitation for the year.⁸⁶ The maximum amount otherwise deductible generally is not less than the plan's unfunded current liability.⁸⁷ In the case of a single-employer plan covered by the PBGC insurance program that terminates during the year, the maximum deductible amount is generally not less than the amount needed to make the plan assets sufficient to fund benefit liabilities as defined for purposes of plan termination under the PBGC insurance program.

In the case of a defined contribution plan, the employer generally may deduct contributions in an amount up to 25 percent of compensation paid or accrued during the employer's taxable year.⁸⁸

Subject to certain exceptions, an employer that makes nondeductible contributions to a plan is subject to an excise tax equal to 10 percent of the amount of the nondeductible contributions for the year.

In the case of multiemployer defined benefit pension plans, the present-law deduction limits may also create the potential that contributions required under collective bargaining agreements are not deductible by the employers obligated to make the contributions. In that case, employers' contribution obligations may be waived, or plan benefits (and thus plan liabilities) may be increased in order to assure that contributions are deductible. However, such measures may cause the plan's funded status to deteriorate, especially in a period of economic downturn. In the case of multiemployer plans, the deduction limit for contributions should be increased to reduce the possibility that contributions required under collective bargaining agreements are not deductible.

In the case of a single-employer defined benefit pension plan, the maximum deductible amount is equal to the greater of:

The provision retains the present-law rule, that, in the case of a single-employer plan covered by the PBGC that terminates during the year, the maximum deductible amount is generally not less than the amount needed to make the plan assets sufficient to fund benefit liabilities as defined for purposes of the PBGC termination insurance program.

In the case of a multiemployer defined benefit plan, the maximum amount deductible is not less than 140 percent of current liability over the value of plan assets.

If an employer sponsors one or more defined benefit pension plans and one or more defined contribution plans that cover at least one of the same employees, an overall deduction limit applies to the total contributions to all plans for a plan year. The overall deduction limit generally is the greater of (1) 25 percent of compensation, or (2) the amount necessary to meet the minimum funding requirements of the defined benefit plan for the year, but not less than the amount of the plan's unfunded current liability.

Under EGTRRA, elective deferrals are not subject to the limits on deductions and are not taken into account in applying the limits to other employer contributions. The combined deduction limit of 25 percent of compensation for defined benefit and defined contribution plans does not apply if the only amounts contributed to the defined contribution plan are elective deferrals.⁹¹

Subject to certain exceptions, an employer that makes nondeductible contributions to a plan is subject to an excise tax equal to 10 percent of the amount of the nondeductible contributions for the year. Certain contributions to a defined contribution plan that are nondeductible solely because of the overall deduction limit are disregarded in determining the amount of nondeductible contributions for purposes of the excise tax. Contributions that are disregarded are the greater of (1) the amount of contributions not in excess of six percent of the compensation of the employees covered by the defined contribution plan, or (2) the amount of matching contributions.

The Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") made a number of changes to the Federal tax laws, including a variety of provisions relating to pensions and individual retirement arrangements ("IRAs"). However, in order to comply with reconciliation procedures under the Congressional Budget Act of 1974 (e.g., section 313 of the Budget Act, under which a point of order may be lodged in the Senate), EGTRRA included a "sunset" provision, pursuant to which the provisions of EGTRRA expire at the end of 2010. Specifically, EGTRRA's provisions do not apply for taxable, plan, or limitation years beginning after December 31, 2010, or to estates of decedents dying after, or gifts or generation-skipping transfers made after, December 31, 2010. EGTRRA provides that, as of the effective date of the sunset, both the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 ("ERISA") will be applied as though EGTRRA had never been enacted.

Certain provisions contained in EGTRRA expire before the general sunset date of 2010.⁹²

List of affected provisions

Following is a list of the provisions affected by the general EGTRRA sunset.

•  

  Individual retirement arrangements ("IRAs")

• Increases in the IRA contribution limits, including the ability to make catch-up contributions (secs. 219, 408, and 408A of the Code and sec. 601 of EGTRRA); and

• Rules relating to deemed IRAs under employer plans (sec. 408(q) of the Code and sec. 602 of EGTRRA).

• Expanding coverage

• Increases in the limits on contributions, benefits, and compensation under qualified retirement plans, tax-sheltered annuities, and eligible deferred compensation plans (secs. 401(a)(17), 402(g), 408(p), 414(v), 415, and 457 of the Code and sec. 611 of EGTRRA);

• Application of prohibited transaction rules to plan loans of S corporation owners, partners, and sole proprietors (sec. 4975 of the Code and sec. 612 of EGTRRA);

• Modification of the top-heavy rules (sec. 416 of the Code and sec. 613 of EGTRRA);

• Elective deferrals not taken into account for purposes of deduction limits (sec. 404 of the Code and sec. 614 of EGTRRA);

• Repeal of coordination requirements for deferred compensation plans of state and local governments and tax-exempt organizations (sec. 457 of the Code and sec. 615 of EGTRRA);

• Modifications to deduction limits (sec. 404 of the Code and sec. 616 of EGTRRA);

• Option to treat elective deferrals as after-tax Roth contributions (sec. 402A of the Code and sec. 617 of EGTRRA);

• Credit for pension plan start-up costs (sec. 45E of the Code and sec. 619 of EGTRRA); and

• Certain nonresident aliens excluded in applying minimum coverage requirements (secs. 410(b)(3) and 861(a)(3) of the Code).

• Enhancing fairness

• Catch-up contributions for individuals age 50 and older (sec. 414 of the Code and sec. 631 of EGTRRA);

• Equitable treatment for contributions of employees to defined contribution plans (secs. 403(b), 415, and 457 of the Code and sec. 632 of EGTRRA);

• Faster vesting of employer matching contributions (sec. 411 of the Code and sec. 633 of EGTRRA);

• Modifications to minimum distribution rules (sec. 401(a)(9) of the Code and sec. 634 of EGTRRA);

• Clarification of tax treatment of division of section 457 plan benefits upon divorce (secs. 414(p) and 457 of the Code and sec. 635 of EGTRRA);

• Provisions relating to hardship withdrawals (secs. 401(k) and 402 of the Code and sec. 636 of EGTRRA); and

• Waiver of tax on nondeductible contributions for domestic and similar workers (sec. 4972(c)(6) of the Code and sec. 637 of EGTRRA).

• Increasing portability

• Rollovers of retirement plan and IRA distributions (secs. 401, 402, 403(b), 408, 457, and 3405 of the Code and secs. 641-644 of EGTRRA);

• Treatment of forms of distribution (sec. 411(d)(6) of the Code and sec. 645 of EGTRRA);

• Rationalization of restrictions on distributions (secs. 401(k), 403(b), and 457 of the Code and sec. 646 of EGTRRA):

• Purchase of service credit under governmental pension plans (secs. 403(b) and 457 of the Code and sec. 647 of EGTRRA):

• Employers may disregard rollovers for purposes of cash-out rules (sec. 411(a)(11) of the Code and sec. 648 of EGTRRA); and

• Minimum distribution and inclusion requirements for section 457 plans (sec. 457 of the Code and sec. 649 of EGTRRA).

• Strengthening pension security and enforcement

• Phase in repeal of 160 percent of current liability funding limit; maximum deduction rules (secs. 404(a)(1), 412(c)(7), and 4972(c) of the Code and secs. 651-652 of EGTRRA);

• Excise tax relief for sound pension funding (sec. 4972 of the Code and sec. 653 of EGTRRA);

• Modifications to section 415 limits for multiemployer plans (sec. 415 of the Code and sec. 654 of EGTRRA);

• Investment of employee contributions in 401(k) plans (sec. 655 of EGTRRA);

• Prohibited allocations of stock in an S corporation ESOP (secs. 409 and 4979A of the Code and sec. 656 of EGTRRA);

• Automatic rollovers of certain mandatory distributions (secs. 401(a)(31) and 402(f)(1) of the Code and sec. 657 of EGTRRA);

• Clarification of treatment of contributions to a multiemployer plan (sec. 446 of the Code and sec. 658 of EGTRRA); and

• Treatment of plan amendments reducing future benefit accruals (sec. 4980F of the Code and sec. 659 of EGTRRA).

• Reducing regulatory burdens

• Modification of timing of plan valuations (sec. 412 of the Code and sec. 661 of EGTRRA);

• ESOP dividends may be reinvested without loss of dividend deduction (sec. 404 of the Code and sec. 662 of EGTRRA);

• Repeal transition rule relating to certain highly compensated employees (sec. 663 of EGTRRA);

• Treatment of employees of tax-exempt entities for purposes of nondiscrimination rules (secs. 410, 401(k), and 401(m) of the Code and sec. 664 of EGTRRA);

• Treatment of employer-provided retirement advice (sec. 132 of the Code and sec. 665 of EGTRRA); and

• Repeal of the multiple use test (sec. 401(m) of the Code and sec. 666 of EGTRRA).

The credit is available with respect to: (1) elective deferrals to a qualified cash or deferred arrangement (a "section 401(k) plan"), a tax-sheltered annuity (a "section 403(b)" annuity), an eligible deferred compensation arrangement of a State or local government (a "section 457 plan"), a SIMPLE, or a simplified employee pension ("SEP"); (2) contributions to a traditional or Roth IRA; and (3) voluntary after-tax employee contributions to a tax-sheltered annuity or qualified retirement plan.

The amount of any contribution eligible for the credit is reduced by distributions received by the taxpayer (or by the taxpayer's spouse if the taxpayer filed a joint return with the spouse) from any plan or IRA to which eligible contributions can be made during the taxable year for which the credit is claimed, the two taxable years prior to the year the credit is claimed, and during the period after the end of the taxable year for which the credit is claimed and prior to the due date for filing the taxpayer's return for the year. Distributions that are rolled over to another retirement plan do not affect the credit.

The credit rates based on AGI are provided in Table 1, below.

              TABLE 1.--CREDIT RATES FOR SAVER'S CREDIT

The provision also provides that an individual may direct that the amount of his or her saver's credit be directly deposited by the Federal government into an IRA, qualified retirement plan, section 403(b) annuity, or governmental section 457 plan designated by the individual (if the plan or other arrangement agrees to accept such direct deposits). The provision does not change the rules relating to the tax treatment of contributions to such plans or other arrangements.

Under present law, most defined contribution plans may include a qualified cash or deferred arrangement (commonly referred to as a "section 401(k)" or "401(k)" plan),⁹³ under which employees may elect to receive cash or to have contributions made to the plan by the employer on behalf of the employee in lieu of receiving cash. Contributions made to the plan at the election of the employee are referred to as "elective deferrals" or "elective contributions." ⁹⁴ A 401(k) plan may be designed so that the employee will receive cash unless an affirmative election to make contributions is made. Alternatively, a plan may provide that elective contributions are made at a specified rate unless the employee elects otherwise (i.e., elects not to make contributions or to make contributions at a different rate). Arrangements that operate in this manner are sometimes referred to as "automatic enrollment" or "negative election" plans. In either case, the employee must have an effective opportunity to elect to receive cash in lieu of contributions.⁹⁵

Nondiscrimination rules

A special nondiscrimination test applies to elective deferrals under a section 401(k) plan, called the actual deferral percentage test or the "ADP" test. The ADP test compares the actual deferral percentages ("ADPs") of the highly compensated employee group and the nonhighly compensated employee group. The ADP for each group generally is the average of the deferral percentages separately calculated for the employees in the group who are eligible to make elective deferrals for all or a portion of the relevant plan year. Each eligible employee's deferral percentage generally is the employee's elective deferrals for the year divided by the employee's compensation for the year.

The plan generally satisfies the ADP test if the ADP of the highly compensated employee group for the current plan year is either (1) not more than 125 percent of the ADP of the nonhighly compensated employee group for the prior plan year, or (2) not more than 200 percent of the ADP of the nonhighly compensated employee group for the prior plan year and not more than two percentage points greater than the ADP of the nonhighly compensated employee group for the prior plan year.

Under a safe harbor, a section 401(k) plan is deemed to satisfy the special nondiscrimination test if the plan satisfies one of two contribution requirements and satisfies a notice requirement (a "safe harbor section 401(k) plan"). A plan satisfies the contribution requirement under the safe harbor rule if the employer either (1) satisfies a matching contribution requirement or (2) makes a nonelective contribution to a defined contribution plan of at least three percent of an employee's compensation on behalf of each nonhighly compensated employee who is eligible to participate in the arrangement. A plan generally satisfies the matching contribution requirement if, under the arrangement: (1) the employer makes a matching contribution on behalf of each nonhighly compensated employee that is equal to (a) 100 percent of the employee's elective deferrals up to three percent of compensation and (b) 50 percent of the employee's elective deferrals from three to five percent of compensation; ⁹⁶ and (2) the rate of match with respect to any elective deferrals for highly compensated employees is not greater than the rate of match for nonhighly compensated employees.

Employer matching contributions are also subject to a special nondiscrimination test, the "ACP test," which compares the average actual contribution percentages ("ACPs") of matching contributions for the highly compensated employee group and the nonhighly compensated employee group. The plan generally satisfies the ACP test if the ACP of the highly compensated employee group for the current plan year is either (1) not more than 125 percent of the ACP of the nonhighly compensated employee group for the prior plan year, or (2) not more than 200 percent of the ACP of the nonhighly compensated employee group for the prior plan year and not more than two percentage points greater than the ACP of the nonhighly compensated employee group for the prior plan year.

A safe harbor section 401(k) plan that provides for matching contributions is deemed to satisfy the ACP test if, in addition to meeting the safe harbor contribution and notice requirements under section 401(k), (1) matching contributions are not provided with respect to elective deferrals in excess of six percent of compensation, (2) the rate of matching contribution does not increase as the rate of an employee's elective deferrals increases, and (3) the rate of matching contribution with respect to any rate of elective deferral of a highly compensated employee is no greater than the rate of matching contribution with respect to the same rate of deferral of a nonhighly compensated employee.

Top-heavy rules

Special rules apply in the case of a top-heavy plan. In general, a defined contribution plan is a top-heavy plan if the accounts of key employees account for more than 60 percent of the aggregate value of accounts under the plan. If a plan is a top-heavy plan, then certain minimum vesting standards and minimum contribution requirements apply.

A plan that consists solely of contributions that satisfy the safe harbor plan rules for elective and matching contributions is not considered a top-heavy plan.

Tax-sheltered annuities

Tax-sheltered annuities ("section 403(b) annuities") may provide for contributions on a salary reduction basis, similar to section 401(k) plans. Matching contributions under a section 403(b) annuity are subject to the same nondiscrimination rules under section 401(m) as matching contributions under a section 401(k) plan (sec. 403(b)(12)). Thus, for example, the safe harbor method of satisfying the section 401(m) rules for matching contributions under a 401(k) plan applies to section 403(b) annuities.

Under the provision, a 401(k) plan that contains an automatic enrollment feature that satisfies certain requirements (a "qualified automatic enrollment feature") is treated as meeting the ADP test with respect to elective deferrals and the ACP test with respect to matching contributions. In addition, a plan consisting solely of contributions made pursuant to a qualified automatic enrollment feature is not subject to the top-heavy rules.

A qualified automatic enrollment feature must meet certain requirements with respect to: (1) automatic deferral; (2) participation; (3) matching or nonelective contributions; and (4) notice to employees.

Automatic deferral

A qualified automatic enrollment feature must provide that, unless an employee elects otherwise, the employee is treated as making an election to make elective deferrals equal to a stated percentage of compensation not in excess of 10 percent and at least equal to: three percent of compensation for the first year the deemed election applies to the participant; four percent during the second year; five percent during the third year; and six percent during the fourth year and thereafter. The stated percentage must be applied uniformly to all eligible employees. Eligible employees mean all employees eligible to participate in the 401(k) plan, other than employees eligible to participate in the 401(k) plan immediately before the date on which the 401(k) plan (or a predecessor 401(k) plan) becomes a qualified automatic enrollment arrangement. Thus, for example, if an employer has a pre-existing 401(k) plan for which all employees are eligible, the automatic enrollment feature would be required to cover newly hired employees. The automatic enrollment feature may also cover existing employees.

Participation requirement

An automatic enrollment feature satisfies the participation requirement for a year if, for the plan year or the immediately preceding plan year, elective deferrals are made on behalf of at least 70 percent of the employees eligible under the automatic enrollment arrangement other than highly compensated employees and employees who were eligible to participate in the 401(k) plan immediately before the qualified automatic enrollment arrangement is effective. The participation requirement is deemed to be satisfied for the first year the qualified automatic enrollment feature is in effect.

Matching or nonelective contribution requirement

A plan including an automatic enrollment feature that provides for matching contributions is deemed to satisfy the ACP test if, in addition to meeting the safe harbor contribution requirements applicable to the qualified automatic enrollment feature: (1) matching contributions are not provided with respect to elective deferrals in excess of six percent of compensation, (2) the rate of matching contribution does not increase as the rate of anemployee's elective deferrals increases, and (3) the rate of matching contribution with respect to any rate of elective deferral of a highly compensated employee is no greater than the rate of matching contribution with respect to the same rate of deferral of a nonhighly compensated employee.

Notice requirement

Under the notice requirement, each employee covered by the arrangement must receive notice of the arrangement which is sufficiently accurate and comprehensive to apprise the employee of such rights and obligations and is written in a manner calculated to be understood by the average employee to whom the arrangement applies.⁹⁸ The notice must explain: (1) the employee's right under the arrangement to elect not to have elective contributions made on the employee's behalf or to elect to have contributions made in a different amount; and (2) how contributions made under the automatic enrollment arrangement will be invested in the absence of any investment election by the employee. The employee must be given a reasonable period of time after receipt of the notice and before the first election contribution is to be made to make an election with respect to contributions and investments.

Corrective distributions

The provision includes rules under which erroneous automatic contributions may be distributed from the plan. It is intended that distributions of such amounts are generally treated as a payment of compensation, rather than as a contribution to and then a distribution from the plan. Thus, for example, the 10-percent early withdrawal tax does not apply to distributions of erroneous automatic contributions. In addition, it is intended that such contributions are not taken into account for purposes of applying the nondiscrimination rules, or the limit on elective deferrals. Similarly, it is intended that distributions of such contributions are not subject to the otherwise applicable withdrawal restrictions.

Application to tax-sheltered annuities

The new safe harbor rules for automatic contribution plans apply with respect to matching contributions under a section 403(b) annuity through the operation of section 403(b)(12).

Certain amounts held in a 401(k) plan or in a 403(b) annuity may not be distributed before severance from employment, age 59-1/2, death, disability, or financial hardship of the employee.

An individual who receives a qualified reservist distribution may, at any time during the two-year period beginning on the day after the end of the active duty period, make one or more contributions to an IRA of such individual in an aggregate amount not to exceed the amount of such distribution. The dollar limitations otherwise applicable to contributions to IRAs do not apply to any contribution made pursuant to the provision. No deduction is allowed for any contribution made under the provision.

This provision applies to individuals ordered or called to active duty after September 11, 2001, and before September 12, 2007. The two-year period for making recontributions of qualified reservist distributions does not end before the date that is two years after the date of enactment.

If refund or credit of any overpayment of tax resulting from the provision would be prevented at any time before the close of the one-year period beginning on the date of the enactment by the operation of any law or rule of law (including res judicata), such refund or credit may nevertheless be made or allowed if claim therefor is filed before the close of such period.

A qualified public safety employee is an employee of any police department or fire department organized and operated by a State or political subdivision of a State if the employee provides police protection, firefighting services, or emergency medical services for any area within the jurisdiction of such State or political subdivision and would have been eligible to retire on or before the effective date of the DROP election and receive an immediate retirement benefit under the defined benefit plan.

An individual may make contributions to a traditional IRA (up to the contribution limit) without regard to his or her adjusted gross income. An individual may deduct his or her contributions to a traditional IRA if neither the individual nor the individual's spouse is an active participant in an employer-sponsored retirement plan. If an individual or the individual's spouse is an active participant in an employer-sponsored retirement plan, the deduction is phased out for taxpayers with adjusted gross income over certain levels.

Individuals with adjusted gross income below certain levels may make contributions to a Roth IRA (up to the contribution limit). Contributions to a Roth IRA are not deductible.

Present law provides an exclusion from gross income for combat pay received by members of the Armed Forces. Thus, combat pay is not includible compensation for purposes of applying the limit on IRA contributions.

An individual may make contributions to a traditional IRA (up to the contribution limit) without regard to his or her adjusted gross income. An individual may deduct his or her contributions to a traditional IRA if neither the individual nor the individual's spouse is an active participant in an employer-sponsored retirement plan. If an individual or the individual's spouse is an active participant in an employer-sponsored retirement plan, the deduction is phased out for taxpayers with adjusted gross income over certain levels.

Individuals with adjusted gross income below certain levels may make contributions to a Roth IRA (up to the contribution limit). Contributions to a Roth IRA are not deductible.

Under present law, a distribution from a qualified retirement plan, a tax-sheltered annuity ("section 403(b) annuity"), an eligible deferred compensation plan of a State or local government employer (a "governmental section 457 plan"), or an individual retirement arrangement (an "IRA") generally is included in income for the year distributed. However, eligible rollover distributions may be rolled over tax free within 60 days to another plan, annuity, or IRA.¹⁰⁰

In general, an eligible rollover distribution includes any distribution to the plan participant or IRA owner other than certain periodic distributions, minimum required distributions, and distributions made on account of hardship.¹⁰¹ Distributions to a participant from a qualified retirement plan, a tax-sheltered annuity, or a governmental section 457 plan generally can be rolled over to any of such plans or an IRA.¹⁰² Similarly, distributions from an IRA to the IRA owner generally are permitted to be rolled over into a qualified retirement plan, a tax-sheltered annuity, a governmental section 457 plan, or another IRA.

Similar rollovers are permitted in the case of a distribution to the surviving spouse of the plan participant or IRA owner, but not to other persons.

If an individual inherits an IRA from the individual's deceased spouse, the IRA may be treated as the IRA of the surviving spouse. This treatment does not apply to IRAs inherited from someone other than the deceased spouse. In such cases, the IRA is not treated as the IRA of the beneficiary. Thus, for example, the beneficiary may not make contributions to the IRA and cannot roll over any amounts out of the inherited IRA. Like the original IRA owner, no amount is generally included in income until distributions are made from the IRA. Distributions from the inherited IRA must be made under the rules that apply to distributions to beneficiaries, as described below.

Minimum distribution rules

Minimum distribution rules apply to tax-favored retirement arrangements. In the case of distributions prior to the death of the participant, distributions generally must begin by the April 1 of the calendar year following the later of the calendar year in which the participant (1) attains age 70-1/2 or (2) retires.¹⁰³ The minimum distribution rules also apply to distributions following the death of the participant. If minimum distributions have begun prior to the participant's death, the remaining interest generally must be distributed at least as rapidly as under the minimum distribution method being used prior to the date of death. If the participant dies before minimum distributions have begun, then either (1) the entire remaining interest must be distributed within five years of the death, or (2) distributions must begin within one year of the death over the life (or life expectancy) of the designated beneficiary. A beneficiary who is the surviving spouse of the participant is not required to begin distributions until the date the deceased participant would have attained age 70-1/2. Alternatively, if the surviving spouse makes a rollover from the plan into a plan or IRA of his or her own, minimum distributions generally would not need to begin until the surviving spouse attains age 70-1/2.

In general, earnings and gains on amounts invested in a deferred annuity contract held by an individual are not subject to tax during the deferral period in the hands of the holder of the contract. When payout commences under a deferred annuity contract, the tax treatment of amounts distributed depends on whether the amount is received "as an annuity" (generally, as periodic payments under contract terms) or not.

For amounts received as an annuity by an individual, an "exclusion ratio" is provided for determining the taxable portion of each payment (sec. 72(b)). The portion of each payment that is attributable to recovery of the taxpayer's investment in the contract is not taxed. The taxable portion of each payment is ordinary income. The exclusion ratio is the ratio of the taxpayer's investment in the contract to the expected return under the contract, that is, the total of the payments expected to be received under the contract. The ratio is determined as of the taxpayer's annuity starting date. Once the taxpayer has recovered his or her investment in the contract, all further payments are included in income. If the taxpayer dies before the full investment in the contract is recovered, a deduction is allowed on the final return for the remaining investment in the contract (sec. 72(b)(3)).

Amounts not received as an annuity generally are included as ordinary income if received on or after the annuity starting date. Amounts not received as an annuity are included in income to the extent allocable to income on the contract if received before the annuity starting date, i.e., as income first (sec. 72(e)(2)). In general, loans under the annuity contract, partial withdrawals and partial surrenders are treated as amounts not received as an annuity and are subject to tax as income first (sec. 72(e)(4)). Exceptions are provided in some circumstances, such as for certain grandfathered contracts, certain life insurance and endowment contracts (other than modified endowment contracts), and contracts under qualified plans (sec. 72(e)(5)). Under these exceptions, the amount received is included in income, but only to the extent it exceeds the investment in the contract, i.e., as basis recovery first.

Long-term care insurance contracts

A qualified long-term care insurance contract is treated as an accident and health insurance contract (sec. 7702B(a)(1)). Amounts received under the contract generally are excludable from income as amounts received for personal injuries or sickness (sec. 104(a)(3)).The excludable amount is subject to a dollar cap of $175 per day or $63,875 annually (for 1997), as indexed, on per diem contracts only (sec. 7702B(d)). If payments under such contracts exceed the dollar cap, then the excess is excludable only to the extent of costs in excess of the dollar cap that are incurred for long-term care services. Amounts in excess of the dollar cap, with respect to which no actual costs were incurred for long-term care services, are fully includable in income without regard to the rules relating to return of basis under section 72.

A plan of an employer providing coverage under a long-term care insurance contract generally is treated as an accident and health plan (benefits under which generally are excludable from the recipient's income under section 105).

Premiums paid for a qualified long-term care insurance contract are deductible as medical expenses, subject to a dollar cap on the deductible amount of the premium per year based on the insured person's age at the end of the taxable year (sec. 213(d)(10)). Medical expenses generally are allowed as a deduction only to the extent they exceed 7.5 percent of adjusted gross income (sec. 213(a)).

Unreimbursed expenses for qualified long-term care services provided to the taxpayer or the taxpayer's spouse or dependent are treated as medical expenses for purposes of the itemized deduction for medical expenses (subject to the floor of 7.5 percent of adjusted gross income). Amounts received under a qualified long-term care insurance contract (regardless of whether the contract reimburses expenses or pays benefits on a per diem or other periodic basis) are treated as reimbursement for expense actually incurred for medical care (sec. 7702B(a)(2)).

Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing treating, mitigating, and rehabilitative services, and maintenance or personal care services that are required by a chronically ill individual and that are provided pursuant to a plan of care prescribed by a licensed health care practitioner (sec. 7702B(c)(1)).

A chronically ill individual is generally one who has been certified within the previous 12 months by a licensed health care practitioner as being unable to perform (without substantial assistance) at least 2 activities of daily (ADLs) for at least 90 days due to a loss of functional capacity (or meeting other definitional requirements) (sec. 7702B(c)(2)).

The guideline premium limitation applicable under section 7702(c)(2) is increased by the sum of charges (but not premium payments) against the life insurance contract's cash surrender value, the imposition of which reduces premiums paid for the contract (within the meaning of sec. 7702(f)(1)).

No medical expense deduction generally is allowed under section 213 for charges against the life insurance contract's cash surrender value, unless such charges are includible in income because the life insurance contract is treated as a "modified endowment contract" under section 72(e)(10) and 7702A (sec. 7702B(e)((3)).

Tax-free exchanges of insurance contracts

Present law provides for the exchange of certain insurance contracts without recognition of gain or loss (sec. 1035). No gain or loss is recognized on the exchange of: (1) a life insurance contract for another life insurance contract or for an endowment or annuity contract; or (2) an endowment contract for another endowment contract (that provides for regular payments beginning no later than under the exchanged contract) or for an annuity contract; or (3) an annuity contract for an annuity contract. The basis of the contract received in the exchange generally is the same as the basis of the contract exchanged (sec. 1031(d)). Tax-free exchanges of long-term care insurance contracts are not permitted.

Capitalization of certain policy acquisition expenses of insurance companies

In the case of an insurance company, specified policy acquisition expenses for any taxable year are required to be capitalized, and are amortized generally over the 120-month period beginning with the first month in the second half of the taxable year (sec. 848). Specified policy acquisition expenses are determined as that portion of the insurance company's general deductions for the taxable year that does not exceed a specific percentage of the net premiums for the taxable year on each of three categories of insurance contracts. For annuity contracts, the percentage is 1.75; for group life insurance contracts, the percentage is 2.05; and for all other specified insurance contracts, the percentage is 7.7. With certain exceptions, a specified insurance contract is any life insurance, annuity, or noncancellable accident and health insurance contract or combination thereof.

Under the provision, any charge against the cash value of an annuity contract or the cash surrender value of a life insurance contract made as payment for coverage under a qualified long-term care insurance contract that is part of or a rider on the annuity or life insurance contract is not includable in income. The investment in the contract is reduced (but not below zero) by the charge.

The provision expands the rules for tax-free exchanges of certain insurance contracts. The provision provides that no gain or loss is recognized on the exchange of a life insurance contract, an endowment contract, an annuity contract, or a qualified long-term care insurance contract for a qualified long-term care insurance contract. The provision provides that a contract does not fail to be treated as an annuity contract, or as a life insurance contract, solely because a qualified long-term care insurance contract is a part of or a rider on such contract, for purposes of the rules for tax-free exchanges of certain life insurance contracts.

The provision provides that, except as otherwise provided in regulations, for Federal tax purposes, in the case of a long-term care insurance contract (whether or not qualified) provided by a rider on or as part of a life insurance contract or an annuity contract, the portion of the contract providing long-term care insurance coverage is treated as a separate contract. The term "portion" means only the terms and benefits under a life insurance contract or annuity contract that are in addition to the terms and benefits under the contract without regard to long-term care coverage. As a result, if the applicable requirements are met by the long-term care portion of the contract, amounts received under the contract as provided by the rider are treated in the same manner as long-term care insurance benefits, whether or not the payment of such amounts causes a reduction in the life insurance contract's death benefit or cash surrender value or in the annuity contract's cash value.

No deduction as a medical expense is allowed for any payment made for coverage under a qualified long-term care insurance contract if the payment is made as a charge against the cash value of an annuity contract or the cash surrender value of a life insurance contract.

For purposes of the definition of a life insurance contract, the guideline premium limitation is increased by charges against the contract's cash surrender value for coverage under the qualified long-term care insurance contract (reduced by charges that reduce the premiums paid for the life insurance contract).

The provision provides that certain retirement-related arrangements are not treated as annuity contracts, for purposes of the provision.

The provision requires information reporting by any person who makes a charge against the cash value of an annuity contract, or the cash surrender value of a life insurance contract, that is excludible from gross income under the provision. The information required to be reported includes the amount of the aggregate of such charges against each such contract for the calendar year, the amount of the reduction in the investment in the contract by reason of the charges, and the name, address, and taxpayer identification number of the holder of the contract.

The provision modifies the application of the rules relating to capitalization of policy acquisition expenses of insurance companies. In the case of an annuity or life insurance contract that includes a qualified long-term care insurance contract as a part of or rider on the annuity or life insurance contract, the specified policy acquisition expenses that must be capitalized is determined using 7.7 percent of the net premiums for the taxable year on such contracts.

The provision increases the amount of pre-funding permitted by treating qualified long-term care insurance coverage under the rider as a qualified additional benefit, for purposes of the present-law definition of a life insurance contract.

A flexible spending arrangement ("FSA") is a reimbursement account or other arrangement under which an employee is reimbursed for medical expenses or other nontaxable employer-provided benefits, such as dependent care. Typically, FSAs are part of a cafeteria plan and may be funded through salary reduction. FSAs may also be provided by an employer outside of a cafeteria plan. FSAs are commonly used, for example, to reimburse employees for medical expenses not covered by insurance.

There is no special exclusion for benefits provided under an FSA. Thus, benefits provided under an FSA are excludable from income only if there is a specific exclusion for the benefits in the Code (e.g., the exclusion for employer-provided health care (other than long-term care) or dependant care assistance coverage). If certain requirements are satisfied, contributions to a health FSA and all distributions to pay medical expenses are excludable from income and from wages for FICA tax purposes.

FSAs that are part of a cafeteria plan must comply with the rules applicable to cafeteria plans generally. One of these rules is that a cafeteria plan may not offer deferred compensation except through a qualified cash or deferred arrangement.¹⁰⁴ Under proposed Treasury regulations, a cafeteria plan is considered to permit the deferral of compensation if it includes a health FSA which reimburses participants for medical expenses incurred beyond the end of the plan year.¹⁰⁵ Thus, amounts in an employee's account that are not used for medical expenses incurred before the end of a plan year must be forfeited. This rule is often referred to as the "use it or lose it" rule. The IRS recently issued guidance allowing a grace period immediately following the end of a plan year during which unused benefits or contributions remaining at the end of the plan year may be paid or reimbursed to plan participants for qualified benefit expenses incurred during a grace period.¹⁰⁶ A plan may allow benefits not used during the plan year to be used to reimburse qualified expenses incurred during the period, not to exceed two and one-half months, immediately following the end of the plan year.

Proposed Treasury regulations contain additional requirements with which health FSAs must comply in order for the coverage and benefits provided under the FSA to be excludable from income.¹⁰⁷ These rules apply with respect to a health FSA without regard to whether the health FSA is provided through a cafeteria plan (i.e., without regard to whether an employee has an election to take cash or benefits).

The proposed regulations define a health FSA as a benefit program that provides employees with coverage under which specified, incurred expenses may be reimbursed (subject to reimbursement maximums and any other reasonable conditions) and under which the maximum amount of reimbursement that is available to a participant for a period of coverage is not substantially in excess of the total premium (including both employee-paid and employer-paid portions of the premium) for such participant's coverage. A maximum amount of reimbursement is not substantially in excess of the total premium if the maximum amount is less than 500 percent of the premium.¹⁰⁸

Under the proposed regulations, the employer-provided health coverage under the FSA and the reimbursements and other benefits received under the health FSA are excludable from an employee's income only if the health FSA satisfies certain additional requirements. According to the proposed regulations, health FSAs are required to: (1) Provide the maximum amount of reimbursement available under the FSA at all times during the period of coverage (properly reduced as of any particular time for prior reimbursements for the same period of coverage); (2) offer coverage for 12 months or, in the case of a short plan year, the entire short plan year; (3) only reimburse medical expenses which meet the definition of medical care under section 213(d); (4) reimburse medical expenses for which the participant provides a written statement from an independent third party stating the amount of the medical expense and that the medical expense has not been reimbursed or is not reimbursable under any other health plan; (5) reimburse medical expenses which are incurred during the participant's period of coverage; and (6) allocate experience gains with respect to a year of coverage among premium payers on a reasonable and uniform basis.¹⁰⁹

Health savings accounts

Present law provides that individuals with a high deductible health plan (and no other health plan other than a plan that provides certain permitted coverage) may establish a health savings account ("HSA").¹¹⁰ An HSA is a tax-exempt trust or custodial account. Subject to certain limitations, contributions to an HSA are deductible above-the-line if made by the individual and are excludable from income and wages if made by the employer (including contributions made through a cafeteria plan through salary reduction). Earnings on amounts in an HSA accumulate on a tax-free basis. Distributions from an HSA that are for qualified medical expenses are excludable from gross income. Distributions from an HSA that are not used for qualified medical expenses are includible in gross income and are subject to an additional tax of 10 percent, unless the distribution is made after death, disability, or the individual attains the age of Medicare eligibility (i.e., age 65). HSAs provide the opportunity to pay for current out-of-pocket medical expenses on a tax-favored basis, as well as the ability to save for future medical and nonmedical expenses.

A high deductible health plan is a health plan that has a deductible that is at least $1,000 for self-only coverage or $2,000 for family coverage (for 2005) and that has an out-of-pocket expense limit that is no more than $5,100 in the case of self-only coverage and $10,200 in the case of family coverage (for 2005).

The maximum aggregate annual contribution that can be made to an HSA is the lesser of (1) 100 percent of the annual deductible under the high deductible health plan, or (2) for 2005, $2,650 in the case of self-only coverage and $5,250 in the case of family coverage.¹¹¹ The annual contribution limits are increased for individuals who have attained age 55 by the end of the taxable year. In the case of policyholders and covered spouses who are age 55 or older, the HSA annual contribution limit is greater than the otherwise applicable limit by $600 in 2005, $700 in 2006, $800 in 2007, $900 in 2008, and $1,000 in 2009 and thereafter.

In the case of employees who are eligible individuals under the HSA rules (i.e., individuals who are covered under a high deductible health plan and no other health plan, other than certain permitted coverage) the provision also allows up to $500 of unused health benefits in an employee's health FSA to be contributed on the employee's behalf to an HSA maintained for the benefit of the employee. Amounts contributed to an HSA are treated as employer contributions for purposes of the HSA rules, including the limits on contributions. As in the case of other amounts contributed to an HSA through a cafeteria plan, such amounts are not subject to the requirement that, in the case of employer contributions, comparable contributions must be made on behalf of all employees.

Qualified health insurance premiums include premiums for accident or health insurance or qualified long-term care insurance contracts covering the taxpayer, the taxpayer's spouse, and the taxpayer's dependents. The qualified health insurance premiums do not have to be for a plan sponsored by the employer; however, the exclusion does not apply to premiums paid by the employee and reimbursed with pension distributions. The maximum amount that may be excluded in any year is $5,000. Amounts excluded from income under the provision are not taken into account in determining the itemized deduction for medical expenses under section 213 or the deduction for health insurance of self-employed individuals under section 162.

[Editor's Note: Table of Vote not reproduced.]

A substitute amendment by Mr. McDermott was defeated by a rollcall vote of 16 yeas to 24 nays. The vote was as follows:

[Editor's Note: Table of Vote not reproduced.]

The bill is estimated to have the following effects on budget receipts for fiscal years 2006-2010:

[Editor's Note: Estimate Table not reproduced.]

U.S. Congress, Congressional Budget Office, Washington, DC, December 2, 2005

Hon. William "Bill" M. Thomas, Chairman, Committee on Ways and Means, House of Representatives, Washington, DC.

Dear Mr. Chairman: The Congressional Budget Office has prepared the enclosed cost estimate for H.R. 2830, the Pension Protection Act of 2005.

If you wish further details on this estimate, we will be pleased to provide them. The CBO staff contact is Craig Meklir.

Sincerely, Donald B. Marron (For Douglas Holtz-Eakin, Director).

Enclosure.

The budgetary effects of the bill would result from:

• Increased income to the PBGC from premiums paid by the sponsors of pension plans--totaling an estimated $8.2 billion over the next 10 years.

• A loss of federal income tax revenue, primarily because more rigorous funding rules would be imposed on plans' sponsors; the Joint Committee on Taxation (JCT) estimates that the changes in law related to defined-benefit pension plans would reduce federal revenues by $5.0 billion over the 2006-2015 period.

• Additional benefit payments--totaling an estimated $0.5 billion over 10 years--that the PBGC would have to make as a result of a number of changes made by the bill.

• Tax provisions affecting retirement savings and health care spending, which JCT estimates would reduce federal revenues by $37.7 billion and $29.2 billion, respectively, over the 2006-2015 period.

Major provisions of H.R. 2830 would:

• Require sponsors of single-employer pension plans to meet a funding target that is at least 100 percent of current liabilities;

• Specify that the discount rate used to calculate the present value of current pension liabilities be based on a segmented yield curve of corporate bonds rather than the interest rate on 30-year Treasury bonds;

• Restrict the use of credit balances to offset required pension contributions;

• Place limits on benefit accruals for participants in certain underfunded plans;

• Increase the limits on the tax-deductible contributions sponsors may make to plans;

• Increase the per-participant premium paid to the PBGC for single-employer plans;

• Require sponsors of single-employer pension plans that have undergone distress or involuntary terminations to pay a termination premium for 3 years;

• Change the funding rules for multiemployer pension plans;

• Enhance disclosure requirements for both single-employer and multiemployer pension plans; and

• Address the legal status of so-called hybrid defined-benefit pension plans.

• Permanently extend tax provisions relating to pensions and individual retirement accounts currently set to expire at the end of 2010;

• Permanently extend the saver's tax credit for certain retirement savings accounts set to expire at the end of 2006;

• Change the rules governing health flexible spending accounts;

• Modify the rules about combinations of life and long-term care insurance;

• Encourage firms to provide automatic enrollment for their employees in defined-contribution pension plans; and

• Allow tax-free distributions from retirement plans for certain public safety officers if the funds are used to pay premiums for health or long-term care insurance.

Pursuant to section 407 of H. Con. Res. 95 (the Concurrent Resolution on the Budget, Fiscal Year 2006), CBO estimates that enacting H.R. 2830 would not cause an increase in direct spending greater than $5 billion in any of the 10-year periods between 2016 and 2055.

CBO has reviewed the nontax portions of H.R. 2830 and determined that they contain no intergovernmental mandates as defined in the Unfunded Mandates Reform Act (UMRA) and would impose no costs on state, local, or tribal governments. Those provisions would impose a number of mandates on sponsors and administrators of single-employer and multiemployer private pension plans. CBO estimates that the direct cost of those private-sector mandates, less the direct savings from those mandates, would exceed the annual threshold specified in UMRA ($123 million in 2005, adjusted annually for inflation) in 2009 and subsequent years.

JCT has determined that the tax provisions of H.R. 2830 contain no intergovernmental or private-sector mandates as defined in UMRA. CBO has reviewed the non-tax provisions of H.R. 2830 and determined that they contain no intergovernmental mandates as defined in UMRA and would impose no costs on state, local, or tribal governments.

Estimated cost to the Federal Government: The estimated budgetary impact of H.R. 2830 is shown in the following table. The costs of this legislation would fall within budget function 600 (income security).

[Editor's Note: Estimate Table not reproduced.]

Basis of Estimate: H.R. 2830 contains changes to both ERISA and the Internal Revenue Code that would affect sponsors of defined-benefit pension plans. Under current law, the funding rules are exactly the same in both ERISA and IRC. In certain instances, however, changes made by the bill to the pension funding requirements of ERISA are inconsistent with changes made to the funding rules in the IRC. That occurs because the amendments to the IRC adopted by the Ways and Means Committee reflect some policy differences from the amendments to ERISA adopted by the Committee on Education and the Workforce. CBO's and JCT's budget estimates assume that, if H.R. 2830 is enacted, additional changes would be made to ERISA to make it consistent with those changes made to IRC by H.R. 2830. Those estimates also assume that H.R. 2830 and the corresponding changes to the ERISA will be enacted by December 2005.

Direct spending

Increase in Flat-Rate Premium. Under current law, sponsors of single-employer pension plans insured by the PBGC are required to pay the agency a premium of $19 per participant. H.R. 2830 would increase the flat-rate premium to $30 per participant in 2006 and index it to wage growth starting in 2007. However, no plans would pay the full increase immediately. The bill would phase in the rate increase differently depending on whether the ratio of a plan's assets to its liabilities (known as its funding ratio) is above or below 80 percent. For plans that have a funding ratio of 80 percent or higher, the increased rate would be phased in over a five-year period; for plans with a funding ratio of less than 80 percent, the rate increase would be phased in over a three-year period. Both phase-in periods would begin in 2006 and the premium rate for all single-employer plans would be the same approximately--$35 per participant--by 2010.

About 35 million people currently participate in tax-qualified, single-employer pension plans. This figure includes active workers, former workers who are vested but have not started collecting retirement benefits, and annuitants. The number of participants in single-employer plans insured by the PBGC has remained nearly constant for the past decade, and CBO assumes it would remain steady for the next 10 years.

The current premium of $19 per participant generates about $650 million in premium income annually for the PBGC. CBO estimates changes to the flat-rate premiums made by H.R. 2830 would increase receipts by $1.3 billion over the 2006-2010 period and $4.9 billion over the 2006-2015 period. The varying amounts of additional premiums from year to year reflect both the phase in of the rate increase and the rounding of the new rates to the nearest dollar, as specified by the bill. Because the PBGC's premiums are recorded as offsetting, collections to a mandatory spending account increases in premium collections are reflected in the budget as decreases in direct spending.

Variable Premiums. Under current law, sponsors of single-employer plans with assets less than liabilities are generally required to pay a variable premium, which is based on the amount of underfunding in the plan. The variable premium rate is $9 per $1,000 of underfunding. The amount of income from this type of premium varies from year to year; in 2004 it generated approximately $800 million in receipts.

H.R. 2830 would affect how much the PBGC collects from variable premiums because it would change the way plans' sponsors calculate the amount of underfunding. Starting in 2006, current law will require plans to discount their current liabilities, in order to determine the amount of underfunding, using an interest rate that is the four-year moving average of the rate on 30-year Treasury bonds. Public Law 108-218, the Pension Funding Equity Act, changed how current liabilities of covered plans are discounted during plan-years 2004 and 2005. During those two years current liabilities axe discounted using an interest rate on high-grade corporate bonds, as determined by the Department of the Treasury. H.R. 2830 would extend the use of the corporate bond rate for plan-year 2006. Then, beginning with plan-year 2007, the bill would require plans to discount their pension obligations using a yield curve based on a three-year weighted average of yields on investment-grade corporate bonds. The yield curve, which would be determined by the Secretary of the Treasury would be divided into three segments: yields for bonds maturing in the five-year period following the first day of each new plan-year; yields for bonds maturing during the next 15-year period; and yields for bonds maturing after the initial 20-year period. These segments would be used to discount benefit payments expected to be made by plans during each of the three periods. The shift to the segmented yield curve would be phased in over three years.

When compared to interest rates on 30-year Treasury bonds, the segmented yield curve (and the single. corporate bond rate) would result in lower discount rates for participants whose benefits will be paid in the near term, and higher discount rates for participants whose benefits will be paid in later years. Discount rates and the present value of pension liabilities have an inverse relationship: increasing the discount rate results in a lower valuation of liability, while lowering the discount rate produces a higher valuation of liability. Based on information provided by the PBGC, CBO estimates that the segmented yield curve would reduce the present value of liabilities among all underfunded plans by approximately 5 percent, thus reducing required future contributions by plans' sponsors.

Other changes to the funding rules (which are discussed in more detail later) would increase contributions. CBO estimates that, under H.R. 2830 firms initially would have to contributeless to their plans, but later would have to contribute more than under current law. The change in contribution patterns would affect how many plans are underfunded and how much underfunding exists in those plans. This, in turn, would affect the PBGC's income from variable premiums. (The change in contributions would also have significant effects on federal revenues, as discussed later in this estimate.)

H.R. 2830 would also have an effect on which plans are required to make a variable premium payment. Current law provides underfunded plans with ways to reduce or avoid variable premium payments. Plans that have reached a statutory "full funding limit" are exempt from paying a variable premium, even though they may be substantially underfunded. H.R. 2830 would eliminate the full funding limit exemption and would require all plans that are underfunded to pay the variable premium on any underfunding.

CBO estimates that enacting H.R. 2830 would increase receipts from variable premiums by $738 million over the 2007-2010 period and by $430 million over the 2007-2015 period.¹ As with flat-rate premiums, increases in receipts from variable premiums are reflected as decreases in direct spending.

Premiums for Certain Terminated Single-Employer Plans. The legislation would create a new premium for sponsors of plans that are terminated on an involuntary or distressed-termination basis. The required payments would be $1,250 per plan participant for three years after the termination. For sponsors whose plans were terminated while the program was being reorganized under chapter 11 of the bankruptcy code, the premium would be levied after the sponsor emerges from bankruptcy. The premium would not apply to firms that are liquidated by a bankruptcy court. CBO estimates that these new premiums would total about $1.0 billion over the 2006-2010 period and $2.9 billion over the 2006-2015 period.

Based on recent PBGC data on terminations, CBO estimates that underfunded plans with about 120,000 participants on average will be terminated in each of the next five years and the number of participants affected will be somewhat greater in subsequent years. We estimate that one-quarter of those terminations will involve liquidation bankruptcy filings. CBO assumes that firms will emerge from bankruptcy over several years following their filing date. The annual income from these payments would grow rapidly during the first few years as sponsors emerge from bankruptcy.

PBGC's Disbursements. H.R. 2830 would affect both how much sponsors are required to contribute to their plans and how much benefits may increase under certain plans insured by the PBGC. Such changes would affect the amount of unfunded liabilities that the PBGC assumes in the event that a pension plan is terminated (i.e., claims) and thus the payments the agency makes to beneficiaries in terminated plans. CBO estimates that the policies contained in H.R. 2930 would increase benefit outlays by $59 million over the 2006-2010 period and by $486 million over the 2006-2015 period.

Several of the changes to the pension funding rules would have countervailing effects on the contributions plans' sponsors would be required to make over the next 10 years. Basing the discount rate for calculating the present value of liabilities on corporate bonds instead of Treasuries would cause the present value of current liabilities among underfunded plans to shrink by more than $50 billion in 2006, CBO estimates. This policy would have the effect of reducing required contributions by plans' sponsors.

Other changes made by the bill would also have an effect on required contributions. Current funding rules require that sponsors of insured plans make contributions above that amount are required only if the actuarial value of a plan's assets is less than 90 percent of its current liabilities. These additional payments (referred to as "deficit reduction contributions") can be amortized over periods ranging from three to 30 years, depending on how the underfunding occurred.² H.R. 2830 would require that, in addition to covering its normal costs, a sponsor must make additional contributions if assets are less than 100 percent of current liabilities (referred to as its "funding target"). The bill generally would require the shortfall to be amortized over a period of seven years. These changes would have the effect of reducing required contributions for some plans (due to the seven-year amortization period) and increasing required contributions for others (because of the higher funding target).

The bill also would limit the use of previously accumulated funding balances, which can be used to offset required contributions. Funding balances usually occur when a sponsor contributes more than the minimum required in a given year. Under current law, no matter how underfunded a plan is, its sponsor may use funding balances to reduce or eliminate required contributions. In addition, the value of funding balances is not adjusted for actual gains or losses on the assets in which they are invested. Instead, these balances are increased each year by the same rate of return assumed for other assets held by the plan. H.R. 2830 would allow only plans that have a funding ratio of 80 percent or higher to use funding balances to offset required pension contributions. In addition, the bill would require plansto adjust the value of any balances for net gains or losses on the plan's assets. These changes to the use of funding balances would generally have the effect of increasing required contributions.

H.R. 2830 would also affect required contributions by: reducing the "smoothie" period used to calculate the actuarial value of assets and liabilities; updating the mortality table used to project future benefits; and adding a "loading factor" to the funding target of plans that are less than 60 percent funded.

In addition to changes in the funding rules, H.R. 2830 would also restrict some benefit payments for certain underfunded plans. Specially, the bill would limit the ability of plans with a funding ratio of less than 80 percent to make lump-sum payments or to amend the plan to increase benefits. It also would effectively freeze normal benefit increases in plans with funding ratios of less than 60 percent. In addition, the bill would prohibit plans from paying benefits for unpredictable contingent events, such as shutdown benefits to workers in facilities that are closed. If enacted these policies would reduce liabilities, and therefore reduce benefit payments that the PBGC would be required to make for plans that are terminated in the future.

Accounting for all the policy changes contained in H.R. 2803, CBO estimates that the annual shortfall between assets and liabilities (on a present-value basis) among plans that the PBGC takes over during the 2006-2015 period would increase by several hundred million dollars. The larger shortfall would manifest itself in higher outlays for benefit payments by the PBGC, as those liabilities eventually come due, with a significant portion of those claims being paid well after 2015. The biggest reason for the increase in claims is the projected decrease in required contributions, as least during the first several years of the period, due to use of the corporate bond yield curve to discount current liabilities.³ This effect would be offset to some degree, especially during the second half of the budget window, by the higher funding target and limits on benefits accruals. Overall, however, CBO estimates that the bill would lead to an increase in underfunding among plans that would be terminated over the next decade, thus increasing outlays by the PBGC for pension benefits.

Transfers from PBGC's Trust Fund. The PBGC's assets are held in two separate funds: an on-budget revolving fund and a nonbudgetary trust fund.⁴ The on-budget fund receives premium payments and makes outlays for benefit payments and administrative costs. The nonbudgetary trust fund holds assets from terminated plans until those assets are liquidated, transferred to the on-budge revolving fund, and spent. Transfers from the nonbudgetary fund to the on-budget fund cover approximately half of all benefit payments and most of the PBGC's administrative costs. As with premiums, these transfers are offsetting collections to a mandatory account, and are reflected in the budget as offsets to outlays.

In CBO's current law projections, the combination of rising benefit payments and level premium income will cause the agency's on-budget fund to be completely exhausted in about 2013. No precedent exists for how the PBGC would proceed if its on-budget fund is depleted. However, CBO assumes that the agency would cover its expenses by increasing the percentage of benefits and other expenses being paid through transfers from its nonbudgetary trust fund, thus increasing offsetting collections above what they would have been if the fund had remained solvent.

CBO estimates the increases in premium receipts resulting from H.R. 2830 would cause the on-budget fund to remain solvent beyond 2015. Because the bill would improve the finances of the on-budget fund, the PBGC would not need to increase the amounts transferred from the nonbudgetary fund in order to help cover benefit payments and other expenses during most of the 10-year projection period. By allowing the on-budge fund to remain solvent through the next decade, the bill would reduce those transfers by $7.4 billion over the 2013-2015 period. Because this change would reduce an offset to mandatory spending, it would result in a net increase in such spending.

Revenues

H.R. 2830 would alter existing tax law related to the treatment of pension plans, certain types of retirement savings, and health care spending. CBO and JCT estimate that enacting H.R. 2830 would reduce revenues by $14.2 billion over the 2006-2010 period and by $71.8 billion over the 2006-2015 period (see Table 2).

H.R. 2830 would affect federal revenues by:

• Altering funding rules for single-employer, defined-benefit pension plans. By affecting the amount of tax-deductible contributions firms make to their pension plans, these changes would increase revenues by $5.4 billion over the 2006-2008 period and then decrease revenues by $10.4 billion over the 2009-2015 period. The change from increases to decreases in revenues is due to the differing phase-in rates of the stricter funding rules and the new discount rates. In the short run, the higherdiscount rates would reduce contributions and increase revenues before the stricter funding rules come fully into effect. Over the longer term, however, the stricter funding rules would more than offset the effect of the higher discount rates, leading to overall revenue losses.

• Permanently extending provisions relating to pensions and individual retirement accounts (IRAs) that were enacted in the Economic Growth and Tax Relief Reconciliation Act 2001 (EGTRRA). Those provisions, which include increased annual contribution limits for IRA's and qualified pension plans, are scheduled to expire at the end of 2010. JCT estimates that the permanent extensions would decrease revenues by $20.4 billion over the 2011-2015 period.

• Changing the rules for health flexible spending accounts (FSAs). Under current law, employees may participate in tax-preferred FSAs, and any balance remaining in the accounts at the end of the year reverts to the employer. This legislation would allow employees to carry to the next year up to $500 in unused amounts in their FSAs. JCT estimates that this carry over would reduce revenues by $6.7 billion over the 2006-2010 period and by $16.9 billion over the 2006-2015 period. Of that decline, $4.8 billion over the 2006-2015 period would be a reduction in receipts from Social Security taxes.

• Permanently extending a credit for contributions to certain retirement savings accounts. This "saver's credit" was enacted in EGTRRA and is set to expire at the end of 2006. The non-refundable credit is available to taxpayers with incomes below certain thresholds who make contributions to qualified retirement plans, such as 401(k)s and IRAs. JCT estimates that making this credit permanent would reduce revenues by $4.5 billion over the 2006-2010 period and by $9.9 billion over the 2006-2015 period.

• Changing the rules about combinations of life and long-term care insurance. Currently, long-term care insurance benefits are tax free, but distributions from annuities that are used to pay for such insurance are not. The bill would allow annuities to include riders for long-term care insurance policies, and withdrawals from these new annuity combinations would be tax-free if used for long-term care. It would also modify the rules for policies containing both life insurance and long-term care coverage. This provision, JCT estimates, would decrease revenues by $1.0 billion over the 2006-2010 period and by $8.6 billion over the 2006-2015 period.

• Making it easier for firms to offer automatic enrollment. Currently employees must elect to participate in defined-contribution pension plans. In order to encourage employers to offer automatic participation in such plans, this bill would create safe harbors from nondiscrimination testing under certain circumstances. As a result employees would make more pre-tax contributions to those plans and employers would make larger tax deductible matching contributions. JCT estimates that this provision would reduce revenues by $1.8 billion over the 2006-2010 period and by $6.1 billion over the 2006-2015 period.

• Allowing certain public safety officers to withdraw limited amounts from governmental retirement plans tax-free. Under current law, amounts withdrawn from retirement plans are taxable if the contributions were made on a pre-tax basis. This bill would allow certain public safety officers to withdraw up to $5,000 per year tax-free if the amounts are used to pay directly for premiums for health and long-term care insurance. JCT estimates that this provision would decrease revenues by $1.4 billion over the 2006-2010 period and by $3.7 billion over the 2006-2015 period.

Long-term effects on direct spending: Pursuant to section 407 of H. Con. Res. 95 (the Concurrent Resolution on the Budget, Fiscal Year 2006), CBO estimates that enacting H.R. 2830 would not cause an increase in direct spending greater than $5 billion in any of the 10-year periods between 2016 and 2055. During the four decades following 2015, reductions in outlays due to higher premium receipts would be larger than increases in outlays resulting from changes to transfers from the nonbudgetary fund and additional benefit payments.

Estimated impact on state, local, and tribal governments: CBO and JCT have reviewed the provisions of H.R. 2830 and determined they contain no intergovernmental mandates as defined in UMRA. State, local, and tribal governments are exempt from the provisions of ERISA that the bill would amend, and the remaining provisions of the bill contain no intergovernmental mandates and would not affect the budgets of state, local, or tribal governments.

Estimated impact on the private sector: Some of the bill's changes to ERISA would impose mandates on sponsors and administrators of single-employer and multiemployer private-pension plans. CBO estimates that the direct cost to affected entities of the mandates in the bill, less the direct savings resulting from those mandates, would exceed the annual threshold specified in UMRA ($123 million in 2005, adjusted annually for inflation) in 2009 and thereafter. Most of the cost would result from the increase in premiums paid to the PBGC. JCT has determined that the tax provisions in the bill contain no private-sector mandates.

Premiums

The bill would increase the premiums that sponsors of single-employer plans are required to pay to the PBGC. CBO estimates that the additional premiums would total $3.1 billion over the 2006-2010 period.

Disclosures

Title II would require multiemployer plans to provide certain information to participants and beneficiaries when a plan enters into "endangered" or "critical" status. Title V would require single-employer plans to provide certain information to participants and beneficiaries when one or more plans sponsored by the employer are in "at risk" status. Both single-employer and multiemployer plans would be required to provide annual funding notices to all participants and beneficiaries within 90 days of the end of the plan-year. CBO estimates that the direct cost of those new requirements would be less than $30 million annually.

Funding rules

Title I would make several changes to the funding rules in ERISA for single-employer, defined-benefit pension plans. Changes in the discount rate plans are required to use to value future liabilities would decrease the contributions sponsors would be required to make to their pension plans. Several other changes in funding rules would increase the amount of annual contributions that they would be required to make. Title II would change the funding rules in ERISA for multiemployer defined-benefit pension plans such that some sponsors would be required to increase the amount of annual contributions that they make to their plans.

The net effect of those changes would be to decrease the total amount of required pension contributions for sponsors of single-employer plans in the early years, and increase total required contributions in later years. The changes in funding rules would not change the liabilities that plans' sponsors have to current and future pension recipients, however. They would only affect the timing of the sponsors' contributions. Because we have little basis for estimating the costs or benefits to sponsors of changes in the amounts contributed to their pension plans (for example, the cost of borrowing additional funds or of using funds that would otherwise be available for other purposes), CBO cannot estimate the direct cost or savings from those provisions.

Lump-sum distributions

Title III would change the rules in ERISA used for determining the amounts of lump-sum distributions to plans' participants. A segmented interest rate based on corporate bond yields and an updated mortality table would be phased in for use in such calculations. Although the updated mortality table would cause a short-term increase in the amount of distributions, the substitution of the segmented interest rate for the 30-year Treasury rate would decrease that cost in most cases. Taken together, CBO estimates that these changes would likely have the net effect of reducing plans' costs.

Previous CBO estimate: On September 26, 2005, CBO transmitted a cost estimate for H.R. 2830, as ordered reported by the House Committee on Education and the Workforce on June 30, 2005. The pension provisions of the two versions of the bill are similar in many ways, but there are several significant differences. Rather than beginning the shift to the segmented bond rate in plan-year 2006, as in the Education and Workforce version of the bill, the Ways and Means Committee's version would extend the single corporate bond rate for one more year and begin the transition to the segmented bond rate in 2007. The latter version also includes a new premium on sponsors of plans that terminate and are taken over by the PBGC. The Ways and Means bill also includes numerous tax provisions affecting retirement savings and health care spending that are not in the earlier version of the bill.

The Education and the Workforce Committee's version of H.R. 2830 would increase federal budget deficits by an estimated $6.5 billion over the 2006-2015 period. CBO and JCT estimate that this version of the bill would increase deficits by $71.5 billion over the 10-year period.

Estimate prepared by: Federal Spending: Craig Meklir. Federal Revenues: Emily Schlect. Impact on State, Local, and Tribal Governments: Leo Lex. Impact on the Private Sector: Peter Richmond.

Estimate approved by: Robert A. Sunshine, Assistant Director for Budget Analysis; G. Thomas Woodward, Assistant Director for Tax Analysis.

The Committee has determined that the revenue provisions of the bill do not contain Federal mandates on the private sector. The Committee has determined that the revenue provision of the bill do not impose a Federal intergovernmental mandate on State, local, or tribal governments. With respect to the non-revenue provisions of the bill, see the CBO letter in part IV.C., above.

The staff of the Joint Committee on Taxation has determined that a complexity analysis is not required under section 4022(b) of the IRS Reform Act because the bill contains no provisions that amend the Code and that have "widespread applicability" to individuals or small businesses.

In compliance with clause 3(e) of rule XIII of the Rules of the House of Representatives, changes in existing law made by the provisions of the bill referred to the Committee, as reported, are shown as follows (existing law proposed to be omitted is enclosed in black brackets, new matter is printed in italic, existing law in which no change is proposed is shown in roman):

[SEC. 412. MINIMUM FUNDING STANDARDS.

We are not alone in reaching that conclusion. The Committee on Investment of Employees Benefits Assets (an association of the Chief Investment Officers of many of the nation's largest corporate pension plans) concluded that proposals similar to those reported by the Committee would "have long-term consequences for current and future workers, with the potential to damage the retirement security of millions of Americans." According to a survey of their members (representing pension plans covering 5 million participants), it would be likely or highly likely that approximately 60% of those pension plans would reduce benefits to current or future workers if the Committee bill became law. These are not plans of financially troubled companies where the managers expect the plan to be terminated because of business conditions. These are adequately-funded ongoing plans that will reduce benefits if the Committee bill becomes law.

The first rule for any effective legislation is "do not harm". The Committee bill fails to meet this standard.

Unless the Congress acts, there could be rush to the bottom as companies figure out how to use bankruptcy to shed their pension obligations. Companies who have successfully used the bankruptcy process to rid themselves of pension liabilities have emerged with cost advantages over their competitors who have not so used the bankruptcy system. As a result, if this bill becomes law, there would be increasing pressure on other companies to seek these cost-cutting measures in bankruptcy.

The Committee bill does little in this area to curb this practice. Congressman McDermott offered a substitute that would have taken steps to reduce the incentives for bankruptcy filings. The substitute was defeated by unanimous vote of the Republican Members of the Committee

The purpose of this legislation should be to strengthen the security of pensions and reduce future terminations of employer provided pension plans. Even the Administration officials that were present during the Committee markup conceded that the bill did not meet that goal. These officials stated that their analysis concluded that the Committee bill would not affect the number of plans that would be terminated in the future nor the unfunded liabilities that would be shifted to the PBGC. Therefore, we can conclude that the bill would not make worker's pensions more secure.

During the markup there was no response to Congressman Levin's question of how the bill would be paid for. In fact, the Committee bill is another unfunded tax cut, the cost of which will be met by borrowing, largely from foreign investors.

Rather than immediately act on this issue, the Republican majority has decided to hold it hostage to force action on their overreaching pension legislation. The Republican majority on the Committee unanimously rejected the substitute offered by Mr. McDermott that would have permitted prompt action on this issue.

Charles B. Rangel. Jim McDermott. Rahm Emanuel. Wm. J. Jefferson. Stephanie Tubbs Jones. Xavier Becerra. Ben Cardin. Sander Levin. John B. Larson. John Lewis. Earl Pomeroy. Pete Stark. Mike Thompson. Richard E. Neal. John Tanner.

² Under present law, certain changes in actuarial assumptions that decrease the liabilities of an underfunded single-employer plan must be approved by the Secretary of the Treasury.

³ The deficit reduction contribution rules apply to single-employer plans, other than single-employer plans with no more than 100 participants on any day in the preceding plan year. Single-employer plans with more than 100 but not more than 150 participants are generally subject to lower contribution requirements under these rules.

⁴ Under an alternative test, a plan is not subject to the deficit reduction contribution rules for a plan year if (1) the plan's funded current liability percentage for the plan year is at least 80 percent, and (2) the plan's funded current liability percentage was at least 90 percent for each of the two immediately preceding plan years or each of the second and third immediately preceding plan years.

⁵ In determining a plan's funded current liability percentage for a plan year, the value of the plan's assets is generally reduced by the amount of any credit balance under the plan's funding standard account. However, this reduction does not apply in determining the plan's funded current liability percentage for purposes of whether an additional charge is required under the deficit reduction contribution rules.

⁶ If the Secretary of the Treasury prescribes a new mortality table to be used in determining current liability, as described below, the deficit reduction contribution may include an additional amount.

⁷ In making these computations, the value of the plan's assets is reduced by the amount of any credit balance under the plan's funding standard account.

⁸ The weighting used for this purpose is 40 percent, 30 percent, 20 percent and 10 percent, starting with the most recent year in the four-year period. Notice 88-73, 1988-2 C.B. 383.

⁹ If the Secretary of the Treasury determines that the lowest permissible interest rate in this range is unreasonably high, the Secretary may prescribe a lower rate, but not less than 80 percent of the weighted average of the 30-year Treasury rate.

¹⁰ Code sec. 412(b)(5)(B)(iii)(II); ERISA sec. 302(b)(5)(B)(iii)(II). Under Notice 90-11, 1990-1 C.B. 319, the interest rates in the permissible range are deemed to be consistent with the assumptions reflecting the purchase rates that would be used by insurance companies to satisfy the liabilities under the plan.

¹¹ Pub. L. No. 108-218 (2004).

¹² In addition, under PFEA 2004, if certain requirements are met, reduced contributions under the deficit reduction contribution rules apply for plan years beginning after December 27, 2003, and before December 28, 2005, in the case of plans maintained by commercial passenger airlines, employers primarily engaged in the production or manufacture of a steel mill product or in the processing of iron ore pellets, or a certain labor organization.

¹³ Code sec. 412(l)(7)(C)(ii); ERISA sec. 302(d)(7)(C)(ii).

¹⁴ Rev. Rul. 95-28, 1995-1 C.B. 74. The IRS and the Treasury Department have announced that they are undertaking a review of the applicable mortality table and have requested comments on related issues, such as how mortality trends should be reflected. Notice 2003-62, 2003-38 I.R.B. 576; Announcement 2000-7, 2000-1 C.B. 586.

¹⁵ For plan years beginning before 2004, the full funding limitation was generally defined as the excess, if any, of (1) the lesser of (a) the accrued liability under the plan (including normal cost) or (b) a percentage (170 percent for 2003) of the plan's current liability (including the current liability normal cost), over (2) the lesser of (a) the market value of plan assets or (b) the actuarial value of plan assets, but in no case less than the excess, if any, of 90 percent of the plan's current liability over the actuarial value of plan assets. Under the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), the full funding limitation based on 170 percent of current liability is repealed for plan years beginning in 2004 and thereafter. The provisions of EGTRRA generally do not apply for years beginning after December 31, 2010.

¹⁶ Code sec. 412(m); ERISA sec. 302(e).

¹⁷ If quarterly contributions are required with respect to a plan, the amount of a quarterly installment must also be sufficient to cover any shortfall in the plan's liquid assets (a "liquidity shortfall").

¹⁸ Code sec. 412(d); ERISA sec. 303. Under similar rules, the amortization period applicable to an unfunded past service liability or loss may also be extended.

¹⁹ Code sec. 4971. An excise tax applies also if a quarterly installment is less than the amount required to cover the plan's liquidity shortfall.

²⁰ The provision does not change the funding rules applicable to insurance contract plans. Proposed changes to the funding rules for multiemployer plans are discussed in Part II below. Governmental plans and church plans continue to be exempt from the funding rules to the extent provided under present law.

²¹ Benefits accruing during the plan year are taken into account in determining normal cost for the plan year.

²² In the case of single-employee plans, the provision repeals the present-law rules under which the amortization period applicable to an unfunded past service liability or loss may be extended.

²³ The transition rule does not apply to a plan if its first plan year begins after December 31, 2006.

²⁴ The applicable long-term corporate bond rate is a rate that is from 90 to 100 percent of the weighted average of the rates of interest on amounts invested conservatively in long-term investment-grade corporate bonds during the four-year period ending on the last day before the plan year begins as determined by the Secretary under the method in effect for 2006.

²⁵ The transition rule does not apply to a plan if its first plan year begins after December 31, 2006.

²⁶ The provision retains the present-law rule under which certain changes in actuarial assumptions that decrease the liabilities of an underfunded single-employer plan must be approved by the Secretary of the Treasury.

²⁷ This loading factor is intended to reflect the cost of purchasing group annuity contracts in the case of termination of the plan.

²⁸ Target normal cost for a plan in at-risk status does not include a loading factor of $700 per plan participant.

²⁹ In the case of a plan's first plan year, the ability to use a valuation date other than the first day of the plan year is determined by taking into account the number of participants the plan is reasonably expected to have on each day during that first plan year.

³⁰ The provision also retains the present-law rules under which the amount of any quarterly installment must be sufficient to cover any liquidity shortfall.

³¹ The provision retains the present-law rules under which a lien in favor of the plan with respect to property of the employer (and members of the employer's controlled group) arises in certain circumstances in which the employer fails to make required contributions.

³² Treas. Reg. sec. 1.401-1(b)(1)(i).

³³ See, e.g., Treas. Reg. secs. 1.401(a)(4)-3(f)(4) and 1.411(a)-7(c).

³⁴ Code sec. 411(d)(6); ERISA sec. 204(g).

³⁵ Code sec. 412(d); ERISA sec. 303.

³⁶ Code sec. 412(f); ERISA sec. 304(b)(1).

³⁷ Code sec. 401(a)(29); ERISA sec. 307.

³⁸ Code sec. 401(a)(33); ERISA sec. 204(i).

³⁹ Code sec. 401(a)(32); ERISA sec. 206(e).

⁴⁰ Code sec. 411(d)(6); ERISA sec. 204(g).

⁴¹ Under the provision, the present-law rules limiting benefit increases while an employer is in bankruptcy continue to apply.