The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) enacted in May of 2001 is expected to have a significant impact on all US retirement plans. While most of the press coverage has focused on liberalised rules for 401(k) and other defined contribution (DC) plans, the impact on defined benefit (DB) plans is also substantial.
Far from disappearing in the wake of growing enthusiasm for 401(k) and other DC plans, coverage under DB plans has grown in the US from 38 to 45m participants from the late 1980s to 2000. The number of DB plans with more than 1,000 participants has increased, and in aggregate, DB plan assets still exceed 401(k) plan assets. With an aging workforce looking for greater retirement income security in what will be longer and longer periods of retirement; the recent reductions in 401(k) accounts due to stock market declines; the growing realisation that there is an unacceptably high probability that retirees will outlive 401(k) plan account balances; and the fact that DB plans are often the most cost effective way to deliver retirement income. Wisely, many employers have kept their DB plans, using 401(k) plans to supplement them.
Under EGTRRA, employers with DB plans can choose to raise compensation and benefit maximums and to liberalise benefits for early or late retirement. As a result, much higher benefits may be paid from DB plans than previously permitted under Internal Revenue Code regulations. In particular, these changes positively affect early retirement incentive plans where retirees in their mid 50s to early 60s could have pensions limited under the old law.
For the majority of plan sponsors, the impact of EGTRRA on funding requirements should be minimal, except for employers with a significant number of very highly paid employees. The greater positive impact is on benefit security, as executives can now receive a higher percentage of their retirement benefits from a qualified funded DB plan. These changes could stimulate increased executive support of qualified DB plans. While nonqualified plans will continue to be widely used, the increased limits of the new law may mean less reliance on these unsecured funding arrangements.
With corporate tax-deductible funding limits increased, employers with well-funded defined benefit plans may now be able to fund and deduct additional contributions. Other employers will enjoy more flexibility in timing contributions and deductions. By increasing the amount that can be funded and deducted as a current expense through a qualified plan, the new limits impact cash flow, annual reports, and corporate taxes.
With regard to the increasingly popular cash balance pension plan (a DB plan that looks like a DC plan) proposed burdensome legislation was not passed. The only change was to require an enhanced communication to participants about any reduction of their future benefit accruals. Although the IRS is not yet issuing favorable determination letters on cash balance plans, it has not stopped employers from establishing them.
George Beram is president of George Beram & Co of Newton MA in US; the firm is part of the IBN Network

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