DESCRIPTION OF THE 

CHAIRMAN’S AMENDMENT IN THE NATURE 

OF A SUBSTITUTE TO H.R. 2830, THE 

“PENSION PROTECTION ACT OF 2005” 

Scheduled for Markup 

By the 

COMMITTEE ON WAYS AND MEANS 

on November 9, 2005 

Prepared by 

the Staff of the 

JOINT COMMITTEE ON TAXATION 

November 8, 2005 

JCX-73-05 
ii 

CONTENTS 

Page

INTRODUCTION .......................................................................................................................... 1 

I. REFORM OF FUNDING RULES FOR SINGLE-EMPLOYER DEFINED BENEFIT 

PENSION PLANS.............................................................................................................. 2 

A. Minimum Funding Standards for Single-Employer Defined Benefit Pension Plans ...... 2 

B. Benefit Limitations Under Single-Employer Defined Benefit Pension Plans............... 21 

1. Prohibition on shutdown benefits and other unpredictable contingent event 

benefits..................................................................................................................... 21

2. Funding-based limits on benefits and benefit accruals............................................ 22 

C. Modification of Transition Rule to Pension Funding Requirements for Interstate 

 Bus Company................................................................................................................ 28 

D. Treatment of Nonqualified Deferred Compensation Plan when Employer’s Defined 

Benefit Plan is in At-Risk Status ................................................................................... 30 

II. FUNDING RULES FOR MULTIEMPLOYER DEFINED BENEFIT PLANS.............. 32 

A. Funding Rules for Multiemployer Defined Benefit Plans ............................................. 32 

B. Additional Funding Rules for Multiemployer Plans in Endangered or Critical 

Status.............................................................................................................................. 37 

C. Measures to Forestall Insolvency of Multiemployer Plans............................................ 44 

III. OTHER PROVISIONS..................................................................................................... 45 

A. Interest Rate Assumption for Determination of Lump-Sum Distributions.................... 45 

B. Interest Rate Assumption for Applying Benefit Limitations to Lump-Sum 

Distributions................................................................................................................... 47 

C. Distributions During Working Retirement .................................................................... 48 

IV. IMPROVEMENTS IN PBGC GUARANTEE PROVISIONS ........................................ 49 

V. DISCLOSURE.................................................................................................................. 54 

A. Section 4010 Filings with the PBGC............................................................................. 54 

VI. PROHIBITED TRANSACTION EXEMPTION FOR THE PROVISION OF 

INVESTMENT ADVICE................................................................................................. 56 

VII. IMPROVEMENTS IN BENEFIT ACCRUAL STANDARDS ....................................... 60 

VIII. DEDUCTION LIMITATIONS ........................................................................................ 64 

A. Increase in Deduction Limits......................................................................................... 64 

B. Updating Deduction Rules for Combination of Plans ................................................... 66 
iii 

IX. ENHANCED RETIREMENT SAVINGS AND DEFINED CONTRIBUTION 

PLANS.............................................................................................................................. 68 

A. Permanency of EGTRRA Pension and IRA Provisions ................................................ 68 

B. Saver’s Credit Made Permanent .................................................................................... 69 

C. Increasing Participation Through Automatic Enrollment Arrangements ...................... 71 

D. Treatment of Distributions to Guardsmen Called to Active Duty ................................. 77 

E. Inapplicability of 10-Percent Additional Tax on Early Distributions of Pension 

Plans of Public Safety Employees ................................................................................. 79 

F. Combat Zone Compensation Taken into Account for Purposes of IRA 

Contributions.................................................................................................................. 80 

G. Direct Deposit of Tax Refunds in an IRA ..................................................................... 81 

X. PROVISIONS TO ENHANCE HEALTH CARE AFFORDABILITY ........................... 84 

A. Tax Treatment of Combined Annuity and Life Insurance Contracts with a 

Long-Term Care Insurance Feature............................................................................... 84 

B. Disposition of Unused Health Benefits in Flexible Spending Arrangements................ 89 

C. Permit Tax-Free Distributions from Governmental Retirement Plans for Premiums 

for Health and Long-Term Care Insurance for Public Safety Officers.......................... 92 
1

INTRODUCTION 

The Committee on Ways and Means has scheduled a markup on November 9, 2005, of 

H.R. 2830, the “Pension Protection Act of 2005.” This document,1

 prepared by the staff of the 

Joint Committee on Taxation, provides a description of the Chairman’s Amendment in the 

Nature of a Substitute to H.R. 2830.2

 1

 This document may be cited as follows: Joint Committee on Taxation, Description of the 

Chairman’s Amendment in the Nature of a Substitute to H.R. 2830, the “Pension Protection Act of 2005” 

(JCX-73-05), November 8, 2005. 

2

 H.R. 2830 was referred to the Committee on Education and the Workforce and the Committee 

on Ways and Means. The Committee on Education and the Workforce reported the bill on September 22, 

2005. See H.R. Rep. No. 109-232, Part I, for provisions included in the bill as reported by Committee on 

Education and the Workforce. 
2 

I. REFORM OF FUNDING RULES FOR SINGLE-EMPLOYER 

DEFINED BENEFIT PENSION PLANS 

A. Minimum Funding Standards for Single-Employer 

Defined Benefit Pension Plans 

Present Law

In general

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”).3

 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). 

General minimum funding rules

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 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 

 3

 Code sec. 412; ERISA secs. 301-308. The minimum funding rules also apply to multiemployer 

plans, but the rules for multiemployer plans differ in various respects from the rules applicable to singleemployer plans. The rules for multiemployer plans are discussed in Part II of this document. The 

minimum funding rules do not apply to governmental plans or to church plans, except church plans with 

respect to which an election has been made to have various ERISA and Code requirements, including the 

funding requirements, apply to the plan. In addition, special rules apply to certain plans funded 

exclusively by the purchase of individual insurance contracts (referred to as “insurance contract” plans). 
3 

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 consisting 

of 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 
4 

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.4

 4

 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. 
5 

Additional contributions for underfunded plans

In general

Under special funding rules (referred to as the “deficit reduction contribution” rules),5 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.6 A plan’s 

“funded current liability percentage” is generally the actuarial value of plan assets as a 

percentage of the plan’s current liability.7

 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.8 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 

 5

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

contribution requirements under these rules. 

6

 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. 

7

 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. 

8

 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. 
6 

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)).9

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 average10 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).11 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.12

Under the Pension Funding Equity Act of 2004 (“PFEA 2004”),13 a special interest rate 

applies in determining current liability for plan years beginning in 2004 or 2005.14 For these 

 9

 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. 

10 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. 

11 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. 

12 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. 

13 Pub. L. No. 108-218 (2004). 

14 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 
7 

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.15 The Secretary of the Treasury has 

required the use of the 1983 Group Annuity Mortality Table.16

Other rules

Full funding limitation

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.17 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. 

 

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. 

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

16 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. 

17 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. 
8 

Timing of plan contributions

In general, plan contributions required to satisfy the funding rules must be made within 

81⁄2 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.18 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.19

Funding waivers

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 a plan year (a “waived funding 

deficiency”).20 A waiver may be granted if the employer (or employers) responsible for the 

contribution 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. Generally, no more than three waivers may be granted within any period of 15 

consecutive plan years. 

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. 

Failure to make required contributions 

An employer is generally subject to an excise tax if it fails to make minimum required 

contributions and fails to obtain a waiver from the IRS.21 The excise tax is 10 percent of the 

amount of the funding deficiency. In addition, a tax of 100 percent may be imposed if the 

funding deficiency is not corrected within a certain period. 

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

19 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”). 

20 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. 

21 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. 
9 

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). 

Description of Proposal

Interest rate required for plan years beginning in 2006

For plan years beginning after December 31, 2005, and before January 1, 2007, the 

proposal 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. 

Funding rules for plan years beginning after 2006 - in general

For plan years beginning after December 31, 2006, in the case of single-employer defined 

benefit plans, the proposal repeals the present-law funding rules (including the requirement that a 

funding standard account be maintained) and provides a new set of rules for determining 

minimum required contributions.22 Under the proposal, the minimum required contribution to a 

single-employer defined benefit pension plan for a plan year generally depends on a comparison 

of the value of the plan’s assets with the plan’s funding target and target normal cost. As 

described in more detail below, under the proposal, credit balances generated under present law 

are carried over (into the “funding standard carryover balance”) and generally may be used in 

certain circumstances to reduce otherwise required minimum contributions. In addition, as 

described more fully below, contributions in excess of the minimum contributions required under 

the proposal generally are credited to a prefunding balance that may be used in certain 

circumstances to reduce otherwise required minimum contributions. To facilitate the use of such 

balances to reduce minimum required contributions, while avoiding use of such balances for 

more than one purpose, in some circumstances the value of plan assets is reduced by the 

prefunding balance and/or the funding standard carryover balance. 

 22 The proposal 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. 
10 

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: 

If: The minimum required contribution is: 

the value of plan assets (reduced by any 

prefunding balance and funding standard 

carryover balance) is less than the funding 

target, 

the sum of: (1) target normal cost; (2) any 

shortfall amortization charge; and (3) any 

waiver amortization charge. 

the value of plan assets (reduced by any 

prefunding balance and funding standard 

carryover balance) exceeds the funding target, 

the target normal cost, reduced by the excess of 

(1) the value of plan assets (reduced by any 

prefunding balance and funding standard 

carryover balance), over (2) the funding target. 

the value of plan assets (reduced by any 

prefunding balance and funding standard 

carryover balance) equals the funding target, 

the target normal cost. 

Under the proposal, a plan’s funding target is the present value of all liabilities under the 

plan attributable to benefits accrued or earned as of the beginning of the plan year. A plan’s 

target normal cost for a plan year is the present value of benefits expected to accrue or be earned 

during the plan year. A shortfall amortization charge is the amount required to amortize a 

funding shortfall. In general, a plan has a funding shortfall for a plan year if the plan’s funding 

target for the year exceeds the value of the plan’s assets (reduced by any prefunding balance and 

funding standard carryover balance). A waiver amortization charge is the amount required to 

amortize a waiver funding deficiency. 

The proposal 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 proposal, 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. 
11 

Funding target and shortfall amortization charges

In general

If the value of a plan’s assets (reduced by any prefunding balance if the employer elects 

to use the prefunding balance to reduce required contributions for the year) is less than the plan’s 

funding target for a plan year, the minimum required contribution is increased by a shortfall 

amortization charge. As discussed more fully below, the shortfall amortization charge is the 

aggregate of the annual installments for the plan year with respect to any shortfall amortization 

bases for the plan year and the six preceding plan years. 

Funding target

A plan’s funding target for a plan year is the present value of all liabilities to participants 

and their beneficiaries under the plan for the plan year. For this purpose, liabilities are taken into 

account to the extent attributable to benefits (including any early retirement or similar benefits) 

accrued or earned as of the beginning of the plan year. Benefits accruing in the plan year are not 

taken into account, irrespective of whether the valuation date for the plan year is later than the 

first day of the plan year.23

Shortfall amortization charge

The shortfall amortization charge for a plan year is the aggregate of the shortfall 

amortization installments for the plan year with respect to any shortfall amortization bases for 

that plan year and the six preceding plan years. The shortfall amortization installments with 

respect to a shortfall amortization base for a plan year are annual installments determined as the 

amount needed to amortize the shortfall amortization base in level annual installments over the 

seven-year period beginning with the plan year. The shortfall amortization installments for a 

plan year are determined using the appropriate segment interest rates for the plan year (discussed 

below). 

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 

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

the plan year. 
12 

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. 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: 

Calendar year in which plan year begins: Applicable percentage of funding target:

2007 92 percent 

2008 94 percent 

2009 96 percent 

2010 98 percent 

Early deemed amortization of funding shortfalls for preceding years

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 shortfall amortization bases for preceding plan years 

are eliminated. In that case, for purposes of determining any shortfall amortization charges for 

that year and succeeding years, the shortfall amortization base for preceding years is zero. 

Waiver amortization charges

The proposal 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”).24 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. 

 24 In the case of single-employer plans, the proposal repeals the present-law rules under which 

the amortization period applicable to an unfunded past service liability or loss may be extended. 
13 

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

Interest rates

The proposal specifies the interest rates that must be used in determining a plan’s target 

normal cost and funding target. Under the proposal, present value is determined using three 

interest rates (“segment” rates), each of which applies to benefit payments expected to be made 

from the plan during a certain period. The first segment rate applies to payments expected to be 

made during the five-year period beginning on the first day of the plan year; the second segment 

rate applies to payments expected to be made during the 15-year period following the initial fiveyear period; and the third segment rate applies to payments expected to be made after the end of 

the 15-year period. Each segment rate is a single interest rate determined monthly by the 

Secretary of the Treasury on the basis of a corporate bond yield curve, taking into account only 

the portion of the yield curve based on corporate bonds maturing during the particular segment 

rate period. 

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 proposal, 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 
14 

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 proposal provides a transition rule for plan years beginning in 2007 and 2008.25 

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 the 33-1⁄3 percent; and (2) the product of the interest rate applicable in 

determining current liability for plan years beginning in 2006,26 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 the 66-2⁄3 percent; and (2) the product of the interest rate applicable in determining current 

liability for plan years beginning in 2006, multiplied by 33-1⁄3 percent. 

Under the proposal, 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). 

Mortality table

The proposal specifies the mortality table that must be used in determining present value 

or making any other computations. In general, the mortality table used must be the RP-2000 

Combined Mortality Table, using Scale AA, as published by the Society of Actuaries, as in effect 

on the date of the enactment of the proposal. Under Treasury regulations, any difference in 

mortality assumptions under this required mortality table and the table used in determining 

current liability for plan years beginning in 2006 is to be phased in ratably over the first five plan 

years beginning in or after 2007, so as to be fully effective for the fifth plan year.27

The Secretary of the Treasury is directed to make revisions at least every 10 years in any 

tables in effect under the proposal to reflect the actual experience of pension plans and projected 

trends in such experience. 

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

2006. 

26 Under the proposal relating to the interest rate used for 2006, the interest rate applicable in 

determining current liability for plan years beginning in 2006 must be within a permissible range (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. 

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

2006. 
15 

The proposal 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 plan 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. 

Other assumptions

Under the proposal, in determining any present value or making any computation, the 

probability that future benefits will be paid in optional forms of benefit provided under the plan 

must be taken into account (including the probability of lump-sum distributions determined on 

the basis of the plan’s experience and other related assumptions). In addition, there must be 

taken into account any difference in the present value of future benefit payments resulting from 

the use of actuarial assumptions, in determining benefit payments in any such optional form of 

benefit, that are different from those specified under the proposal. 

The proposal 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.28 

Special assumptions for at-risk plans

The proposal 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 the 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 

 28 The proposal 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. 
16 

participants will elect benefits at the times and in the forms as 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.29

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.30

If a plan has been in at-risk status for fewer than five consecutive plan years, the amount 

of a plan’s funding target or target normal cost for a plan year is determined as the sum of: 

(1) the amount of the funding target or target normal cost determined without regard to the atrisk rules, plus (2) the transition percentage for the plan year of the excess the amount of the 

funding target or 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

In general

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. 

 29 This loading factor is intended to reflect the cost of purchasing group annuity contracts in the 

case of termination of the plan. 

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

plan participant. 
17 

Funding standard carryover balance

In the case of a single-employer plan that is in effect for a plan year beginning in 2006 

and, as of the end of the 2006 plan year, has a positive balance in the funding standard account 

maintained under the funding rules as in effect for 2006, the plan sponsor may elect to maintain a 

funding standard carryover balance. The funding standard carryover balance consists of a 

beginning balance in the amount of the positive balance in the funding standard account as of the 

end of the 2006 plan year, decreased (as described below) and adjusted to reflect the rate of net 

gain or loss on plan assets. 

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). 

Prefunding balance

The plan sponsor may elect to maintain a prefunding balance, which consists of a 

beginning balance of zero, increased and decreased (as described below) and adjusted to reflect 

the rate of net gain or loss on plan assets. 

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. 
18 

Other rules

In determining the prefunding balance or funding standard carryover balance as of the 

valuation date for a plan year (before applying any increase or decrease as described above), the 

plan sponsor must adjust the balance in accordance with regulations prescribed by the Secretary 

of the Treasury, to reflect the rate of net gain or loss on plan assets. The rate of net gain or loss 

is determined on the basis of the fair market value of the plan assets and the gain or loss 

experienced by all plan assets for the period beginning with the valuation date for the preceding 

plan year and ending with the date preceding the valuation date for the current plan year, 

properly taking into account, in accordance with regulations, all contributions, distributions, and 

other plan payments made during the period. 

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

Valuation date

Under the proposal, all determinations made with respect to minimum required 

contributions for a plan year (such as the value of plan assets and liabilities) must be made as of 

the plan’s valuation date for the plan year. In general, the valuation date for a plan year must be 

the first day of the plan year. However, any day in the plan year may be designated as the plan’s 

valuation date if, on each day during the preceding plan year, the plan had 500 or fewer 

participants.31 For this purpose, all defined benefit pension plans (other than multiemployer 

plans) maintained by the same employer (or a predecessor employer), or by any member of such 

employer’s controlled group, are treated as a single plan, but only participants with respect to 

such employer or controlled group member are taken into account. 

Value of plan assets

The proposal allows the value of plan assets to be determined on the basis of any 

reasonable actuarial valuation method as under present law, with certain modifications. Any 

actuarial valuation method used may not result in a determination of the value of plan assets that 

at any time is less than 90 percent or more than 110 percent of the fair market value of the assets 

 31 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. 
19 

at that time. In addition, a valuation method may not provide for averaging of fair market values 

over more than the three most recent plan years (including the current year). 

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 plan 

assets. 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. 

Timing rules for contributions

As under present law, the due date for the payment of a minimum required contribution 

for a plan year is 8-1⁄2 months after the end of the plan year. Any payment made on a date other 

than the valuation date for the plan year must be adjusted for interest at the plan’s effective rate 

of interest for the plan year for the period between the valuation date and the payment date. 

Similar to present-law rules, quarterly contributions must be made during a plan year if the plan 

had a funding shortfall for the preceding plan year (that is, if the value of the plan’s assets, 

reduced by the funding standard carryover balance and prefunding balance, was less than the 

plan’s funding target for the preceding plan year).32

Excise tax on failure to make minimum required contributions

The proposal retains the present-law rules under which an employer is generally subject 

to an excise tax if it fails to make minimum required contributions and fails to obtain a waiver 

from the IRS.33 The excise tax is 10 percent of the aggregate unpaid minimum required 

contributions for all plan years remaining unpaid as of the end of any plan year. In addition, a 

tax of 100 percent may be imposed if any unpaid minimum required contributions remain unpaid 

after a certain period. 

Conforming changes

The proposal makes various technical and conforming changes to reflect the new funding 

requirements. 

 32 The proposal also retains the present-law rules under which the amount of any quarterly 

installment must be sufficient to cover any liquidity shortfall. 

33 The proposal 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. 
20 

Effective Date

The extension of the present-law interest rate is effective for plan years beginning after 

December 31, 2005, and before January 1, 2007. The modifications to the single-employer plan 

funding rules are generally effective for plan years beginning after December 31, 2006. 
21 

B. Benefit Limitations Under Single-Employer 

Defined Benefit Pension Plans 

1. Prohibition on shutdown benefits and other unpredictable contingent event benefits 

Present Law

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. Under present law, unpredictable contingent event 

benefits generally are not taken into account for funding purposes until the event has occurred. 

Defined benefit pension plans are not permitted to provide “layoff” benefits (i.e., 

severance benefits).34 However, defined benefit pension plans may provide subsidized early 

retirement benefits, including early retirement window benefits.35 

An amendment of a qualified retirement plan may not decrease the accrued benefit of a 

plan participant.36 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. 

Description of Proposal

Under the proposal, a single-employer defined benefit pension plan may not provide 

benefits to which participants are entitled solely by reason of the occurrence of: (1) a plant 

shutdown; or (2) any other unpredictable contingent event. For this purpose, the term 

unpredictable contingent event means an event other than: (1) attainment of any age, 

performance of any service, receipt or derivation of any compensation, or the occurrence of 

death or disability; or (2) an event which is reasonably and reliably predictable (as determined by 

the Secretary of the Treasury). 

 34 Treas. Reg. sec. 1.401-1(b)(1)(i). 

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

36 Code sec. 411(d)(6); ERISA sec. 204(g). 
22 

Under the proposal, 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 

proposal. 

Effective Date

The proposal generally applies with respect to plant shutdowns, or other unpredictable 

contingent events, occurring after December 31, 2006. 

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 proposal, the proposal 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 proposal 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 proposal is not to be treated as a termination of the collective 

bargaining agreement. 

2. Funding-based limits on benefits and benefit accruals 

Present Law

In general

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.37 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.38

 37 Code sec. 412(d); ERISA sec. 303. 

38 Code sec. 412(f); ERISA sec. 304(b)(1). 
23 

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.39 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.40

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 

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

40 Code sec. 401(a)(33); ERISA sec. 204(i). 
24 

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.41

Prohibition on reductions in accrued benefits

An amendment of a qualified retirement plan may not decrease the accrued benefit of a 

plan participant.42 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. 

Description of Proposal

In general

Under the proposal, 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

Limitations on plan amendments increasing benefit liabilities

Certain plan amendments may not take effect during a plan year if the plan’s funding 

target attainment percentage for the plan year: (1) is less than 80 percent; or (2) would be less 

than 80 percent taking into account the amendment.43 In such a case, no amendment may take 

effect if it has the effect of increasing the liabilities of the plan by reason of any increase in 

benefits, the establishment of new benefits, any change in the rate of benefit accrual, or any 

change in the rate at which benefits vest under the plan. For this purpose, any increase in 

benefits by reason of an increase in the benefit rate provided under the plan or on the basis of an 

increase in compensation is treated as effected by a plan amendment. 

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 

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

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

43 Under the proposal, the present-law rules limiting benefit increases while an employer is in 

bankruptcy continue to apply. 
25 

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. 

Funding-based limitation on certain forms of distribution

A plan must provide that, if the plan’s funding target attainment percentage is less than 

80 percent for a plan year, the plan will not make any prohibited payments after the valuation 

date for the plan year. For this purpose, prohibited payment is defined as under the present-law 

rule restricting distributions during a period of a liquidity shortfall: (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. However, the restriction on distributions does not 

apply to a plan for any plan year if the terms of the plan (as in effect for the period beginning on 

June 29, 2005, and ending with the plan year) provide for no benefit accruals with respect to any 

participant during the period. 

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).44 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. 

 44 Funding target attainment percentage is defined for this purpose as under the proposal relating 

to minimum funding rules for single-employer plans. 
26 

Determining funding levels

Under the proposal, 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 proposal, 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 

proposal. 

Restoration of benefits

If a limitation on distributions or accruals apply 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. 

Effective Date

The proposal generally applies with respect to plan years beginning after December 31, 

2006. 
27 

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 proposal, the proposal 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 proposal 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 proposal is not to be treated as a termination of the collective bargaining 

agreement. 
28 

C. Modification of Transition Rule to Pension Funding 

Requirements for Interstate Bus Company 

Present Law

Defined benefit pension plans are required to meet certain minimum funding rules. In 

some cases, additional contributions are required if a single-employer defined benefit pension 

plan is underfunded. Additional contributions generally are not required in the case of a plan 

with a funded current liability percentage of at least 90 percent. A plan’s funded current liability 

percentage is the value of plan assets as a percentage of current liability. In general, a plan’s 

current liability means all liabilities to employees and their beneficiaries under the plan. 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. 

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 
29 

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. 

Description of Proposal

The proposal revises the special rule for a plan that is sponsored by a company engaged 

primarily in interurban or interstate passenger bus service and that meets the other requirements 

for the special rule under present law. The proposal extends the application of the special rule 

for plan years beginning in 2004 and 2005 to plan years beginning in 2006. The proposal also 

provides several special rules relating to determining minimum required contributions and 

unfunded vested benefits for plan years beginning after 2006 when the new funding rules for 

single-employer plans apply. 

Under the proposal, 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 proposal, 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 phasein, 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 2011.45 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. 

Effective Date

The proposal is effective for plan years beginning after December 31, 2005. 

 45 The term “funding shortfall” is defined under the proposal relating to minimum funding rules 

for single-employer plans and means: (1) the excess (if any) of the plan’s funding target for the plan year 

(i.e., the present value of liabilities under the plan), over (2) the value of the plan’s assets, reduced by any 

prefunding and funding standard carryover balances. 
30 

D. Treatment of Nonqualified Deferred Compensation Plan when Employer’s 

Defined Benefit Plan is in At-Risk Status 

Present Law

Amounts deferred under a nonqualified deferred compensation plan for all taxable years 

are currently includible in gross income to the extent not subject to a substantial risk of forfeiture 

and not previously included in gross income, unless certain requirements are satisfied.46 For 

example, distributions from a nonqualified deferred compensation plan may be allowed only 

upon certain times and events. Rules also apply for the timing of elections. If the requirements 

are not satisfied, in addition to current income inclusion, interest at the underpayment rate plus 

one percentage point is imposed on the underpayments that would have occurred had the 

compensation been includible in income when first deferred, or if later, when not subject to a 

substantial risk of forfeiture. The amount required to be included in income is also subject to a 

20-percent additional tax. 

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. 

Description of Proposal

Under the proposal, if during any period in which a defined benefit pension plan of an 

employer is in at-risk status,47 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 deferred compensation, such transferred 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. 

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 

 46 Code section 409A. 

47 At-risk status is defined as under the proposal relating to funding rules for single-employer 

defined benefit pension plans and applies if a plan’s funding target attainment percentage for the 

preceding year was less than 60 percent. 
31 

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 proposal 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. 

Effective Date

The proposal is effective for transfers or other reservations of assets after December 31, 

2005. 
32 

II. FUNDING RULES FOR MULTIEMPLOYER DEFINED BENEFIT PLANS 

A. Funding Rules for Multiemployer Defined Benefit Plans 

Present Law

Multiemployer plans

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

In general

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 consisting 
33 

of two elements for each plan year. These elements are referred to as: (1) normal cost; and 

(2) supplemental cost. 

Normal 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. 

Supplemental cost

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. 

Valuation of assets

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. 

Reasonableness of assumptions

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. 
34 

Charges and credits to the funding standard account

In general

Under the minimum funding standard, the portion of the cost of a plan that is required to 

be paid for a particular year depends upon the nature of the cost. For example, the normal cost 

for a year is generally required to be funded currently. Other costs are spread (or amortized) 

over a period of years. In the case of a multiemployer plan, past service liability is amortized 

over 40 or 30 years depending on how the liability arose, experience gains and losses are 

amortized over 15 years, gains and losses from changes in actuarial assumptions are amortized 

over 30 years, and waived funding deficiencies are amortized over 15 years. 

Normal cost

Each plan year, a plan’s funding standard account is charged with the normal cost 

assigned to that year under the particular acceptable actuarial cost method adopted by the plan. 

The charge for normal cost will require an offsetting credit in the funding standard account. 

Usually, an employer contribution is required to create the credit. For example, if the normal 

cost for a plan year is $150,000, the funding standard account would be charged with that 

amount for the year. Assuming that there are no other credits in the account to offset the charge 

for normal cost, an employer contribution of $150,000 will be required for the year to avoid an 

accumulated funding deficiency. 

Past service liability

There are three separate charges to the funding standard account one or more of which 

may apply to a multiemployer plan as the result of past service liabilities. In the case of a plan in 

existence on January 1, 1974, past service liability under the plan on the first day on which the 

plan was first subject to ERISA is amortized over 40 years. In the case of a plan which was not 

in existence on January 1, 1974, past service liability under the plan on the first day on which the 

plan was first subject to ERISA is amortized over 30 years. Past service liability due to plan 

amendments is amortized over 30 years. 

Experience gains and losses

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. The actuarial assumptions are required to be 

reasonable, as discussed below. 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. In the case of a multiemployer plan, experience gains and losses for a year are 

generally amortized over a 15-year period, resulting in credits or charges to the funding standard 

account. 
35 

Gains and losses from changes in assumptions

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. In the case of a multiemployer plan, the gain or loss for a 

year from changes in actuarial assumptions is amortized over a period of 30 years, resulting in 

credits or charges 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 
36 

the actuarial assumptions that apply when a plan terminates. The alternative standard has been 

rarely used. 

Description of Proposal

The proposal modifies the amortization periods applicable to multiemployer plans so that 

the amortization period for most charges is 15 years. Under the proposal, in the case of a plan 

which was not in existence on January 1, 1974, past service liability under the plan on the first 

day on which the plan is first subject to ERISA is amortized over 15 years (rather than 30); past 

service liability due to plan amendments is amortized over 15 years (rather than 30); and 

experience gains and losses resulting from a change in actuarial assumptions are amortized over 

15 years (rather than 30). As under present law, experience gains and losses and waived funding 

deficiencies are amortized over 15 years. The new amortization periods do not apply to amounts 

being amortized under present-law amortization periods, that is, no recalculation of amortization 

schedules already in effect is required under the proposal. The proposal eliminates the 

alternative funding standard account. 

The proposal 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 proposal 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 proposal 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 midterm rate, or (2) the rate of interest used under the plan in determining costs. 

Effective Date

The proposal is effective for plan years beginning after December 31, 2006.
37 

B. Additional Funding Rules for Multiemployer Plans 

in Endangered or Critical Status 

Present Law

Multiemployer defined benefit plans are subject to minimum funding rules similar to 

those applicable to single-employer plans.48 Certain modifications to the single-employer plan 

funding rules apply to multiemployer plans that experience financial difficulties, referred to as 

“reorganization status.” A plan is in reorganization status for a year if the contribution needed to 

balance the charges and credits to its funding standard account exceeds its “vested benefits 

charge.”49 The plan’s vested benefits charge is generally the amount needed to amortize, in 

equal annual installments, unfunded vested benefits under the plan over: (1) 10 years in the case 

of obligations attributable to participants in pay status; and (2) 25 years in the case of obligations 

attributable to other participants. A plan in reorganization status is eligible for a special funding 

credit. In addition, a cap on year-to-year contribution increases and other relief is available to 

employers that continue to contribute to the plan. 

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.50 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.51 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.52 

 48 See section II.A. for a discussion of the minimum funding rules for multiemployer defined 

benefit plans. 

49 ERISA sec. 4241. 

50 ERISA sec. 4244A. 

51 ERISA sec. 4245. 

52 The limit of benefits that the PBGC guarantees under a multiemployer plan is the sum of 100 

percent of the first $11 of monthly benefits and 75 percent of the next $33 of monthly benefits for each 

year of service. ERISA sec. 4022A(c). 
38 

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. 

Description of Proposal

In general

The proposal 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 plain is maintained for the 

current plan year continue in effect for the succeeding plan years, or (2) that employer and 

employee 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 
39 

during the funding improvement period, taking into account amortization extensions (the 

“benchmarks”). 

The proposal 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 proposal 

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 first 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 proposal 

(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 proposal, 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 proposals 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 proposals must include (1) at 

least one proposal 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 proposal 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 
40 

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: 

1. As of the beginning of the current plan year, the funded percentage of the plan is less 

than 65 percent and the sum of (A) the market value of plan assets, plus (B) the 

present value of reasonably anticipated employer and employee contributions for the 

current plan year and each of the six succeeding plan years (assuming that the terms of 

the collective bargaining agreements continue in effect) is less than the present value 
41 

of all nonforfeitable benefits for all participants and beneficiaries projected to be 

payable under the plan during the plan year and each of the six succeeding plan years 

(plus administrative expenses), 

2. As of the beginning of the current plan year, the sum of (A) the market value of plan 

assets, plus (B) the present value of the reasonably anticipated employer and employee 

contributions for the current plan year and each of the four succeeding plan years 

(assuming that the terms of the collective bargaining agreements continue in effect) is 

less than the present value of all nonforfeitable benefits for all participants and 

beneficiaries projected to be payable under the plan during the current plan year and 

each of the four succeeding plan years (plus administrative expenses), 

3. As of the beginning of the current plan year, the funded percentage of the plan is less 

than 65 percent and the plan has an accumulated funding deficiency for the current 

plan year or is projected to have an accumulated funding deficiency for any of the four 

succeeding plan years (not taking into account amortization period extensions), 

4. (A) The plan’s normal cost for the current plan year, plus interest for the current plan 

year on the amount of unfunded benefit liabilities under the plan as of the last day of 

the preceding year, exceeds the present value (as of the beginning of the plan year) of 

the reasonably anticipated employer and employee contributions for the current plan 

year, (B) the present value (as of the beginning of the plan year) of nonforfeitable 

benefits of inactive participants is greater than the present value (as of the beginning 

of the current plan year) of nonforfeitable benefits of active participants, and (C) the 

plan is projected to have an accumulated funding deficiency for the current plan year 

or any of the four succeeding plan years (not taking into account amortization period 

extensions), or 

5. (A) The funded percentage of the plan is greater than 65 percent for the current plan 

year and (B) the plan is projected to have an accumulated funding deficiency during 

any of the succeeding three plan years (not taking into account amortization period 

extensions). 

As previously discussed, a plan is in critical status if the plan is in endangered status for 

the preceding plan year and the requirements applicable to endangered plans were not met with 

respect to the plan. A plan is also in critical status the annual certification whether a plan is in 

endangered or critical status is not made. 

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 
42 

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 plans 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 
43 

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. 

Effective Date

The proposal is effective for plan years beginning after December 31, 2005. 
44 

C. Measures to Forestall Insolvency of Multiemployer Plans 

Present Law

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. 

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.53 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. 

Description of Proposal

Under the proposal, 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 five plan years. If the plan sponsor makes 

a determination that the plan will be insolvent for any of the next five plan years, the plan 

sponsor must make the comparison of plan assets and benefit payments under the plan at least 

annually until the plan sponsor makes a determination that the plan will not be insolvent in any 

of the next five plan years. 

Effective Date

The proposal is effective with respect to determinations made in plan years beginning 

after December 31, 2005.

 53 Code sec. 418E(d)(1); ERISA sec. 4245(d)(1). 
45 

III. OTHER PROVISIONS 

A. Interest Rate Assumption for Determination of Lump-Sum Distributions 

Present law

Accrued benefits under a defined benefit pension plan generally must be paid in the form 

of an annuity for the life of the participant unless the participant consents to a distribution in 

another form. Defined benefit pension plans generally provide that a participant may choose 

among other forms of benefit offered under the plan, such as a lump-sum distribution. These 

optional forms of benefit generally must be actuarially equivalent to the life annuity benefit 

payable to the participant. 

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.54 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. 

Description of Proposal

The proposal changes the mortality table and interest rate used to calculate the minimum 

value of lump sums payable from a defined benefit pension plan. 

The mortality table that must be used for calculating lump sums is based on the mortality 

the 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. 

 54 Code sec. 417(e)(3); ERISA sec. 205(g)(3). 
46 

The proposal 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 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 2006 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 proposal 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. 

Effective Date

The proposal is effective for plan years beginning after December 31, 2006.
47 

B. Interest Rate Assumption for Applying Benefit Limitations 

to Lump-Sum Distributions 

Present Law

Annual benefits payable under a defined benefit pension plan generally may not exceed 

the lesser of (1) 100 percent of average compensation, or (2) $170,000 (for 2005).55 The dollar 

limit generally applies to a benefit payable in the form of a straight life annuity. If the benefit is 

not in the form of a straight life annuity (e.g., a lump sum), the benefit generally is adjusted to an 

equivalent straight life annuity. For purposes of adjusting a benefit in a form that is subject to 

the minimum value rules, such as a lump-sum benefit, the interest rate used generally must be 

not less than the greater of: (1) the rate applicable in determining minimum lump sums, i.e., the 

interest rate on 30-year Treasury securities; or (2) the interest rate specified in the plan. In the 

case of plan years beginning in 2004 or 2005, the interest rate used must be not less than the 

greater of: (1) 5.5 percent; or (2) the interest rate specified in the plan. 

Description of Proposal

Under the proposal, for purposes of adjusting a benefit in a form that is subject to the 

minimum value rules, such as a lump-sum benefit, the interest rate used generally must be not 

less than the greater 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 if the rate applicable in determining minimum 

lump sums were used; or (3) the interest rate specified in the plan. 

Effective Date

The proposal is effective for distributions made in years beginning after December 31, 

2005.

 55 Code sec. 415(b). 
48 

C. Distributions During Working Retirement 

Present Law

For purposes of the qualification requirements applicable to pension plans, stock bonus 

plans, and profit-sharing plans, a pension plan is a plan established and maintained primarily to 

provide systematically for the payment of definitely determinable benefits to employees over a 

period of year, usually life, after retirement.56 A pension plan (i.e., a defined benefit plan or 

money purchase pension plan) may not provide for distributions before the attainment of normal 

retirement age (commonly age 65) to participants who have not separated from employment.57

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.58 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. 

Description of Proposal

Under the proposal, a pension plan does not fail to be a qualified retirement plan merely 

because it provides for distributions to a participant who has attained age 62 and has not 

separated from employment at the time of the distribution. 

Effective Date

The proposal is effective for plan years beginning after December 31, 2005.

 56 Treas. Reg. sec. 1.401-1(b)(1)(i). 

57 See, e.g., Rev. Rul. 74-254. 

58 Prop. Treas. Reg. secs. 1.401(a)-1(b)(1)(iv) and 1.401(a)-3. 
49 

IV. IMPROVEMENTS IN PBGC GUARANTEE PROVISIONS 

Present Law

The PBGC 

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.59 

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 

 59 The four criteria for a distress termination are: (1) the contributing sponsor, and every member 

of the controlled group of which the sponsor is a member, is being liquidated in bankruptcy or any similar 

Federal law or other similar State insolvency proceedings; (2) the contributing sponsor and every member 

of the sponsor’s controlled group is being reorganized in bankruptcy or similar State proceeding; (3) the 

PBGC determines that termination is necessary to allow the employer to pay its debts when due; or (4) 

the PBGC determines that termination is necessary to avoid unreasonably burdensome pension costs 

caused solely by a decline in the employer’s work force. 
50 

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, lumpsum benefits payable to encourage early retirement) is guaranteed.60

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.61 The dollar limit is indexed annually 

for 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.62

PBGC premiums

In general

The PBGC is funded by assets in terminated plans, amounts recovered from employers 

who terminate underfunded plans, premiums paid with respect to covered plans, and investment 

earnings. All covered single-employer plans are required to pay a flat per-participant premium 

and underfunded plans are subject to an additional rate variable premium based on the level of 

underfunding. The amount of both the flat rate premium and the variable rate premium are set 

by statute; the premiums are not indexed for inflation. 

 60 ERISA sec. 4022(b) and (c). 

61 The PBGC generally pays the greater of the guaranteed benefit amount and the amount that 

was covered by plan assets when it terminated. Thus, depending on the amount of assets in the 

terminating plan, participants may receive more than the amount guaranteed by PBGC. 

Special rules limit the guaranteed benefits of individuals who are substantial owners covered by a 

plans whose benefits have not been increased by reason of any plan amendment. A substantial owner 

generally is an individual who: (1) owns the entire interest in an unincorporated trade or business; (2) in 

the case of a partnership, is a partner who owns, directly or indirectly, more than 10 percent of either the 

capital interest or the profits interest in the partnership; (3) in the case of a corporation, owns, directly or 

indirectly, more than 10 percent in value of either the voting stock of the corporation or all the stock of 

the corporation; or (4) at any time within the preceding 60 months was a substantial owner under the plan. 

ERISA sec. 4022(b)(5). 

62 The phase in does not apply if the benefit is less than $20 per month. 
51 

Flat rate premiums

The annual flat rate per participant premium is $19 per participant. 

Variable rate premiums 

The variable rate premium is equal to $9 per $1,000 of unfunded vested benefits. 

“Unfunded vested benefits” is the amount which would be the unfunded current liability (as 

defined under the minimum funding rules) if only vested benefits were taken into account and if 

benefits were valued at the variable premium interest rate. No variable rate premium is imposed 

for a year if contributions to the plan for the prior year were at least equal to the full funding 

limit for that year. 

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 PFEA 2004, in determining the amount of 

unfunded vested benefits for PBGC variable rate premium purposes 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. 

Description of Proposal

Flat rate premiums

Beginning in 2006, the proposal 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. 63 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: 

If the plan year begins in: The flat rate premium is: 

2006 $21.20 

2007 $23.40 

2008 $25.60 

2009 $27.80 

2010 and thereafter $30, as adjusted starting in 2007 

for increases in average wages 

 63 In general, if the premium amount as indexed is not a multiple of $1, the amount is rounded to 

the nearest $1; if the amount is a multiple of $.50, the amount is rounded to the next highest dollar 

amount. 
52 

A faster phase-in schedule applies to plans with funding below a certain level. If the 

funding target percentage of a plan for the preceding plan year was less than 80 percent, then the 

flat rate premium is determined under the following table: 

If the plan year begins in: The flat rate premium is: 

2006 $22.67 

2007 $26.33 

2008 and thereafter $30, as adjusted starting in 2007 

for increases in average wages 

Under the proposal, the same flat rate premium will apply to all plans, regardless of 

funding status, in 2010 and thereafter. 

Variable rate premium

For 2006, the proposal 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 proposal. Thus, under 

the proposal, unfunded vested benefits are equal to the amount which would be the plan’s 

funding shortfall for the year64 if plan assets were valued at fair market value and only vested 

benefits were taken into account.65 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 

proposal, if the segment rates were based on the yields of corporate bond rates, rather than a 

three-year average of such rates. Under the proposal, 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 proposal. 

Premium for certain terminating plans

The proposal 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 

 64 The assumptions used are the same as under the minimum funding rules. Thus, for a plan in atrisk status, the at-risk assumptions are used. 

65 For this purpose, the fair market value of plan assets is not reduced by the plan’s prefunding 

balance and funding standard carryover balance. 
53 

(1) reorganization in bankrupty (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 first 12-month period does not start until 

discharge of the party in the reorganization proceeding. 

Effective Date

The proposal relating to flat-rate premiums is effective for plan years beginning after 

December 31, 2005. The extension of the present-law interest rate for purposes of calculating 

the variable rate premium is effective for plan years beginning in 2006. The modifications to the 

variable rate premiums to conform to the new funding rules of the proposal are affective for plan 

years beginning after December 31, 2006. The proposal relating to termination premiums is 

effective for reorganization proceedings begun after October 26, 2005. 
54 

V. DISCLOSURE 

A. Section 4010 Filings with the PBGC 

Present Law

In some cases, certain financial information with respect to the members of a controlled 

group and actuarial information with respect to plans maintained by members of the controlled 

group must be reported annually to the PBGC (“section 4010 information”).66 This reporting is 

required if: (1) the aggregate unfunded vested benefits (determined using the interest rate used 

in determining variable-rate premiums) as of the end of the preceding plan year under all plans 

maintained by members of the controlled group exceed $50 million (disregarding plans with no 

unfunded vested benefits); (2) the conditions for imposition of a lien (i.e., required contributions 

totaling more than $1 million have not been made) have occurred with respect to an underfunded 

plan maintained by a member of the controlled group; or (3) minimum funding waivers in excess 

of $1 million have been granted with respect to a plan maintained by any member of the 

controlled group and any portion of the waived amount is still outstanding. Information 

provided to the PBGC in accordance with these requirements is not available to the public. 

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.67

Description of Proposal

The proposal revises the circumstances in which reporting of section 4010 information is 

required. Specifically, instead of requiring reporting if the aggregate unfunded vested benefits as 

of the end of the preceding plan year under all plans maintained by members of the controlled 

group exceed $50 million, the proposal requires reporting if: (1) the aggregate funding targets 

attainment percentage with respect to a controlled group for the preceding plan year is less than 

60 percent; or (2) the aggregate funding targets attainment percentage with respect to a 

controlled group for the preceding plan year is less than 75 percent and the plan sponsor is in an 

industry with respect to which the PBGC determines that there is substantial unemployment or 

underemployment and the sales and profits are depressed or declining. The aggregate funding 

targets attainment percentage with respect to a controlled group for a plan year is the percentage, 

determined by taking into account all plans maintained by the members of the controlled group 

as of the end of the plan year, which: (1) the aggregate total of the values of plan assets, as of the 

end of the plan year, is of (2) the aggregate total of the funding targets of the plans, as of the end 

of the plan year, taking into account only vested benefits. 

Under the proposal, 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 

 66 ERISA sec. 4010. 

67 ERISA sec. 4071. 
55 

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 singleemployer 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 proposal 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 proposal, 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 proposal. 

Effective Date

The proposal is effective for plan years beginning after 2006. 
56 

VI. PROHIBITED TRANSACTION EXEMPTION FOR THE 

PROVISION OF INVESTMENT ADVICE 

Present Law

ERISA and the Code prohibit certain transactions between an employer-sponsored 

retirement plan and a disqualified person.68 Disqualified persons include a fiduciary of the plan, 

a person providing services to the plan, and an employer with employees covered by the plan. 

For this purpose, a fiduciary includes any person who (1) exercises any authority or control 

respecting management or disposition of the plan’s assets, (2) renders investment advice for a fee 

or other compensation with respect to any plan moneys or property, or has the authority or 

responsibility to do so, or (3) has any discretionary authority or responsibility in the 

administration of the plan. 

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. 

Description of Proposal

The proposal adds a new category of prohibited transaction exemptions in connection 

with the provision of investment advice with respect to plan assets for a fee if: (1) the 

investment of plan assets is subject to the direction of plan participants or beneficiaries; (2) the 

 68 Code sec. 4975; ERISA sec. 406. Under ERISA, the prohibited transaction rules apply to 

employer-sponsored retirement plans and welfare benefit plans. Under the Code, the prohibited 

transaction rules apply to qualified retirement plans and qualified retirement annuities, as well as 

individual retirement accounts and annuities, Archer MSAs, health savings accounts, and Coverdell 

education savings accounts. The prohibited transaction rules under ERISA and the Code generally do not 

apply to governmental plans or church plans. 
57 

advice is provided to the plan or a participant or beneficiary by a fiduciary adviser in connection 

with a sale, acquisition or holding of a security or other property (an “investment transaction”) 

for purposes of investment of plan assets; and (3) certain other requirements are met. Under the 

proposal, the following are exempt from prohibited transaction treatment: (1) the provision of 

investment advice to the plan, participant or beneficiary; (2) an investment transaction (including 

any lending of money or other extension of credit associated with the investment transaction) 

pursuant to the advice; and (3) the direct or indirect receipt of fees or other compensation by a 

fiduciary adviser or an affiliate thereof (or any employee, agent or registered representative of 

the fiduciary adviser or an affiliate) in connection with the provision of the advice or an 

investment transaction pursuant to the advice. 

Under the proposal, 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 proposal. 
58 

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 proposal, “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 proposal 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 proposal; (2) the terms of 

the arrangement require compliance by the fiduciary adviser with the requirements of the 

proposal; 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 proposal 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 proposal 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. 
59 

Effective Date

The proposal is effective with respect to investment advice provided on or after January 

1, 2006.
60 

VII. IMPROVEMENTS IN BENEFIT ACCRUAL STANDARDS 

Present Law

Prohibition on age discrimination

In general

A prohibition on age discrimination applies to benefit accruals under a defined benefit 

pension plan.69 Specifically, an employee's benefit accrual may not cease, and the rate of an 

employee's benefit accrual may not be reduced, because of the attainment of any age. However, 

this prohibition is not violated solely because the plan imposes (without regard to age) a limit on 

the amount of benefits that the plan provides or a limit on the number of years of service or years 

of participation that are taken into account for purposes of determining benefit accrual under the 

plan. Moreover, for purposes of this requirement, the subsidized portion of any early retirement 

benefit may be disregarded in determining benefit accruals. 

In December 2002, the IRS issued proposed regulations that dealt with the application of 

the age discrimination rules.70 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. 

Cash balance and other hybrid plans

Certain types of defined benefit pension plans, such as cash balance plans and pension 

equity plans, are referred to as “hybrid” plans because they combine features of a defined benefit 

pension plan and a defined contribution plan. 

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). 

 69 Code sec. 411(b)(1)(H); ERISA sec. 204(b)(1)(H). 

70 67 Fed. Reg. 76123. 
61 

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. 

An age discrimination issue has arisen as a result of front-loaded interest credits under 

cash balance plans because there is a longer time for interest credits to accrue on pay credits to 

the account of a younger employee. A similar issue may arise with respect to other types of 

hybrid plans. Several court cases have considered whether front-loaded interest credits under 

cash balance plans violate the age discrimination rules and have reached inconsistent 

conclusions.71

The December 2002 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. In June 2004, the IRS announced the withdrawal of the proposed age 

discrimination regulations, including the special rules for eligible cash balance plans.72 

According to the Announcement, “[t]his will provide Congress an opportunity to . . . address 

cash balance and other hybrid plan issues through legislation.” 

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. 

Most cash balance plans are designed to permit a lump-sum distribution of a participant’s 

hypothetical account balance upon termination of employment. As is the case with defined 

benefit pension plans generally, such a lump-sum amount is required to be not less than the 

present value of the benefit payable at normal retirement age, determined using the statutory 

interest and mortality assumptions.73 A participant's normal retirement benefit under a cash 

 71 Tootle v. ARINC Inc., 222 F.R.D. 88 (D. Md. 2004); Cooper v. IBM Personal Pension Plan, 

274 F. Supp. 2d 1010 (S.D. Ill. 2003); Eaton v. Onan, 117 F. Supp. 2d 812 (S.D. Ind. 2000). 

72 IRS Announcement 2004-57, 2004-27 I.R.B. 15. 

73 Berger v. Xerox Corp. Retirement Income Guarantee Plan, 338 F.3d 755 (7th Cir. 2003); 

Esden v. Bank of Boston, 229 F.3d 154 (2d Cir. 2000), cert. dismissed, 531 U.S. 1061 (2001); Lyons v. 

Georgia Pacific Salaried Employees Retirement Plan, 221 F.3d 1235 (11th Cir. 2000), cert. denied, 532 

U.S. 967 (2001); West v. AK Steel Corp. Retirement Accumulation Plan, 318 F. Supp.2d 579 (S.D. Ohio 

2004); Notice 96-8, 1996-1996-1 C.B. 359. Additionally, under Esden, if participants accrue interest 
62 

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, 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. 

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 will cause a 

discrepancy between the value of the minimum lump-sum and the employee’s hypothetical 

account balance. 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.74

Description of Proposal

Age discrimination rules

Under the proposal, 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 is identical to the participant 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 addition, under the proposal, plans do not violate the prohibition on age discrimination 

solely because of the following plan designs or features: 

1. A plan under which the accrued benefit payable under the plan upon distribution (or 

any portion thereof) is expressed as the balance of a hypothetical account maintained 

for the participant is not treated as violating the prohibition on age discrimination 

solely because interest accruing on the account balance is taken into account. 

2. A plan is not treated as violating the prohibition on age discrimination solely because, 

under the plan, benefits attributable to employer contributions may be offset by: 

 

credits under a cash balance plan at an interest rate that is higher than the interest assumptions prescribed 

by the Code for determining the present value of the annuity, the interest credits must be reflected in the 

projection of the participant’s hypothetical account balance to normal retirement age in order to avoid 

violating the Code’s prohibition against forfeitures. 

74 This result is sometimes referred to as “whipsaw.” 
63 

(1) Social Security or Railroad Retirement benefits; (2) benefits under another 

qualified retirement plan of the same employer; or (3) benefits under a retirement 

program for officers or employees of the Federal Government or a State or local 

government. For this purpose, allowable offsets based on such benefits may consist of 

offsets equal to all or part of the actual benefit payment amounts, reasonable 

projections or estimations of such benefit payment amounts, or actuarial equivalents of 

such actual benefit payment amounts, projections, or estimations (determined on the 

basis of reasonable actuarial assumptions). 

3. A plan is not treated as violating the prohibition on age discrimination solely because 

the plan provides for disparity in contributions or benefits with respect to which the 

permitted disparity requirements are met. 

4. A plan is not treated as violating the prohibition on age discrimination solely because 

the plan provides for pre-retirement indexing of accrued benefits under the plan. For 

this purpose, the term “pre-retirement indexing” means, in connection with an accrued 

benefit, the periodic adjustment of the accrued benefit by means of the application of a 

recognized index or methodology so as to protect the economic value of the benefit 

against inflation before distribution. 

Calculating minimum lump-sum distributions under hybrid plans

The proposal 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 proposal, 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. 

Effective Date

The proposal is effective for periods beginning on or after June 29, 2005.
64 

VIII.DEDUCTION LIMITATIONS 

A. Increase in Deduction Limits 

Employer contributions to qualified retirement plans are deductible subject to certain 

limits.75 In general, the deduction limit depends on the kind of plan. 

In the case of a defined benefit pension plan, 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.76 The maximum amount otherwise deductible generally is not less than the plan’s 

unfunded current liability.77 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. 

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. 

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. 

Description of Proposal

The proposal modifies the maximum deductible amount in the case of both singleemployer defined benefit pension plans and multiemployer defined benefit pension plans. 

 75 Code sec. 404. 

76 The full funding limitation is the excess, if any, of (1) the accrued liability of 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. However, the full funding limit is not 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. 

77 In the case of a plan with 100 or fewer participants, unfunded current liability for this purpose 

does not include the liability attributable to benefit increases for highly compensated employees resulting 

from a plan amendment that is made or becomes effective, whichever is later, within the last two years. 
65 

In the case of a single-employer defined benefit pension plan, the maximum deductible 

amount is equal to the greater of: 

1. the excess (if any) of the sum of 150 percent of the plan’s funding target plus the 

normal cost for the plan year over the value of plan assets (determined as under the 

minimum funding rules), and 

2. the excess (if any) of the sum of the plan’s at-risk normal cost and at-risk funding 

target for the plan year over the value of the plan assets (determined as under the 

minimum funding rules). For this purpose, the at-risk funding target and at-risk 

normal cost are used regardless of whether the plan is in fact in at-risk status. 

In determining the maximum deductible amount, the value of plan assets is not reduced 

by any pre-funding balance or funding standard account carryover balance. 

The proposal 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. 

Effective Date

The proposal is effective for contributions for taxable years beginning after December 31, 

2006.
66 

B. Updating Deduction Rules for Combination of Plans 

Present Law

Employer contributions to qualified retirement plans are deductible subject to certain 

limits.78 In general, the deduction limit depends on the kind of plan. 

In the case of a defined benefit pension plan, 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.79 The maximum amount otherwise deductible generally is not less than the plan’s 

unfunded current liability.80 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. 

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.81 

 78 Code sec. 404. 

79 The full funding limitation is the excess, if any, of (1) the accrued liability of 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. However, the full funding limit is not 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. 

80 In the case of a plan with 100 or fewer participants, unfunded current liability for this purpose 

does not include the liability attributable to benefit increases for highly compensated employees resulting 

from a plan amendment that is made or becomes effective, whichever is later, within the last two years. 

81 Under the general EGTRRA sunset, this rule expires for plan years beginning after 2010. 
67 

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. 

Description of Proposal

Under the proposal, the overall limit on employer deductions for contributions to 

combinations of defined benefit and defined contribution plans applies to contributions to one or 

more defined contribution plans only to the extent that such contributions exceed six percent of 

compensation otherwise paid or accrued during the taxable year to the beneficiaries under the 

plans. 

In addition, for purposes of determining the excise tax on nondeductible contributions, 

matching contributions to a defined contribution plan that are nondeductible solely because of 

the overall deduction limit are disregarded. 

Effective Date

The proposal is effective for contributions for taxable years beginning after December 31, 

2006. 
68 

IX. ENHANCED RETIREMENT SAVINGS AND 

DEFINED CONTRIBUTION PLANS 

A. Permanency of EGTRRA Pension and IRA Provisions 

Present Law

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 2010.82 

Description of Proposal

The proposal repeals the sunset provision of EGTRRA as applied to the provisions 

relating to pensions and IRAs. 

Effective Date

The proposal is effective on the date of enactment.

 82 The saver's credit (sec. 25B) expires at the end of 2006. Another provision of the proposal 

makes the saver's credit permanent. 
69 

B. Saver’s Credit Made Permanent 

Present Law

Present law provides a temporary nonrefundable tax credit for eligible taxpayers for 

qualified retirement savings contributions. The maximum annual contribution eligible for the 

credit is $2,000. The credit rate depends on the adjusted gross income (“AGI”) of the taxpayer. 

Joint returns with AGI of $50,000 or less, head of household returns of $37,500 or less, and 

single returns of $25,000 or less are eligible for the credit. The AGI limits applicable to single 

taxpayers apply to married taxpayers filing separate returns. The credit is in addition to any 

deduction or exclusion that would otherwise apply with respect to the contribution. The credit 

offsets minimum tax liability as well as regular tax liability. The credit is available to 

individuals who are 18 or over, other than individuals who are full-time students or claimed as a 

dependent on another taxpayer’s return. 

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 

Joint Filers Heads of 

Households All Other Filers Credit Rate 

$0-$30,000 $0-$22,500 $0-$15,000 50 percent 

$30,001-$32,500 $22,501-$24,375 $15,001-$16,250 20 percent 

$32,501-$50,000 $24,376-$37,500 $16,251-$25,000 10 percent 

Over $50,000 Over $37,500 Over $25,000 0 percent 

The credit does not apply to taxable years beginning after December 31, 2006. 

Description of Proposal

The proposal makes the saver’s credit permanent. 
70 

Effective Date 

The proposal is effective on the date of enactment. 
71 

C. Increasing Participation Through Automatic Enrollment Arrangements 

Present Law

Qualified cash or deferred arrangements--in general83

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),84 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".85 

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. 86 

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 

 83 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. 

84 Legally, a section 401(k) plan is not a separate type of plan, but is a profit-sharing, stock 

bonus, or pre-ERISA money purchase plan that contains a qualified cash or deferred arrangement. The 

terms “section 401(k) plan” and “401(k) plan” are used here for convenience. 

85 The maximum annual amount of elective deferrals that can be made by an individual is subject 

to a limit ($14,000 for 2005). An individual who has attained age 50 before the end of the taxable year 

may also make catch-up contributions to a section 401(k) plan, subject to a limit ($4,000 for 2005). 

86 Treasury regulations provide that whether an employee has an effective opportunity to receive 

cash is based on all the relevant facts and circumstances, including the adequacy of notice of the 

availability of the election, the period of time during which an election may be made, and any other 

conditions on elections. Treas. Reg. sec. 1.401(k)-1(e)(2). 
72 

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; 

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. In 

addition, the rate of matching contribution with respect to any rate of elective deferral of a highly 

compensated employee cannot be greater than the rate of matching contribution with respect to 

the same rate of elective deferral of a nonhighly compensated employee. 

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. 
73 

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. 

ERISA provisions

Fiduciary rules

ERISA contains general fiduciary standards87 that apply to all fiduciary actions, including 

investment decisions with respect to plan assets. Plan fiduciaries may be held personally liable 

for breaches of fiduciary duty. 

A defined contribution plan may permit participants and beneficiaries to make investment 

decisions with respect to their individual accounts. For example, it is common for 401(k) plans 

to provide participants with investment authority with respect to their own elective contributions. 

Under a safe harbor rule, ERISA fiduciary liability does not apply to investment decisions made 

by plan participants if plan participants control the investment of their individual accounts. If the 

safe harbor applies, a plan fiduciary may be liable for the investment alternatives made available, 

but not for the specific investment decisions of participants. Department of Labor regulations 

provide detail as to the requirements that must be satisfied for the safe harbor to apply, for 

example, the number and type of investment options that must be available, the information that 

must be provided to plan participants, and the frequency with which participants must be allowed 

to give investment instructions. The safe harbor is often referred to as the "404(c) safe harbor" 

after the section of ERISA which contains the rule. According to the Department of Labor, a 

participant or beneficiary is not considered to have exercised control if the participant or 

beneficiary is merely apprised of investments that will be made on his or her behalf in the 

absence of instructions to the contrary. 

 87 ERISA requires that a plan fiduciary must discharge his or her duties solely in the interest of 

participants and beneficiaries and: (1) for the exclusive purpose of providing benefits to plan participants 

and beneficiaries and defraying reasonable expenses of plan administration; (2) with the care, prudence, 

and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and 

familiar with such matters would use in the conduct of an enterprise of a like character and with like aims; 

by diversifying the investments of the plan so as to minimize the risk of large losses, unless under the 

circumstances it is clearly prudent not do to so; and in accordance with plan documents insofar as they are 

consistent with ERISA. 
74 

Preemption

Subject to certain exceptions, ERISA preempts any and all State laws relating to any 

employee benefit plan, other than any generally applicable State criminal law. 

Description of Proposal

In general

Under the proposal, 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.88 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 

qualified automatic enrollment arrangement (or a predecessor) is adopted. 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. 

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. 

 88 Similarly, the new safe harbor applies with respect to matching contributions under a section 

403(b) annuity through the operation of section 403(b)(12). 
75 

Matching or nonelective contribution requirement

Contributions

An automatic enrollment feature satisfies the contribution requirement if the employer 

either (1) satisfies a matching contribution requirement or (2) makes a nonelective contribution 

to a defined contribution plan of at least two percent of an employee’s compensation on behalf of 

each nonhighly compensated employee who is eligible to participate in the automatic enrollment 

feature. 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 50 percent of the employee’s elective deferrals as do not 

exceed six percent of compensation 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. Alternatively, matching contributions satisfy the requirement in (1) if 

the rate of match does not increase as an employee's rate of elective contributions increases and 

the aggregate amount of matching contributions at such rate of elective contributions is at least 

equal to the aggregate amount of matching contributions which would be made if matching 

contributions were made on the basis of the percentage described in (1). The matching 

contributions may be made to the plan of which the automatic enrollment arrangement is a part 

or to another plan of the employer. 

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 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. 

Vesting

Any matching or other employer contributions taken into account in determining whether 

the requirements for a qualified automatic enrollment feature are satisfied must vest at least as 

rapidly as under two-year cliff vesting. That is, employees with at least two years of service 

must be 100 percent vested with respect to such contributions. 

Withdrawal restrictions

Any matching or other employer contributions taken into account in determining whether 

the requirements for a qualified automatic enrollment feature are satisfied are subject to the 

withdrawal rules applicable to elective contributions. 

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 
76 

employee of such rights and obligation and is written in a manner calculated to be understood by 

the average employee to whom the arrangement applies.89 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 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 proposal includes rules under which erroneous automatic contributions may be 

distributed from the plan, including a waiver of the 10-percent early withdrawal tax. 

Application to tax-sheltered annuities

Rules similar to the automatic contribution rules apply to matching contributions under 

tax-sheltered annuities (sec. 403(b)). 

Effective Date

The proposal is effective for years beginning after December 31, 2005. 

 89 Employees who are not required to be covered by the qualified automatic enrollment feature, 

i.e., employees previously covered under the 401(k) plan, are required to receive the notice if they are 

covered by the automatic enrollment feature. 
77 

D. Treatment of Distributions to Guardsmen Called to Active Duty 

Present Law

Under present law, a taxpayer who receives a distribution from a qualified retirement 

plan prior to age 59-1/2, death, or disability generally is subject to a 10-percent early withdrawal 

tax on the amount includible in income, unless an exception to the tax applies. Among other 

exceptions, the early distribution tax does not apply to distributions made to an employee who 

separates from service after age 55, or to distributions that are part of a series of substantially 

equal periodic payments made for the life (or life expectancy) of the employee or the joint lives 

(or life expectancies) of the employee and his or her beneficiary. 

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. 

Description of Proposal

Under the proposal, the 10-percent early withdrawal tax does not apply to a qualified 

reservist distribution. A qualified reservist distribution is a distribution (1) from an IRA or 

attributable to elective deferrals under a qualified cash or deferred arrangement (a “section 

401(k) plan”) or similar arrangement, (2) made to an individual who (by reason of being a 

member of a reserve component) was ordered or called to active duty for a period in excess of 

179 days or for an indefinite period, and (3) that is made during the period beginning on the date 

of such order or call to duty and ending at the close of the active duty period. A 401(k) plan or 

tax-sheltered annuity does not violate the distribution restrictions applicable to such plans by 

reason of making a qualified reservist distribution. 

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 proposal. No deduction is allowed for any 

contribution made under the proposal. 

This proposal 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 distributed does not end before the date that is two years after the date of 

enactment. 

Effective Date

The proposal applies to distributions after September 11, 2001. 

If refund or credit of any overpayment of tax resulting from the proposal 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 
78 

credit may nevertheless be made or allowed if claim therefor is filed before the close of such 

period. 
79 

E. Inapplicability of 10-Percent Additional Tax on Early Distributions of 

Pension Plans of Public Safety Employees 

Present Law

Under present law, a taxpayer who receives a distribution from a qualified retirement 

plan prior to age 59-1/2, death, or disability generally is subject to a 10-percent early withdrawal 

tax on the amount includible in income, unless an exception to the tax applies. Among other 

exceptions, the early distribution tax does not apply to distributions made to an employee who 

separates from service after age 55, or to distributions that are part of a series of substantially 

equal periodic payments made for the life (or life expectancy) of the employee or the joint lives 

(or life expectancies) of the employee and his or her beneficiary. 

Description of Proposal

Under the proposal, the 10-percent early withdrawal tax does not apply to distributions to 

a qualified safety employee from a governmental plan to the extent that such distributions are 

attributable to a deferred retirement option plan or “DROP” benefit. A DROP benefit is a feature 

of a governmental defined benefit plan under which an employee elects to receive credits to an 

account (including a notional account) in the plan which are not in excess of the plan benefits 

that would have been provided if the employee had retired under the plan at a specified earlier 

retirement date and which are in lieu of increases in the employee’s accrued pension benefit 

under such defined benefit plan based on years of service after the effective date of the DROP 

election. The waiver of the penalty is available only to amounts that would have been payable as 

an annuity from the defined benefit plan had the individual retired and taken the defined benefit 

plan benefit. 

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. 

Effective Date 

The proposal is effective for distributions made after the date of enactment. 
80 

F. Combat Zone Compensation Taken into Account 

for Purposes of IRA Contributions 

Present Law

There are two general types of individual retirement arrangements (“IRAs”): traditional 

IRAs and Roth IRAs. The total amount that an individual may contribute to one or more IRAs 

for a year is generally limited to the lesser of: (1) a dollar amount ($4,000 for 2005); and (2) the 

amount of the individual's compensation that is includible in gross income for the year. In the 

case of an individual who has attained age 50 before the end of the year, the dollar amount is 

increased by an additional amount ($500 for 2005). In the case of a married couple, 

contributions can be made up to the dollar limit for each spouse if the combined compensation of 

the spouses that is includible in gross income is at least equal to the contributed amount. IRA 

contributions in excess of the applicable limit are generally subject to an excise tax of six percent 

per year until withdrawn. 

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. 

Description of Proposal

Under the proposal, for purposes of applying the limit on IRA contributions, an 

individual's gross income is determined without regard to the exclusion for combat pay. Thus, 

combat pay received by an individual is treated as includible compensation for purposes of 

determining the amount that the individual (and the individual's spouse) can contribute to an 

IRA. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2005. 
81 

G. Direct Deposit of Tax Refunds in an IRA 

Present Law

Rules relating to individual retirement arrangements ("IRAs")

In general

Present law provides tax-favored savings through traditional and Roth IRAs. 

Contributions to a traditional or Roth IRA for a year may be made by the due date for the tax 

return for the year (determined without regard to extensions). 

Traditional IRAs

Under present law, an individual may generally make deductible contributions to a 

traditional IRA for a taxable year up to the lesser of a dollar amount ($4,000 for 2005) or the 

individual's taxable compensation for the year.90 A contribution of up to the dollar limit for each 

spouse may be made to a traditional IRA provided the combined compensation of the spouses is 

at least equal to the contributed amount. The amount of contributions that can be made to a 

traditional IRA is reduced to the extent the individual makes contributions to a Roth IRA. 

If an individual is an active participant in an employer-sponsored retirement plan, the 

maximum IRA deduction limit is phased out over certain levels of modified adjusted gross 

income. In the case of a married taxpayer filing a joint return, the phase-out range is: $70,000 to 

$80,000 of modified adjusted gross income for 2005; $75,000 to $85,000 of modified adjusted 

gross income for 2006; and $80,000 to $100,000 of modified adjusted gross income for 2007 and 

thereafter.91 

In the case of single taxpayers who are active participants in an employer-sponsored 

retirement plan, the phase-out range is $50,000 to $60,000 of modified adjusted gross income in 

2005 and thereafter. 

If an individual is not an active participant in an employer-sponsored retirement plan, but 

the individual’s spouse is, the maximum IRA deduction limit is phased out for modified adjusted 

gross income of $150,000 to $160,000. 

An individual may make nondeductible contributions to a traditional IRA to the extent 

the individual does not or may not make deductible contributions. 

Distributions from a traditional IRA are includible in gross income to the extent they 

represent the return of nondeductible contributions. Subject to certain exceptions, if the 

 90 The dollar limit is increased for individuals who are age 50 or older. 

91 The income phase-out range for a married taxpayer who is an active participant and who files a 

joint return is $0 to $10,000 of modified adjusted gross income. 
82 

distribution is made prior to age 59-1/2, death, or disability, a 10-percent additional early 

withdrawal tax applies to the taxable amount of a distribution. 

Roth IRAs

Individuals with modified adjusted gross income below certain levels may make 

nondeductible contributions to a Roth IRA. The maximum annual contribution that may be made 

to a Roth IRA is the lesser of a dollar limit ($4,000 for 2005) or the individual’s taxable 

compensation for the year.92 The contribution limit is reduced to the extent an individual makes 

contributions (deductible or nondeductible) to any other IRA for the same taxable year. As 

under the rules relating to IRAs generally, a contribution of up to the dollar limit for each spouse 

may be made to a Roth IRA provided the combined compensation of the spouses is at least equal 

to the contributed amount. The maximum annual contribution that can be made to a Roth IRA is 

phased out for single individuals with modified adjusted gross income between $95,000 and 

$110,000 and for married taxpayers filing joint returns with modified adjusted gross income 

between $150,000 and $160,000.93

Taxpayers with modified adjusted gross income of $100,000 or less generally may 

convert a traditional IRA into a Roth IRA. The amount converted is includible in income as if a 

withdrawal had been made, except that the 10-percent early withdrawal tax does not apply and, if 

the conversion occurred in 1998, the income inclusion may be spread ratably over four years. 

Married taxpayers who file separate returns cannot convert a traditional IRA into a Roth IRA. 

Amounts held in a Roth IRA that are withdrawn as a qualified distribution are not 

includible in income, or subject to the additional 10-percent tax on early withdrawals. A 

qualified distribution is a distribution that: (1) is made after the five-taxable year period 

beginning with the first taxable year for which the individual made a contribution to a Roth IRA, 

and (2) is made after attainment of age 59-1/2, on account of death or disability, or is made for 

first-time homebuyer expenses of up to $10,000. 

Distributions from a Roth IRA that are not qualified distributions are includible in 

income to the extent attributable to earnings. Subject to certain exceptions, if the distribution is 

made prior to age 59-1/2, death, or disability, a 10-percent additional early withdrawal tax 

applies to the taxable amount of a distribution, and subject to the 10-percent early withdrawal tax 

(unless an exception applies). 

Direct deposit of tax refunds

Under current IRS procedures, a taxpayer may direct that his or her tax refund be 

deposited into a checking or savings account with a bank or other financial institution (such as a 

 92 The dollar limit is increased for individuals who are age 50 or older. 

93 In the case of a married taxpayer filing a separate return, the income phaseout range is $0 to 

$10,000 of modified adjusted gross income. 
83 

mutual fund, brokerage firm, or credit union) rather than having the refund sent to the taxpayer in 

the form of a check. 

Description of Proposal

The Secretary is directed to develop forms under which all or a portion of a taxpayer's 

refund may be deposited in an IRA of the taxpayer (or the spouse of the taxpayer in the case of a 

joint return). The proposal does not modify the rules relating to IRAs, including the rules 

relating to timing of contributions. 

Effective Date

The form required by the proposal is to be available for taxable years beginning after 

December 31, 2006. 
84 

X. PROVISIONS TO ENHANCE HEALTH CARE AFFORDABILITY 

A. Tax Treatment of Combined Annuity and Life Insurance Contracts 

with a Long-Term Care Insurance Feature 

Present Law

Annuity contracts

In general, earnings and gains on amounts invested in a deferred annuity contract 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

Tax treatment

Present law provides favorable tax treatment for qualified long-term care insurance 

contracts meeting the requirements of section 7702B. 

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), 
85 

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)). 

Definitions

A qualified long-term care insurance contract is defined as any insurance contract that 

provides only coverage of qualified long-term care services, and that meets additional 

requirements (sec. 7702B(b)). The contract is not permitted to provide for a cash surrender value 

or other money that can paid, assigned or pledged as collateral for a loan, or borrowed (and 

premium refunds are to be applied as a reduction in future premiums or to increase future 

benefits). Per diem-type and reimbursement-type contracts are permitted. 

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)). 

Long-term care riders on life insurance contracts 

In the case of long-term care insurance coverage provided by a rider on or as part of a life 

insurance contract, the requirements applicable to long-term care insurance contracts apply as if 

the portion of the contract providing such coverage were a separate contract (sec. 7702B(e)). 

The term "portion" means only the terms and benefits that are in addition to the terms and 
86 

benefits under the life insurance 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 

contract's death benefit or cash surrender value. 

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 moth 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. 

Description of Proposal

The proposal provides for the tax rules applicable to long-term care insurance that is 

provided by a rider on or as part of an annuity contract, and modifies the tax rules applicable to 

long-term care insurance coverage provided by a rider on or as part of a life insurance contract. 

Under the proposal, 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-
87 

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 proposal expands the rules for tax-free exchanges of certain insurance contracts. The 

proposal 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 proposal 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 proposal 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. 

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 proposal provides that certain retirement-related arrangements are not treated as 

annuity contracts, for purposes of the proposal. 

The proposal 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 proposal. 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 proposal 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 proposal increases the amount of pre-funding permitted by treating qualified longterm care insurance coverage under the rider as a qualified additional benefit, for purposes of the 

present-law definition of a life insurance contract. 
88 

Effective Date

The proposal is generally effective for contracts issued before, on, or after December 31, 

2006, but only with respect to periods beginning after that date. The proposal expanding the 

rules for tax-free exchanges of certain insurance contracts applies with respect to exchanges 

occurring after December 31, 2006.
89 

B. Disposition of Unused Health Benefits in Flexible Spending Arrangements 

Present Law

Flexible spending arrangements

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.94 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.95 

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.96 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.97 These rules apply with respect to a health FSA without regard to whether the 

 94 Sec. 401(k). 

95 Prop. Treas. Reg. 1.125-2 Q&A-5(a). 

96 Notice 2005-42. 

97 Prop. Treas. Reg. 1.125-2 Q&A-7(b). 
90 

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 employerpaid 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.98 

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.99

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”).100 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 

 98 Prop. Treas. Reg. 1.125-2 Q&A-7(c). 

99 Prop. Treas. Reg. 1.125-2 Q&A-7(b). 

100 Sec. 223. Revenue Ruling 2004-45 provides guidance on the extent to which individuals may 

make contributions to an HSA when also covered by a health FSA or a health reimbursement 

arrangement. 
91 

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.101 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. 

Description of Proposal

The proposal allows up to $500 of unused health benefits in an employee’s health FSA to 

be carried forward to the employee’s health FSA for the next plan year. An employee’s unused 

health benefit is the excess of the maximum amount of reimbursement allowable to the employee 

over the actual amount of reimbursement made during the year. 

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 proposal 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. 

Effective Date

The proposal is effective for taxable years beginning after December 31, 2005.

 101 These amounts are the same as the maximum deductible amounts permitted under a high 

deductible plan for purposes of Archer medical savings accounts (“MSAs”). 
92 

C. Permit Tax-Free Distributions from Governmental Retirement Plans for Premiums 

for Health and Long-Term Care Insurance for Public Safety Officers 

Present Law

Under present law, a distribution from a qualified retirement plan under section 401(a), a 

qualified annuity plan under section 403(a), a tax-sheltered annuity under section 403(b) (a 

“403(b) annuity”), an eligible deferred compensation plan maintained by a State or local 

government under section 457 (a “governmental 457 plan”), or an individual retirement 

arrangement under section 408 (an “IRA”) generally is included in income for the year 

distributed (except to the extent the amount received constitutes a return of after-tax 

contributions or a qualified distribution from a Roth IRA).102 In addition, a distribution from a 

qualified retirement or annuity plan, a 403(b) annuity, or an IRA received before age 59-1⁄2, 

death, or disability generally is subject to a 10-percent early withdrawal tax on the amount 

includible in income, unless an exception applies.103

Description of Proposal

The proposal provides that certain pension distributions from an eligible retirement plan 

used to pay for qualified health insurance premiums are excludible from income. An eligible 

retirement plan includes a governmental qualified retirement or annuity plan, 403(b) annuity, or 

457 plan. The exclusion applies with respect to eligible retired public safety officers who make 

an election to have qualified health insurance premiums deducted from amounts distributed from 

an eligible retirement plan and paid directly to the insurer. An eligible retired public safety 

officer is an individual who, by reason of disability or attainment of normal retirement age, is 

separated from service as a public safety officer104 with the employer who maintains the eligible 

retirement plan from which pension distributions are made. 

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 proposal 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. 

 102 Secs. 402(a), 403(a), 403(b), 408(d), and 457(a). 

103 Sec. 72(t). 

104 The term "public safety officer" has the same meaning as under section 1204(8)(A) of the 

Omnibus Crime Control and Safe Streets Act of 1986. 
93 

Effective Date

The proposal is effective for distributions made in taxable years beginning after 

December 31, 2005.