The New Pension
Protection Act of 2006 Promotes Savings, Protects Pensions
It’s been
described as the most sweeping pension legislation in more than three
decades. The new Pension Protection Act of 2006, which was signed into law
by President Bush on August 17, includes provisions designed to strengthen
traditional pension plans that now represent some 44 million American
workers and retirees. The new law also does much to promote savings: it
makes permanent increased IRA, retirement plan, and catch-up contribution
limits, and the tax-advantaged benefits of all 529 college savings and
prepaid tuition plans. The new law also eases qualified plans and IRA
payout and rollover rules. In addition, the new law includes many changes
for charitable contribution deductions and charitable organizations,
including eased rules for transfers from IRAs, tightened clothing and
household good contribution rules, and stricter recordkeeping requirements
for money contributions. Here’s a summary of some of the major
provisions of the new law that directly affect financial planners and
Americans:
Traditional Pension
Plans
The new law overhauls the
funding and disclosure rules for defined benefit pension plans, changes
the rules for conversions of pension plans to cash balance plans, and
makes many other changes relating to pension plans and their
beneficiaries.
For instance, the
new law requires most pension plans to become fully funded over a
seven-year period. The new law increased the deduction limits for single-
and multi-employer plans, under certain circumstances. And the new law
restricts plans from offering any lump sum benefit payments when the plan
is less than 60 percent funded. In addition, payouts under nonqualified
deferred compensation and special pension plans for executives are
restricted for severely under funded plans. With respect to valuing
pension liabilities, the new law extends the use of a long-term corporate
bond interest rate instead of the 30-year Treasury rate. And the new law
revises the rules for calculating the amount of a lump-sum distribution
from a defined benefit plan.
The new law also
provides legal protection to employers who now provide traditional pension
plans but want to convert those plans into hybrid "cash balance"
plans, which are part traditional pension and part defined contribution
plan. PPA clarifies that this is legal. Under current law, the ambiguity
allowed employee lawsuits to emerge challenging the switch.
Retirement Savings
Incentives
The Pension Protection
Act of 2006 allows employers to automatically enroll workers in
defined-contribution retirement plans. And it provides employers with a
safe harbor for automatic enrollment, default investment selection for
automatic enrollment, and automatic escalation of contributions, as well
as 404(c) protection for default elections. The new law also gives workers
the right to sell publicly-traded company stock received as a matching
contribution in their retirement plan account after three years of service
for original matching contributions, and immediately for employee
contributions. The new law prohibits companies from forcing employees to
invest any of their own retirement savings contributions in company stock.
And the new law permanently extends "Saver's Credit" for
low-income taxpayers who contribute to an IRA. The Saver’s credit was
set to expire 12/31/06, and indexes the credit to inflation.
Investment Advice
The new law will also
enable qualified fiduciary advisers to deliver personally-tailored
investment advice face-to-face, by phone, or electronically for 401(k)s
and IRAs, including HSAs, Archer MSAs, and Coverdell education savings
accounts.
Under the new law,
fiduciary advisers for employer-sponsored plans must base their
recommendations on a computer model certified and audited by an
independent third party. Advisers who don’t use a computer model can
charge a fee for their investment advice to 401(k) plan participants, but
the fees may not vary based on the investments selected. The Department of
Labor and Treasury will develop guidelines regarding computer models
"as soon as practicable after the date of enactment".
IRAs
The new law makes
permanent the IRA and pension provisions enacted in the 2001 tax cut
legislation that were scheduled to sunset after 2010. The 2001 law
increased annual contribution limits for IRAs and workplace plans such as
the 401(k); created additional catch-up contributions for individuals age
50 and older; and created incentives for small employers to offer workers
retirement savings options. Under the new law, the current contribution
limit for IRAs of $4,000 rises to $5,000 in 2008 and is adjusted for
inflation after that.
The Pension
Protection Act of 2006 liberalizes a number of qualified plan and IRA
payout and rollover rules. For instance, after 2007, taxpayers who plan to
do a Roth conversion would be permitted to make direct rollovers from
qualified plans to Roth IRAs vs having to go to a regular IRA. Although
technically called a "rollover," it is not. For non-spouse
beneficiaries, it is worth noting that this must be a trustee-to-trustee
transfer. In other words, a check cannot be issued directly to the
non-spouse beneficiary and then deposited into his/her IRA. If it’s done
this way, this opportunity is lost for good. And non-spouse designated
beneficiaries can make rollovers of inherited amounts in qualified plans
or IRAs to their own IRAs after 2006. PPA also gives taxpayers the option
of depositing a portion of their federal tax refund directly into an IRA
and other accounts.
And, in what will
surely help older workers continue working on a part-time basis for former
employers, defined benefit plans could make in-service distributions to
age-62-or-older participants.
Other provisions
PPA also permits insurers
to add long-term care insurance riders to annuity contracts and the new
law will likely encourage the development of combination products that
consolidate various insurance protections into a single product while
providing a savings feature.
The new law tightens the rules in
areas where Congress perceived abuses in charitable giving. And the
legislation permits tax-free IRA transfer rollovers directly to charitable
organizations for tax years 2006 and 2007. Only those taxpayers age 70 ½
and older can do this and the tax-free distribution is limited to $100,000
per year.
September 2006— This column is
produced by the Financial Planning Association, the membership
organization for the financial planning community, and is provided by
McGuire & Co., LLC, a local member of the FPA.
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