Articles
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,
2006, 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_ and older
can do this and the tax-free distribution is limited to $100,000
per year.
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