On August 17, President Bush signed into law the Pension Protection Act of 2006 (the Pension Act). While intended to stabilize traditional pension plans, this large, complex bill also makes permanent many of the tax-saving retirement and education opportunities established on a temporary basis by reform passed in 2001. In addition, this measure tightens some of the rules governing charitable donations.Traditional Pension Reform
Traditional pensions, or defined benefit plans, promise an employee a retirement benefit typically based on salary and years of service at a company. When troubled pension plans fail to meet their obligations, such as some in the airline industry, a greater burden falls on the Pension Benefit Guaranty Corporation (PBGC), the federal corporation that insures defined benefit plans.
To help alleviate pension-funding problems, this legislation raises the deduction limits for employer contributions and requires higher funding levels. This bill also stipulates that employers with at-risk plans adhere to stricter funding requirements and clarifies regulations for cash balance plans, which are hybrid plans incorporating aspects of traditional pensions and savings plans.Tax Breaks for Retirement Savings
In 2001, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) enhanced retirement opportunities, but these favorable provisions were set to expire in 2010. Thanks to the Pension Act, many of these valuable savings options are now permanent, including the following:
- Higher IRA contribution amounts: For 2006–2008, you may contribute a maximum of $4,000 to an IRA, or a combination of IRAs, and this amount rises to $5,000 in 2008. For 2009 and later years, this amount will be adjusted annually for inflation.
- Higher salary deferral limits for defined contribution plans: In 2006, you may defer as much as $15,000 to a 401(k), 403(b), or 457 plan. You may contribute up to $10,000 to a SIMPLE plan. These amounts will be adjusted for inflation in the future.
- Additional "catch-up" contributions: Those age 50 and older have an opportunity to accelerate their retirement savings with certain vehicles. The IRA catch-up is $1,000, and this amount will not be adjusted annually for inflation. The current $5,000 401(k) catch-up and the $2,500 SIMPLE catch-up will be adjusted annually for inflation in $500 increments.
- The Roth 401(k): EGTRRA permitted employers sponsoring traditional 401(k)s and 403(b)s to begin offering a Roth option in 2006. Contributions are made with after-tax dollars, earnings grow tax free, and distributions are tax free, provided the owner has reached age 59½ and has owned the account for at least five years. Thanks to the Pension Act, the Roth option is here to stay.
- Higher benefit levels for defined benefit plans: The annual benefit limit for defined benefit plans ($175,000 in 2006) will continue to be indexed for inflation annually.
In addition to making these EGTRRA provisions permanent, the Pension Act creates some new opportunities, including permitting employers to automatically enroll employees in 401(k) plans. However, employees must have the option to opt out of their company's 401(k) plan. The Pension Act also allows 401(k), IRA, and retirement plan providers to offer personalized investment advice to accountholders.
Under the new law, 401(k) participants are now able to make hardship withdrawals on behalf of any listed beneficiary. The old law limited this option to spouses and dependents.
The Pension Act also permits any beneficiary to roll over his or her interest in a qualified retirement plan, tax-sheltered annuity (TSA), or government plan to an IRA, upon the death of the account owner. Taxes will only be due when normal distributions are taken. Formerly, only spousal beneficiaries were permitted this option.
Beginning in 2008, you may roll over funds from a qualified retirement plan, TSA, or government plan directly into a Roth IRA, and the rollover will be treated as a conversion. You must satisfy all conversion requirements, including having income less than $100,000. In 2010, this income restriction will be eliminated.Charitable Giving Incentives and Restrictions
There is good news for those who wish to donate their IRA assets to charity. Through 2008, taxpayers may exclude from gross income up to $100,000 of IRA distributions that would otherwise be included, provided the distributions are given to qualified, tax-exempt organizations. Both traditional IRAs and Roth IRAs are eligible.
Cracking down on some abused loopholes, the Pension Act requires taxpayers to substantiate any cash or monetary gift donated to charity. Acceptable documentation includes a bank record or written communication from the charity, which specifies the amount and date of contribution, as well as the name of the charity. This change emphasizes the importance of getting a receipt for all charitable contributions. The Pension Act also tightens the rules governing non cash donations and stipulates that donations of clothing and household items must be in "good condition."No Sunset for 529 Plans
More and more taxpayers have been investing in 529 plans to help fund a college education. Contributions are made with after-tax dollars, but earnings grow on a tax-deferred basis. Distributions for qualified education expenses are currently tax free, but the provisions permitting tax-free distributions were set to expire at the end of 2010. The Pension Act permanently continues the favorable tax treatment for 529 plans.Top of Page