After much debate, the Pension Protection Act of 2006 has
become law. The new law contains many significant changes to the federal laws
governing traditional defined benefit pension plans, as well as defined
contribution plans (such as 401(k) salary deferral plans and profit sharing
plans) and Individual Retirement Accounts. The Act will have an impact on almost
every employer sponsoring a retirement plan and every employee participating in
a plan.
The new law also contains provisions that change some
important rules for income-tax charitable contribution deductions and exempt
charitable organizations.
This summary is intended to familiarize you with the new law.
However, since many of the changes are complex, you’ll want professional
guidance before acting on any of the law’s provisions.
Defined Benefit Plans
The Pension Protection Act (the “Act”) overhauls the rules affecting defined benefit
pension plans. The changes are generally effective for the 2008 plan year (with
some exceptions). The new law:
Reforms funding
requirements for single- and multi-employer plans.
Increases the tax
deduction limits for defined benefit plan sponsors, under certain conditions.
Changes the rules
for calculating lump-sum distributions from defined benefit plans.
Provides special
funding relief for specific industries, including airlines.
Restricts benefit
payouts with respect to underfunded plans and imposes significant tax penalties
on executives whose employers set aside or reserve assets in a nonqualified
deferred compensation plan when the employer’s defined benefit plan is
considered to be “at risk” or the plan sponsor is in bankruptcy.
The Act also affects so called “cash-balance plans” and other
hybrid retirement plans. For example, the Act imposes requirements on
conversions of defined benefit plans to hybrid plans, generally effective for
conversions occurring after June 29, 2005.
Pension Rules’ “Sunset” Reversed
The Economic Growth and Tax Relief Reconciliation Act of 2001
(EGTRRA) overhauled many retirement plan and IRA rules. Many of the changes were
set to expire after 2010, while at least one was due to “sunset” (expire) at the
end of 2006. Under the Act, the EGTRRA provisions relating to retirement plans
and IRAs become permanent.
Section 529 Plans
Certain changes made in EGTRRA regarding the tax treatment of
qualified tuition programs (so-called “529 plans”) were scheduled to “sunset”
after 2010, including the provision that qualified withdrawals from qualified
tuition accounts are exempt from income tax. The Act makes these changes
permanent.
Other Pension Provisions
Automatic enrollment. For plan years beginning on or after January 1, 2008, the Act provides
several incentives for sponsoring employers to adopt automatic enrollment in
their 401(k) plans.
Investment advice. The Act permits retirement plan service providers who offer investments
to the plan (“fiduciary advisers”) to recommend their own funds without
violating fiduciary rules, if certain requirements are met. The new rules are
generally applicable beginning in 2007.
New participant disclosure rules.
Among several changes: Defined
contribution plans must provide benefit statements at least quarterly to
participants who can direct their own investments and annually to participants
who cannot. Special requirements apply to the content of the statements for
participant-directed plans. The new requirements generally go into effect for
plan years beginning after 2006.
DB(k) Plans.
For plan years beginning in 2010 and later, an “eligible combined plan” will
allow 401(k) deferrals to be made to a defined benefit pension plan. Several
requirements apply.
Direct rollovers. Starting in 2008, participants will be able to make direct rollovers of
distributions from their qualified plans (e.g., 401(k) plans), 403(b)
tax-sheltered annuity plans, and governmental 457 deferred compensation plans to
Roth IRAs. The conversion will be taxable, but all future earnings on the Roth
IRA will be tax free, if all requirements are met.
Inherited benefits. Beginning in 2007, non-spouse beneficiaries of a decedent’s balance in a
qualified plan (such as a 401(k) plan) may roll over the inherited amounts to
their own IRAs. Previously, only surviving spouses could do this.
In-service distributions. For distributions in plan years beginning after 2006,
defined benefit plans can make in-service distributions to participants age 62
or older seeking to phase into retirement.
After-tax amounts. Beginning in 2007, the portability of after-tax retirement plan
contributions is expanded. The new law allows direct rollovers of after-tax
contributions between different types of employer plans (from a 401(k) plan to a
403(b) tax-sheltered annuity, for instance).
Tax refunds to IRAs. Starting in 2007, taxpayers can have all or part of their federal
income-tax refunds directly deposited into an IRA, within applicable limits.
Saver’s Credit.
The income limits applicable to the Saver’s Credit (a tax credit for
lower-income individuals who save for retirement) will be adjusted for
inflation. The law also makes the credit permanent.
IRA income limits. The income-related limits that apply to deductible contributions to
traditional IRAs and after-tax contributions to Roth IRAs are made subject to
inflation indexing.
Hardship withdrawals. Hardship withdrawals will be permitted for hardships of a person who is
a participant’s beneficiary under the plan, even if that beneficiary is not a
spouse or dependent. Similar rules will apply to unforeseeable financial
emergencies for beneficiaries of 457(b)/409A deferred compensation arrangements.
Charitable Contribution Provisions
The new law also makes several
changes applicable to charitable contribution deductions and charitable
organizations, including:
An income-tax
exclusion for otherwise taxable distributions of up to $100,000 paid to a
qualified charity from a traditional IRA or Roth IRA, provided the IRA owner is
at least 70½. This change would apply for 2006 and 2007.
An increase —
from 30% to 50% of a taxpayer’s “contribution base” (modified adjusted gross
income) — in the charitable contribution deduction limit for qualified
conservation contributions. The deduction limit rises to 100% of the
contribution base for eligible farmers and ranchers who specify that the donated
land remain available for agriculture or livestock production. This change also
would apply for 2006 and 2007.
Effective for
contributions made after August 17, 2006, disallowance of deductions for
charitable contributions of clothing and household items that are not in good
used (or better) condition.
A requirement
that monetary contributions of any amount made after 2006 be supported with a
bank record or a receipt from the charitable organization showing (1) the name
of the charity, (2) the contribution date, and (3) the contribution amount.
A tightening of
the rules governing charitable donations of partial interests in tangible
personal property (artwork, for example). Among the new rules: The charity would
have to receive complete ownership of the item within ten years or at the death
of the donor, whichever occurs first. This rule is effective for contributions
made after August 17, 2006.
The doubling of
excise taxes applicable to certain prohibited activities by charities, social
welfare organizations, private foundations, and managers of tax-exempt
organizations.
Summary
The Pension Protection Act of 2006 is one of the most significant pension laws
passed during the last 30 years. It is designed to preserve the pensions of
millions of American workers and to make it easier for employees to contribute
to, invest in, and transfer their retirement savings plan accounts. It will also
require sponsoring employers to meet more requirements. From a charitable-giving
perspective, the law provides new opportunities — and responsibilities.
If you
have questions about how the new law applies to your business or personal
situation, please let us know.
The information provided in the newsletter has been obtained
from sources believed to be reliable but its accuracy is not guaranteed.
