By Kay Bell • Bankrate.com
-- Posted: Aug. 16, 2006
It took federal lawmakers almost two years of debate, half a dozen stabs at earlier legislation and an end-of-session deadline to finally agree on a law designed to shore up company pension plans.
But buried in the 900-plus pages of the Pension Protection Act of 2006 are several tax provisions that will benefit individuals who do their own golden years' saving.
The law also contains welcome news for folks looking for ways to cover the high cost of college. The philanthropic, however, face some new, good and not-so-good donation guidelines.
Defined-contribution plans get a lot of attention in the new pension law. These are company-sponsored retirement plans such as 401(k)s, which help you save for tomorrow while simultaneously reducing today's tax bill.
These retirement plans require employees to take an active part in saving for their post-work years. That, say financial experts, poses a couple of challenges.
Many workers invest their 401(k) money too cautiously or worse, they don't put any money at all into the plan. The new pension law will change that.
1. Sign right up, automatically
"Historically, with 401(k) plans, you affirmatively elected in," says Mark Luscombe, principal tax analyst at CCH, a tax publisher and software provider. "Now companies will be permitted to assume you're in unless you choose otherwise."
Workers who are "kind of lazy about doing anything for retirement" could find this a good move, says Bob D. Scharin, senior tax analyst with RIA, a Thomson business and provider of tax information and software to tax professionals.
But will it work?
"Whether it will actually increase participation, we'll have to wait and see," says Luscombe. "Some workers, when they see a cut in their paycheck, might barge in and elect out."
Some companies are already automatically enrolling employees in savings plans, but the new law clarifies the situation. It offers employers additional guidance and makes it easier for companies to institute the system beginning in 2008.
While such a system might mean more work for a business, Luscombe says some companies might choose that method because it could provide benefits for upper-level employees.
To prevent company plans from disproportionately benefiting higher-income workers, federal nondiscrimination rules require that companies make sure their plans represent all employee levels.
"When there's greater plan participation by workers in the lower pay ranges, employees with larger salaries are allowed to also contribute more," says Luscombe.
2. Investment advice
When companies automatically enroll employees in 401(k)s, expect the default plan to be one that doesn't pose too big a risk. Such plans, however, also tend to offer lower, and slower growing, returns.
Many workers, when given a choice, already pick "safer" 401(k) options. For some, that's a wise move. But it's not right for all.
In an effort to help employees determine which plan best suits their needs, the new law allows for workers to get investment advice regarding their various company-sponsored options.
However, any fees or commissions for the advice cannot be based on the savings plan a worker chooses. This prohibition was included in the new law to answer concerns that advisers would guide workers toward plans that benefit the fund company more than the employee. Expect companies, workers, consumer groups and Uncle Sam to be closely monitoring how well this safeguard works.
3. Refunds to retirement
If you have an IRA, in addition to your company retirement plan, the pension law wants to help you add to that, too. When you get your tax refund next year, you can tell the IRS to deposit it directly into your IRA. The IRS has been sending refunds to filers' checking and savings accounts for years. Now IRAs will be added, along with new Form 8888 that will let you split and deposit a refund into as many as three accounts.
Some tax-prep companies were already providing the direct-to-IRA service, says Luscombe, but there was concern about the associated fees. Now individuals can accomplish it themselves, but Luscombe's "suspicion is that a lot of people won't take advantage of this."
4. Easier rolling into Roths
Since the Roth IRA appeared in 1998, thousands of retirement savers have been drawn to its tax-free earnings and withdrawal potential. But the plans pose a problem for workers who want to take their company retirement accounts with them when they leave jobs.
Currently, you must put your former workplace's 401(k) or similar-plan money into a traditional, individual retirement account. The reason: Both the traditional IRA and company account contain tax-deferred contributions and earnings, so they are treated the same under the tax code; i.e., you'll pay taxes on the money when it's withdrawn.
Once all the money is in a traditional IRA, then you can convert that account to a Roth. The new pension law cuts this two-step process in half.
Beginning in 2008, you can directly roll defined-contribution-plan money into a Roth IRA. You'll have to meet the other Roth conversion requirements, such as making less than $100,000. And taxes on the converted amounts will still be assessed. But those tax calculations will now be done as part of the simpler, one-step transfer.
5. Permanent IRA contribution levels
Contributions to all IRAs got a boost in 2001 when major tax-law changes increased the amounts individuals are allowed to contribute to these accounts: $4,000 this year and next; $5,000 in 2008; adjusted for inflation after that.
But those amounts will drop back to the $2,000 level in 2010. And the catch-up provision that now allows workers age 50 or older to add another $1,000 to an IRA would have disappeared.
Such future contribution worries are no more. Current IRA contributions levels and catch-up allowances, as well as similar provisions at greater levels for 401(k)s, will be permanent, thanks to the pension law.
