Date: Nov 17, 2006
What does the Pension Protection Act of 2006 mean for you? The bad news for American workers is that the Act dispels any illusions they might have had that their retirement needs would be taken care of substantially by their employers. The good news is that it's easier to plan for retirement. Steve Weisman shows you how this new law can benefit you.
The Pension Protection Act of 2006 that was signed into law by President Bush in August 2006 presents both good news and bad news for Americans looking forward to a secure retirement. The bad news for American workers is that the Act dispels any illusions they might have had that their retirement needs would be taken care of substantially by their employers. The day of the "defined benefit retirement plan" has passed. Now, the defined contribution plan, such as the 401(k), is king. The good news is that Congress has made it easier for people to do the kind of planning they need to do to provide for retirement.
Benefits and Detriments
The first positive step by Congress involves "sunsets." A sunset can be beautiful when you’re gazing at the sky. When the term sunset refers to the practice of Congress putting a termination date on advantageous laws, however, it’s not quite so beautiful. The federal government requires a certain amount of money to operate. When a tax break is granted to the public, Congress often puts a time limit on the availability of that particular tax break. By doing so, Congress can anticipate that future revenues needed to run the government will be restored at the end of a certain period. "Sunsetting" is the term for terminating such a law with a limited shelf life. Of course, this tactic can be highly misleading. Some might even call it "Enron accounting." However, in response to political pressure, Congress often makes previously "sunsetted" laws permanent—and that’s just what happened with many of the provisions of the Pension Protection Act of 2006. This is good news for you.
In 2001, Congress allowed for phased-in increases in the amount that people could contribute to IRAs. These increases, which were part of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRA), unfortunately were set to expire in 2010. Now, they not only have been made permanent, but also indexed for inflation. Taxpayers now can contribute $4,000 annually to an IRA, whether it’s a Roth IRA or a traditional IRA, while taxpayers who are at least 50 years old can play catch-up and contribute an extra $1,000. Previously, the catch-up provision was limited to $500.
These catch-up provisions in the Pension Protection Act of 2006 are particularly helpful for those of us who live by the motto of "not putting off until tomorrow what you can put off until the day after tomorrow," because unfortunately today is the tomorrow we should have worried about yesterday. In 2008, the annual IRA contribution limit will rise to $5,000 and then rise in $500 yearly increments thereafter to adjust for inflation. Unfortunately, the catch-up provisions for IRA contributions will not increase from the present $1,000. However, catch-up provisions for Americans 50 and over for SIMPLE-IRAs and 401(k) plans, which presently stand at $2,500 and $5,000 respectively, will be adjusted for inflation beginning in 2009.
Another new provision of the Pension Protection Act of 2006 that will make saving for retirement easier is the ability of a worker who leaves his job to roll his qualified retirement plan directly into a Roth IRA. Previously, that worker would have had to go through the additional complicated steps of first putting the retirement plan into a traditional IRA and then doing a conversion into a Roth IRA. This provision of the new law will become available in 2008.
Another benefit of the new law affects inherited 401(k) plans. In the past, a person who inherited a 401(k) plan from his or her deceased spouse was able to roll over the 401(k) funds into his or her own IRA and continue tax-deferred growth of the account. However, children and other non-spouses were required to withdraw the money (according to the terms of the company’s plan) in a lump sum, without the ability to roll the funds into an IRA. Starting in 2007, however, non-spouses such as children and unmarried partners will have the ability to roll over inherited 401(k) funds into an IRA, from which they will be required to take distributions based upon their age while they continue to defer taxes on the funds that remain in that IRA. So, for example, a 25-year-old who inherits his parent’s 401(k) can roll the money into an IRA and continue to defer taxes on that IRA for more than 58 years.
Taking Advantage of the New Laws
As always, the devil is in the details, and numerous technical requirements must be met to utilize the new retirement laws effectively. For example, with regard to the IRA rollover law for non-spouses, a non-spouse who inherits a 401(k) plan may not roll the money into an IRA in his or her name alone. The account must be designated as an inherited IRA and titled accordingly: "Fred Flintstone, deceased, IRA for the benefit of Pebbles Flintstone" is one example. This type of long title can save you the excise tax that would be tacked on if the IRA’s title didn’t include the name of the deceased original IRA holder along with the beneficiary's name.
The Pension Protection Act of 2006 also took some of the uncertainty away from Roth 401(k), a hybrid retirement vehicle that was introduced in 1998 but set to expire in 2010. Under the new law, this retirement savings program has been made permanent. The conventional Roth IRA that permits tax-free growth and withdrawal of funds has some income eligibility limits; in 2006, those limits are $110,000 of adjusted gross income for unmarried individuals and $160,000 for married taxpayers. However, the Roth 401(k) has no such income eligibility limits. This change presents a tremendous opportunity for people who would otherwise not be eligible for a Roth IRA to take advantage of the wonders of tax-free compound growth through a Roth 401(k) at work.
In all, the Pension Protection Act of 2006 contains more than twenty opportunities for retirement savings. There’s something for everyone, but not everything will be appropriate for everyone. Headlines never tell the whole story, and with retirement planning the important word is "planning." Although some of these changes in the law seem simple, they all have conditions, advantages, and disadvantages. Make sure that you fully understand any retirement vehicle you may be considering, but don’t delay. The sooner you plan, the sooner you save.