The New Pension Reform Act and You

By: The new law helps those workers saving for retirement, but may bring the curtain down on employer-funded pensions.; Christopher Gearon; Source: AARP Bulletin Date Posted: 2006-09-14 14:52:00-04:00

The most significant pension reforms in a generation, signed into law in August, offer added incentives and flexibility to workers who largely are saving for their own retirement, but may mark the end of an era for employer-funded worker pensions.

At first glance, much of the 907-page law is designed to strengthen traditional pensions by requiring companies to beef up financial contributions to fund their specific pension obligations. However, because of the higher financing requirements facing companies sponsoring traditional pensions, the law, say some experts, will likely spur companies to terminate defined benefit pensions.

"We'll see almost no new pension plans going forward for large firms," says Michael Kitces, director of financial planning for Pinnacle Advisory Group in Columbia, Md., "and see more employers shut them down or convert them."

The legislation protects older workers of companies determined to terminate their traditional pension plans from so-called wearaway—a practice in which companies freeze pension benefits after converting to a cash balance pension plan. Depending on how a conversion formula is set, older, longer-tenured workers may continue to work without earning new pension benefits.

John Rother, AARP's Director of Policy and Strategy, believes the message Congress is sending with the pension law is at least twofold.

"To employers, the message is you've got to put more money toward [pensions], and get serious on funding them," says Rother. "The message Congress is sending to workers is for most people, especially younger people, [retirement funding] is up to you."

But, adds Rother, "this legislation does not fix the problem that 50 percent of people don't have some type of pension."

For those who save for retirement in a 401(k), IRA or other defined contribution plan, Congress enacted or extended several favorable retirement savings measures. In addition to the retirement related benefits, the Pension Protection Act of 2006 also provides tax changes related to college savings for kids and grandkids, charitable giving and other areas. "The winners in general are anyone who wants to save for retirement, particularly those over age 50 who want to continue using the valuable catch-up contributions for years to come," says Steve Yeager, a Warsaw, Ind., financial adviser.

How the New Law Works for You

The Pension Protection Act of 2006 makes it easier for workers to start and contribute to a retirement savings plan in these ways:

Encouraging employers to enroll workers automatically in 401(k) or 403(b) savings plans. It ' s estimated that at least 12 million workers eligible for such plans haven ' t signed up. Until now, workers have had to proactively start retirement plans; now more will have to go out of their way to opt out of one. The law allows employers to earmark 3 percent of a worker ' s salary into a 401(k) and as much as 6 percent over time to help workers save more.
Giving taxpayers the option of depositing portions of their federal tax refund directly into an IRA. " It ' s really a painless way to make a contribution to an IRA, " says Sallie Olson, a CPA and retirement plan specialist with Aldrich Kilbride & Tatone of Portland, Ore.
Permitting 401(k) and other similar plan providers to offer face-to-face, personally tailored investment advice to help workers manage their retirement savings plans. The goal is to ease anxiety for workers not used to making investment decisions. The law takes several steps to prevent adviser conflicts-of-interest.

Continuing Tax-Friendly Savings Perks

As a result of the new law, several retirement savings incentives—originally passed by Congress in 2001 but set to disappear after 2010—now become permanent. Retirement specialists expect the changes to make long-range retirement planning more predictable and provide older workers enhanced options to beef up their nest eggs. These changes include the following:

Allowing workers in employer-sponsored 401(k), 403(b) and other similar plans to put up to $15,000 this year in pretax income in 2006, and higher amounts each year — based on inflation — beginning in 2007. Individuals with a regular IRA or Roth IRA — plans funded with after-tax money allowed to grow tax-free — can contribute up to $4,000 in 2006 and 2007, $5,000 in 2008, and even more in later years to reflect inflation. If you are 50 or older, you may increase these amounts by $1,000 each year.
Continuing to let workers 50 and older in 401(k) and similar retirement plans sock away, on a tax-deferred basis, an additional $5,000 this year and more in following years, based on inflation. That ' s $20,000 that an older worker can set aside pre-tax for retirement. " This especially helps those who have finally finished paying for college, " says Alice Orzechowski, a Frederick, Md., CPA. " They now have a few years to beef up their own retirement accounts. "
Making permanent the so-called Saver ' s Credit — which would have disappeared after Dec. 31 — which provides up to a 50 percent tax credit for low- and moderate-income families that contribute up to $2,000 a year to a retirement plan. " The Saver ' s Credit, if you ask me, is the equivalent of a government match " to your retirement savings, Yeager says. " Credits are much better than deductions; that ' s money in your pocket. "
Increasing the ease of transferring money between plans, including portability of after-tax contributions. For example, starting in 2008 it becomes easier to roll money from an IRA to a Roth IRA, and the new law gives employers enhanced options to offer Roth 401(k) retirement plans.

Changes for Giving, Saving, Planning

The reform law also contains several nonretirement changes.

Donating to charities: " The law dramatically changes certain rules, " Orzechowski says. " No deduction is allowed for cash, check or other monetary donations unless the taxpayer has a bank record or written acknowledgement from the charity. " No deduction either for clothing and household donations, unless they are in " good " condition, a term Congress did not define.

A good change: Those 70½ and older in 2006 and 2007 can make tax-free distributions from their IRA directly to a charity. "This new rule benefits taxpayers who do not itemize, as well as those who would be adversely affected by the normal restrictions and limitations on charitable contributions," Orzechowski adds.
Saving for college: The law permanently extends the rules and tax benefits of the Section 529 college-savings plans popular with those saving for their children ' s and grandkids ' educations.
Planning for long-term care: Beginning in 2010, the law allows individuals who have built up cash value in an annuity or life insurance policy to buy long-term-care insurance coverage without declaring the premium payments from the policy as income for tax purposes, and receive long-term-care benefits tax-free.

Additional Related Links

The Big Freeze (March 2006)

Pension Concerns (March 2006)

The Do-It-Yourself Pension (September 2005)

Glossary: Pension Terms (November 2003)