The NAELA eBulletin -- October 3, 2006

A weekly newsletter by Robert Fleming, CELA; Professor Kim Dayton, and David McGuffey, CELA. The eBulletin is published by the National Academy of Elder Law Attorneys via email and on the Web at http://www.naela.org/applications/ebulletins/.

Contents
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Essay: 

1. The Pension Protection Act of 2006 by Jon Forman

Highlights of this Week's eBulletin

Jon Forman is the Alfred P. Murrah Professor of Law at the University of Oklahoma, vice chair of the Oklahoma Public Employees Retirement System (OPERS), and the author of Making America Work (Urban Institute Press 2006).  He wrote this piece especially for the NAELA E-Bulletin.

1.  The Pension Protection Act of 2006 by Jon Forman
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The Pension Protection Act of 2006 (Public Law 109-280) was signed into law by President Bush on August 17, 2006. It is the most significant pension legislation since the Employee Retirement Income Security Act of 1974 (ERISA). Among other things, the new law makes a number of retirement savings incentives permanent, toughens the funding rules that govern traditional pension plans, and authorizes 401(k) plans to provide investment advice and automatic enrollment of participants. These changes should help promote retirement income security.

First, the Pension Protection Act permanently extends a variety of pension and savings incentives that were scheduled to sunset in 2011. The annual limit on Individual Retirement Account (IRA) contributions will increase from $4,000 this year to $5,000 in 2008, and it will be indexed for inflation thereafter. The provision that allows individuals who are at least 50 years old to make an additional “catch-up” contribution of $1,000 a year is also made permanent. Also, starting in 2007, taxpayers will be able to have a portion of their income tax refunds directly deposited into their IRAs.

Similarly, the annual limit on 401(k) plan contributions has increased to $15,000 in 2006 (plus another $5,000 for those over age 50), and these amounts are indexed for future inflation. 

The Act also expands the saver’s tax credit for low- and moderate-income workers. The credit is equal to a percentage—50, 20, or 10 percent, depending on income level—of up to $2,000 of qualified retirement savings contributions ($1,000 maximum credit in 2006). The credit was scheduled to expire at the end of 2006, but the Act makes it permanent and indexes the income and rate levels for inflation.

Second, the Pension Protection Act toughens the funding rules that govern traditional “defined benefit” pension plans. One provision generally requires employers to fix any funding shortfall within seven years, and new disclosure rules give workers more information about the financial status of their pension plans. Moreover, poorly funded plans will be subject to limitations on benefit increases, lump sum payments, and shutdown benefits. Employers will, however, be able to deduct more in the years in which they can afford to make larger contributions.

The Act also makes it easier for employers to utilize cash balance and other innovative pension plan designs, and it allows employers to set up Roth 401(k) plans, under which employees will be able to designate their salary deferral contributions as after-tax Roth contributions.

Third, the Pension Protection Act encourages employers to automatically enroll employees in their 401(k) plans. Starting in 2008, employers will be able to satisfy the IRS’s so-called “nondiscrimination” test if they automatically enroll each employee in the 401(k) plan, withhold and contribute a few percent of compensation on behalf of those employees, and make small matching contributions. These 401(k) plans will qualify for favorable tax treatment, even if many employees instead elect to contribute at less than the target levels, or not at all.

Also, starting in 2007, employers will have an easier time providing investment advice to help their employees manage their 401(k) accounts. Employers will be able to provide investment advice through computer models that take into account the employee’s age, expected retirement age, income, risk tolerance, and other variables. Alternatively, investment advice could be provided by certain third-party experts on an individual basis, but only if that advice is based on a flat fee charged to each employee, regardless of the investments selected or amounts involved. Another provision protects plans that use a diversified stock and bond fund as the default investment, rather than an ultra-safe but low-yield, money market fund. The Act also requires plans that invest in publicly traded employer stock to allow employees to diversify their individual account holdings. In general, employees must have the right to diversify their own contributions immediately and must be allowed to diversify most employer contributions after three years of service. Together, these investment provisions should help employees get better rates of return on their retirement savings.

The Pension Protection Act also accelerates the vesting of employer contributions to 401(k) and similar plans. Starting next year, employer contributions need to be either 100 percent vested after three years of service (down from five years) or 20 percent vested after two years with an additional 20 percent vesting each year thereafter until 100 percent is vested after six years of service (down from three-to-seven-year graduated vesting).

Another provision facilitates phased retirement by allowing workers over the age of 62 to take in-service distributions from their traditional pensions. Eligible workers will be able to go from full-time to part-time work and receive pension benefits to maintain their current income levels. Also, 401(k) plans will be allowed to let participants make hardship withdrawals to help parents or other beneficiaries, even if those beneficiaries are not dependents or spouses.

The Act also includes a number of provisions that make it easier to fund health care and long-term care costs. For example, one provision makes it easier for pension plans to use excess assets to fund retiree health care, and another provision allows long-term care insurance to be offered as part of an annuity or life insurance contract.

Finally, the Act also includes a package of charitable giving incentives and loophole closers. For example, one provision allows tax-free distributions from IRAs for charities. Otherwise taxable distributions of up to $100,000 a year will be excluded from the IRA owner’s taxable income as long as the distribution is made after the owner has reached age 70½ and is made payable to the charity.

Another provision makes it harder to take a current deduction for contributions of a future interest in paintings and other collectibles. A charity receiving a fractional interest in tangible personal property must take complete ownership of the property within 10 years or the death of the donor, whichever is first.  In addition, the charity must take possession of the property and use it at least once during the 10-year period as long as the donor remains alive.

The Act also increases the penalties on taxpayers and charities that abuse the charitable contribution rules. Also, one provision denies the deduction for contributions of clothing and household items unless the items are in good condition, and another provision requires that donors have a receipt or cancelled check for all cash donations.

     Jon Forman can be reached at (405) 325-4779 or by e-mail at jforman@ou.edu