2006 Tax Legislation Update

What You Need to Know About the Pension Protection Act of 2006

As you might expect from its name, the Pension Protection Act of 2006
(PPA) attempts to protect workers by imposing new regulations on
employer pension plans. It tightens minimum funding requirements and
places restrictions on employers that don’t, or can’t, comply with the
funding rules for defined benefit plans. Most of these new pension rules
won’t take effect until 2008.
However, the PPA also provides new benefits for savers, more flexible
withdrawals and rollovers, and makes permanent some savings incentives that
were previously scheduled to expire. Some of these provisions take effect
immediately. Here’s a summary of some upcoming changes.
Provisions Taking Effect in 2006

Tax-Free Direct Gifts to Charities

In 2006 and 2007 only, IRA owners 70½ and older can make tax-free
direct gifts of up to $100,000 each year from an IRA to qualifying charitable
organizations. Distributions to qualifying organizations can be used to satisfy
minimum distribution requirements. These charitable distributions are not
deductible; however, they are also not considered taxable income.
Penalty-Free Withdrawals for Reservists and Guardsmen
Premature withdrawals from certain qualified retirement plans and IRAs will
be penalty-free for reservists and members of the National Guard who are
called to active duty for at least 180 days. Distributions made while called to
active duty may be redeposited within two years after the end of the active
duty period. This provision applies to anyone ordered or called to active duty
after Sept. 11, 2001, and before Dec. 31, 2007. Affected personnel have up
to a year to request a tax refund for previous tax overpayments related to
premature withdrawals.
Saver’s Credit
The Saver’s Credit — a retirement savings income tax credit for lower-income
workers — is now available indefinitely rather than expiring after 2006. The
adjusted gross income (AGI) limit for eligibility is $50,000 for joint filers
($25,000 for singles), but beginning in 2007 it will be indexed for inflation in
$500 increments.

Penalty-Free Withdrawals for Public Safety Employees
Police officers, firefighters and emergency medical technicians
can now take penalty-free retirement plan withdrawals
as early as age 50 (down from age 55) if the employee
separates from service and he or she participates in a government
pension plan with a Deferred Retirement Option
Plan (DROP) benefit feature.

IRAs and Qualified Retirement Plans

• The law extends availability of the higher contribution limits and catch-up contributions introduced in 2001 for traditional and Roth IRAs and qualified retirement plans (see tables below) and indexes them for inflation. Without Congressional action, the higher limits and the ability to make catch-up contributions would have expired after 2010. As a result, Congress has preserved your ability to invest substantial amounts for your retirement. Keep in mind that based on these higher contribution limits plus catch-up contributions beginning at age 50, a 30-year old making the maximum IRA contributions annually could accumulate more than $1 million in his or her IRA by age 65.

• The definition of a hardship withdrawal now includes hardships suffered by the beneficiary of a 401(k). The beneficiary does not have to be a spouse or dependent. (This rule is effective when the IRS writes the regulations but no later than 180 days after PPA’s enactment.)

529 Plans
Qualified higher education withdrawals from Section 529
plans will continue to be tax-exempt. Under previous law,
qualified withdrawals after 2010 would have been taxed at
the beneficiary’s rate. Qualified withdrawals must be used
for tuition, fees, room and board, books, supplies, and
equipment required by a higher educational institution.

Provisions Taking Effect in 2007
Individual Retirement Accounts (IRAs)

• The law will make it easier for workers to save for retirement by letting taxpayers have all or part of their income tax refunds deposited directly into their IRAs.
• Rollovers from qualified retirement plans into inherited IRAs (also known as “for-benefit-of” or “FBO” IRAs) by nonspouse beneficiaries will be allowed. For example, children who are beneficiaries of a parent’s 401(k) will be able to roll the deceased parent’s retirement plan assets into an FBO IRA and stretch out distributions over the beneficiary’s life expectancy.
• Eligibility for Roth IRAs and deductibility of traditional IRA contributions are subject to limits based on a taxpayer’s modified adjusted gross income (MAGI). These MAGI limits will be indexed for inflation in $1,000 increments.

Investment Advice Rule
Qualified fiduciary advisors will be permitted to offer personal investment advice to participants in employer sponsored retirement plans. The investment
advice arrangement must provide that advisors’ pay will not vary depending on investment alternatives selected or that an unbiased computer model — certified by an independent
expert — will be used to generate recommended portfolios. The bill also directs the Department of Labor to determine the feasibility of applying computer models
to IRAs.

Defined Benefit and Defined Contribution Plans

• Defined benefit plans will be able to provide in-service withdrawals to employees who are at least age 62. Plan sponsors will also be required to periodically provide participants with benefit statements.
• All employer contributions to defined contribution plans (including nonmatching contributions) will be required to vest either 100% after three years or at a rate of 20% per year from years two through six.
• For plan years beginning on or after Jan. 1, 2007, simplified annual filing requirements will be available for retirement plans with fewer than 25 participants. One participant plans with less than $250,000 in assets will be exempt from annual filing requirements.
• Any defined contribution plan holding publicly traded employer securities will be required to permit participants to diversify out of employer stock beginning in 2007. The plan will also be obligated to offer at least three additional materially different investment alternatives. And the employer will need to provide participants with 30-days’ advance notice of their diversification right.

Provisions Taking Effect in 2008

401(k) and other Deferred Compensation Retirement Plans

• PPA clarifies how employers may automatically enroll their employees in 401(k) plans. This rule is expected to dramatically increase participation in these retirement savings vehicles.
• Direct rollovers of 401(k) plans and other qualified plans into Roth IRAs will be allowed. This change will eliminate the need to roll qualified plan assets into a traditional IRA first. Eligibility requirements (for example, MAGI cannot exceed $100,000) and tax consequences when executing a Roth conversion remain unchanged.

Defined Benefit Plans

• The minimum funding standards will be revamped by replacing the minimum funding standard accounting rule and the deficit reduction contribution (DRC) for certain plans with a single minimum funding calculation.
• Disclosure requirements will be enhanced, including new required notices to plan participants highlighting detailed information on plan funding.
• Interest rate assumptions used in calculating lump sum distributions from defined benefit plans will change. Current rules, which will remain in effect for 2006 and 2007, use 30-year Treasury rates. From 2008 through 2011, a participant’s lump sum will be determined based on a mixture of the corporate bond yield curve and the 30-year Treasury rate. Full implementation of the corporate bond yield curve will begin in 2012.
• Defined benefit plans that are less than 60% funded will not be able to pay lump sum distributions. In years in which plans are at least 60% but less than 80% funded, limited lump sum distributions will be allowed.

Conclusion

As with other far-reaching pieces of legislation, additional
guidance and further details regarding implementation
and oversight of these provisions is expected. Be sure to
consult your personal or business tax and legal advisory
team as you take advantage of these new investment
opportunities. Most important, take steps now to benefit
from the new resources, vehicles and tools available to
help build your nest egg.