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PENSION
PROTECTION ACT OF 2006: Background The Pension Protection Act of 2006 amends numerous rules related to individual savings and benefit incentives. The amendments are numerous and sweeping, and affect individuals in current and future planning. Rollovers to Roth IRAs The Act amends the rules governing direct rollovers to Roth IRAs. The amendment allows direct rollovers of distributions from employer-sponsored tax-qualified plans, tax-sheltered annuities, and certain governmental plans to Roth IRAs. Distributions that are rolled over to Roth IRAs from qualified plans are subject to the same rollover rules and limitations that apply to traditional IRA distributions. Thus, for example, a rollover from a tax-qualified retirement plan into a Roth IRA is includible in gross income (except to the extent it represents a return of after-tax contributions), and the 10-percent early distribution tax does not apply. Similarly, an individual with AGI of $100,000 or more cannot roll over amounts from a tax-qualified retirement plan directly into a Roth IRA. (However, for tax years beginning in 2010, the $100,000 AGI limit on the conversion of a traditional IRA to a Roth IRA is eliminated.) The amendment applies to distributions made after December 31, 2007. Automatic 401(k) Enrollment The Act strongly encourages automatic enrollment in 401(k) plans. Under the Act, a 401(k) plan that contains an automatic enrollment feature that satisfies certain requirements (a "qualified automatic enrollment feature") is deemed to meet certain nondiscrimination tests, as well as the top-heavy rules. The administration of these tests and rules is often an expensive proposition for employers. An employer that wishes to take advantage of the new law must implement a “qualified automatic enrollment feature.” Under such a feature, the plan must provide that, unless an employee elects otherwise, the employee is treated as making an election to make elective deferrals equal to a stated percentage of compensation not in excess of 10 percent and at least equal to three percent of compensation for the first year the deemed election applies to the participant, four percent during the second year, five percent during the third year, and six percent during the fourth year and thereafter. The stated percentage must be applied uniformly to all eligible employees. An automatic enrollment feature must also require the employer to either (1) satisfy a matching contribution requirement, or (2) make a three-percent nonelective contribution to a defined contribution plan. Any matching or other employer contributions taken into account in determining whether the requirements for a qualified automatic enrollment feature are satisfied must vest at least as rapidly as under two-year cliff vesting. That is, employees with at least two years of service must be 100 percent vested with respect to such contributions. The automatic enrollment rules are generally effective for years beginning after December 31, 2007. Vesting Under present law, in general, a plan is not a qualified plan unless a participant's employer-provided benefit fully vests upon the completion of five years of service or pursuant to a seven-year graded vesting schedule. Faster vesting schedules apply to employer matching contributions. Employer matching contributions are required to fully vest after three years of service or pursuant to a six-year graded vesting schedule. Effective for contributions for plan years beginning after December 31, 2006, the Act applies the present-law vesting schedule for matching contributions to all employer contributions to defined contribution plans. Permanency of EGTRRA Pension and IRA Provisions The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) made many taxpayer-friendly changes to the Internal Revenue Code. It authorized catch-up contributions for older workers, increased contribution limits and benefits, made some retirement arrangements more attractive for small businesses, and expanded rollover options for taxpayers with 457 and 403(b) plans. Like most of EGTRRA's provisions, the enhanced retirement savings incentives were temporary and would have ended after December 31, 2010. However, the Pension Protection Act of 2006 repeals the sunset provision in EGTRRA that applies to retirement savings plans. The major EGTRRA retirement provisions that are made permanent rather than sunset at the end of 2010 include: · Permanent higher dollar amount for IRA contributions ($4,000 in 2006 and 2007, $5,000 in 2008, inflation adjusted thereafter). · Permanent higher dollar limits on defined contribution plans ($44,000 in 2006), elective deferrals (including $15,000 in 2006 for 401(k) plan deferrals) and compensation that may be taken into account under a plan. · Permanent catch-up contributions for older workers ($1,000 after 2005 for IRAs, $2,500 for SIMPLE plans, $5,000 for 401(k) plans). · Permanent faster vesting of employer matching contributions. · Permanent Roth 401(k) and 403(b) plans. · Elective deferrals not taken into account for purposes of deduction limits (enhancing the availability of so-called solo-401(k) plans). · Purchase of service credit under governmental pension plans. · Automatic rollovers of certain mandatory distributions. Government Plans and the Purchase of Permissive Service CreditA qualified retirement plan maintained by a State or local government employer may provide that a participant may make after-tax employee contributions in order to purchase permissive service credit, subject to certain limits. Permissive service credit means credit for a period of service recognized by the governmental plan which the participant has not received under the plan and which the employee receives only if the employee voluntarily contributes to the plan an amount (as determined by the plan) that does not exceed the amount necessary to fund the benefit attributable to the period of service and that is in addition to the regular employee contributions, if any, under the plan. The Act modifies the definition of permissive service credit by providing that permissive service credit means service credit which relates to benefits to which the participant is not otherwise entitled under such governmental plan, rather than service credit which such participant has not received under the plan. Credit qualifies as permissive service credit if it is purchased to provide an increased benefit for a period of service already credited under the plan (e.g., if a lower level of benefit is converted to a higher benefit level otherwise offered under the same plan), as long as it relates to benefits to which the participant is not otherwise entitled. In addition, the Act allows participants to purchase credit for periods regardless of whether service is performed, subject to the limits on nonqualified service. These provisions are generally effective as if they were included in the amendments made by the Taxpayer Relief Act of 1997. Hardship Distributions Distributions
from a 401(k) plan, a tax-shelter annuity, a Effective August 17, 2006, the Act directs the Secretary of the Treasury (i.e., the IRS) to revise the rules for determining whether a participant has had a hardship or unforeseeable emergency to provide that, if an event would constitute a hardship or unforeseeable emergency under the plan if it occurred with respect to the participant's spouse or dependent, such event will, to the extent permitted under the plan, constitute a hardship or unforeseeable emergency if it occurs with respect to a beneficiary under the plan. The provision requires that the revised rules be issued within 180 days after the date of enactment (August 17, 2006). Non-Spousal Beneficiary Rollovers Under present law, a distribution from a qualified retirement plan, a tax-sheltered annuity, an eligible deferred compensation plan of a State or local government employer, or an IRA generally is included in income for the year distributed. However, certain distributions (“eligible rollover distributions”) may be rolled over tax-free within 60 days to another plan, annuity, or IRA. Certain distributions may not be rolled over. For example, minimum required distributions cannot be rolled over to another plan. Under current law, a potential inequity results from the application of the foregoing rules in the case of the death of an IRA owner or plan participant. For example, if a plan participant dies before minimum distributions have begun, then either (1) the entire remaining interest must be distributed within five years of the death, or (2) distributions must begin within one year of the death over the life (or life expectancy) of the designated beneficiary. A retirement plan sponsor may decide to apply the five-year rule to the participant’s designated beneficiary, and make an immediate distribution to the beneficiary. Unless the beneficiary is the participant’s surviving spouse, immediate taxation could occur. Unlike surviving spouses, non-spouse beneficiaries cannot take advantage of a tax-free rollover by rolling the amounts to an IRA. Effective for distributions after December 31, 2006, the Act eliminates this inequity by providing that such distributions to a non-spousal beneficiary may be transferred directly to an IRA. As such, the beneficiary will be able to take distributions over his or her life expectancy rather than over a five-year period. The Act clarifies, however, that the benefit is limited in this regard. The IRA will be treated as an “inherited” IRA of the non-spouse beneficiary, and not as the beneficiary’s own IRA. (A surviving spouse can treat a rollover IRA as his or her own IRA, permitting yet greater flexibility.) Tax Refunds and IRAs Under current IRS procedures, a taxpayer may direct that his or her tax refund be deposited into a checking or savings account with a bank or other financial institution (such as a mutual fund, brokerage firm, or credit union) rather than having the refund sent to the taxpayer in the form of a check. Under the Act, the IRS is directed to develop forms under which all or a portion of a taxpayer's refund may be deposited in an IRA of the taxpayer (or the spouse of the taxpayer in the case of a joint return). The new provision does not modify the rules relating to IRAs, including the rules relating to timing and deductibility of contributions. The new form required by the Act is required to be available for taxable years beginning after December 31, 2006. In-Service Pension Distributions In general, a pension plan (i.e., a defined benefit plan or money purchase pension plan) may not provide for distributions before the attainment of normal retirement age (commonly age 65) to participants who have not separated from employment. Effective for distributions in plan years beginning after December 31, 2006, the Act provides that in-service distributions may be made to an employee who has attained age 62 and who is not separated from employment at the time of the distribution.
A qualified tuition program generally is exempt from income tax. Contributions to a qualified tuition account are not deductible by the contributor or includible in income of the designated beneficiary or account owner. Earnings accumulate tax-free until a distribution is made. If a distribution is made to pay qualified higher education expenses, no portion of the distribution is subject to income tax. If a distribution is not used to pay qualified higher education expenses, the earnings portion of the distribution is subject to Federal income tax and a 10-percent additional tax (subject to exceptions for death, disability, or the receipt of a scholarship). A contribution to a qualified tuition account (or with respect to a prepaid tuition contract) is treated as a completed gift of a present interest from the contributor to the designated beneficiary. Such contributions qualify for the per-donee annual gift tax exclusion ($12,000 for 2006). A contributor may contribute in a single year up to five times the per-donee annual gift tax exclusion amount to a qualified tuition account and, for gift tax purposes, treat the contribution as having been made ratably over the five-year period beginning with the calendar year in which the contribution is made.
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Summary As you can see, the Pension Act made a number of important changes, several which may have an impact on your savings posture. While the foregoing summary is intended to be an accurate account of the new law, it is not intended to be tax advice. As such, you should consult with the text of the new law, as well as its legislative history and tax counsel, for specific guidance. As always, we would be pleased to assist you before you act on any information contained in this letter. For additional guidance, or if you would like to discuss how this will affect your tax planning, please contact our firm at (412) 881-4411. If you do not have a contact at Case | Sabatini, simply ask for Jim Dee and he'll make sure to put you in touch with the CPA whose background most closely matches your needs. Visit Case | Sabatini's Home Page. Disclaimer: To ensure compliance with requirements imposed by the Internal Revenue Service, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding any penalties that may be imposed, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. |
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