The bulk of the Pension Protection Act is designed to force employers to shore up their pension plans. Many pensions are underfunded, which means that promised pension benefits could potentially exceed the funds available, leaving pensions strapped for cash. The Pension Protection Act of 2006 "requires most pension plans to become fully funded over a seven-year period" starting in 2008, according to a CCH Tax Briefing. To achieve full pension funding, the new law allows employers to deduct the cost of making additional contributions to fund the pension, provides strict funding guidelines, and imposes a 10% excise tax on companies that fail to correct their funding deficiencies.
IRA, 401k, and other Retirement Plan Provisions
The Pension Protection Act provides or extends over 20 tax benefits for other retirement savings. Employers are now allowed to automatically enroll their employees into a 401k retirement plan with default contribution levels. Employees will need to opt-out of the 401k if they don't want to utilize the 401k plan. Military personnel who are called to active duty can now take a penalty-free withdrawal from their 401k or IRA if they are called to active duty between September 11, 2001, and December 31, 2007. The IRS will allow these individuals to re-deposit the withdrawal up to two years after the end of their active duty and thereby avoid paying income tax on the withdrawal. The new law also makes it much easier to make hardship withdrawals from 401k plans. The new law also allows hardship withdrawals "with respect to any person listed as a beneficiary under the 401(k) plan," according to CCH.
Additionally, there's an important new provision for non-spouse beneficiaries of a retirement plan. The new law allows non-spouse beneficiaries to roll over assets inherited from a qualified retirement plan into an IRA. The beneficiary will avoid tax on the rollover, and will be taxed only when the assets are withdrawn. Previously, this tax treatment was available only for people who inherited retirement assets from a deceased spouse. The new law will mean more flexible retirement and estate planning for non-spouse beneficiaries, such as domestic partners.
The Pension Protection Act allows a direct rollover from a 401k to a Roth IRA, with the rollover treated as a Roth conversion.
The new law extends a number of retirement benefits. IRA contributions will be $4,000 in 2006 and 2007, $5,000 in 2008, and adjusted for inflation after 2008. Catch-up contributions for individuals age 50 or older will be $1,000 for IRAs, $2,500 for SIMPLE-IRAs, and $5,000 for 401k plans. IRA catch-up contribution limits, however, will not be adjusted for inflation. SIMPLE and 401k catch-up contributions will be adjusted in $500 increments based on inflation.
The new law permanently allows for Roth 401k and Roth 403b plans. Under previous tax law, Roth-type 401k and 403b plans were not allowed after 2010. The new law removes this sunset provision. Like a Roth IRA, an individual makes post-tax contributions to a Roth 401k or Roth 403b plan, up to the plan limits. The assets grow tax-deferred and may be withdrawn tax-free in retirement.
The new law also permanently allows the Retirement Savings Tax Credit, which would have expired at the end of 2006.
Stricter Rules on Charitable Donations
The Pension Protection Act toughens the tax laws for charitable donations. Under the new law, taxpayers must keep records of all cash donations. Individuals must show a receipt from the charity, a canceled check, or credit card statement to prove their donation. No tax deduction will be allowed if the taxpayer cannot provide any supporting documentation. Taxpayers will not need to mail in the receipts with their tax return. Instead, taxpayers will need to keep receipts and other documentation with their copy of the return in the event of an IRS audit.
The new law also toughens the rules for non-cash donations. Donated items, such as cars, clothing, and household goods, must be in good condition. "The new law does not define 'good condition,'" according to CCH. No tax deduction is allowed for items in less than good condition. Kay Bell provides this word of warning, "Perhaps the IRS will, at least for a while in this new requirement's initial stages, start pulling more returns that list donated property and asking filers to confirm the worth of their gifts."
Charitable IRA Donations
The Pension Protection Act allows taxpayers over 70.5 years old to donate money to charity directly from their IRA account. The distributions will be tax-free and avoid the penalty on early withdrawals. Taxpayers are allowed to donate up to $100,000 per year from their IRA. Since the distribution will not be included in taxable income, individuals will not be able to claim a tax deduction for the charitable contribution. This provision will be effective for the years 2006 and 2007 only.
- CCH Tax Briefing: Congress Passes Comprehensive Pension Reform Bill (PDF, 8 pages)
- RIA News Briefing: House and Senate Pass "Pension Protection Act"
- Joint Committee on Taxation (Congress): Technical Explanation of H.R. 4 (PDF, 386 pages)
- Joint Committee on Taxation (Congress): Estimated Budget Effects of H.R. 4 (PDF, 8 pages)
- Library of Congress: Pension Protection Act (HR 4) Legislative Information
- Kay Bell: A closer look at charitable giving
- Kay Bell: Some welcome tax breaks (in the Pension Protection Act)