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William Perez

The Pension Protection Act of 2006 offers retirement tax breaks, tough rules on charity

By August 10, 2006

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The House of Reprensentatives and the Senate have both passed the Pension Protection Act of 2006 (H.R. 4, Public Law 109-280), a massive tax law aimed at strengthening pension funds and providing a multitude of other tax changes. The President signed the bill into law on August 17, 2006. Here's a summary of the major tax law changes enacted in the Pension Protection Act.

Pension Provisions

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.

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Comments
August 17, 2006 at 7:48 pm
(1) Shannon JOnes says:

According to an article I read on CNNMoney site, catch up provisions WILL be adjusted for inflation. Which information is correct?

August 17, 2006 at 8:41 pm
(2) taxes says:

Catch-up contributions for SIMPLE-IRAs and 401k will be adjusted for inflation. IRA catch-ups, however, won’t be.

September 7, 2006 at 4:33 pm
(3) Barbara Williams says:

I have read in several other places that the charitable IRA rollover is for those aged 70 1/2 and over and anyone under 59 1/2 WOULD be penalized for premature distribution. Which information is correct?

October 25, 2006 at 11:46 pm
(4) TAX GUY says:

Barbara. You are correct. The exclusion is only available to distributions made on or after the date on which the donee reaches the age of 70.5. As such, there will never be a situation where the exclusion allows avoidance of the early withdrawal penalty.

November 8, 2006 at 2:08 pm
(5) Ann says:

Is there ANY way an employee can roll contributions out of a poorly performing 403b WITHOUT leaving their job?

November 27, 2006 at 1:02 pm
(6) Jessica says:

I work for a financial planner and Allianz is telling us that the contribution to a charity (Pension Protection Act) will have taxable income. They have learned this from their legal dept. and accountant. Do which is correct?

December 8, 2006 at 9:38 pm
(7) Roger Glynn says:

I believe that the ‘About’ article on the pension act should be updated to remove the impression that people under 70.5 can avoid the income tax for distributions to charitable organizations. This incomplete description could be very confusing and potentially costly (notwithstanding disclaimers, etc).

December 8, 2006 at 9:53 pm
(8) taxes says:

I have updated the paragraph about the Charitable IRA Donation. Thanks for pointing this out!

December 21, 2006 at 8:43 am
(9) robert c. bressman says:

the pension plan act of 2006 requires employers to be fully funded after 2008 what if your plan is only funded at 55% now, can your company cut your benefit before 2008?

December 29, 2006 at 10:23 am
(10) Mike Reynolds MBA, CPA says:

The sleeper in the bill is the provision reducing retiree lump sum benefits in defined contribution plans that use the 30 year T-Bill rate in the lump sum formula. The lump sum benefit reduction begins in 2008.

September 11, 2007 at 11:48 pm
(11) Glenn DaGian says:

If a company has a fully funded pension (defined-benefit)plan and now uses the 30year T-Bill rate in it’s lump sum formula, will the new 2006 Pension Reform Act mandate using the corporate composite bond rate in new lump sum calculations?

October 7, 2007 at 6:36 pm
(12) Linda Brown says:

Regarding non-spouse beneficiaries of a retirement plan…are there any time-sensitive dates regarding when it was inherited, etc. Let’s say a non-spouse inherited a qualified SIP in 2004 and it has been left there since that date. Since the inheritance was prior to the Pension Protection Act, is it still able to be rolled into an IRA (assuming that it is still with the original investment company)? Also, are there any special rules that apply to the new IRA or is it treated just like a regular one?

October 16, 2007 at 10:13 am
(13) Jeff McLeod says:

One benefits of the Pension Protection Act is due to expire 12-31-2007. The charitable deduction of $100.000 for Individual Retirement Accounts (IRA). Why was this given such a short time period?

November 8, 2007 at 10:49 am
(14) susan schroeder says:

My employer has just provided info on changes to our cash balance pension plan—including “IRS compensation limits” and and instead of investement choices (now restrieted to balances through 12-31-2007), we are to earn interest based on 10 year US Treasury Notes. What’s going on here? Does this indicate my company’s plan is under-funded?

January 15, 2008 at 9:04 am
(15) Fred says:

Under the Act, can I retire from my company, receive my pension, and be rehired by the company through a third party without impacting my pension?

Thanks

February 4, 2008 at 8:34 pm
(16) TOM says:

My company has always promised retirement for 30 years of service regardless of age…Now with the PPA, I received a letter from the union stating the company and union can choose to eliminate the unreduced early retirement benefit with 30 yrs of service; allowing early retirement at age 55yrs only with benefits reduced at 0.6% for each month that benefits commence prior to normal retirement age…I am two years away from getting my 30 years , and have only stayed with this company because of the early retirement…I thought the PPA was supposed to help workers not harm them..

February 13, 2008 at 8:18 am
(17) Chris says:

Well we had a really good pension at work but due to all these regulations it is being stopped. Thanks all you short sited politicians. A couple of jokers rip off some people and we get Sarbannes Oxley and this. What a joke.

August 8, 2008 at 7:32 pm
(18) Dale McCann says:

What is the possibility that the direct charitible contributions from IRA accounts for people 70 1/2 may be reinstated for 2008 and additional years?

August 16, 2008 at 6:32 pm
(19) unlawflcombatnt says:

I just heard from one of my forum members that if a pension plan is undefunded, they can reduce the amount of their lump-sum benefit.

Is that correct?

September 3, 2008 at 5:45 pm
(20) Richard says:

Can I begin receiving distributions from my employer while still employed and at what age? Also, what information do I need to give my employer who will most likely reply that they have never heard of this. Thanks, Richard

November 11, 2008 at 9:22 pm
(21) Bill Flanders says:

I am currently collecting a pension from my first job which I started receiving at the age of 55. I live in NJ and pay taxes on my pension.
Are there states that do not tax pensions and, if so, which states are they and how much % of my pension would I save by moving to one of those states?

July 8, 2009 at 12:42 pm
(22) Mike Thomas says:

I am told by a previous employer that I must be gin taking the SRIP part of retirement at 55.

Is this law?I don’t wish to take because of the severe reduction because of age.

July 8, 2009 at 2:01 pm
(23) William Perez says:

You’ll have to read the plan documents for your employer’s particular retirement plan. I’m not too familiar with SRIP plans, but from what I’ve read they seem to be an alternative pension plan that is customized-designed by the employer. You may also want to consult with a financial planner who may be able to read over the plan documents with you and advise you more properly.

October 5, 2009 at 9:40 pm
(24) deb says:

I left a company in 1996. Is is true that you can no longer request a lump sum pension amount if it was left with the company prior to 2005?

January 20, 2010 at 4:11 pm
(25) Janice Steelman says:

I was told by the Princile Financil Group, that I had to fill out a form, stating I would take an annuity for my money I put in on my Pension fund, in case they didn’t have the money to pay me my lump sum, because of the Pension Protection Act of 2006,Iust hope I get what I paid in. My employers money I am taking in annunities.

June 8, 2010 at 2:34 pm
(26) Stephanie says:

There’s a spelling mistake in the first line.

June 12, 2010 at 6:32 am
(27) JayJay says:

Can I pay off my retirement home with retirement funds?

October 30, 2010 at 2:08 pm
(28) marie lord says:

i am 70 yrs of age and injured at work. My company
put me on mandatory sick leave and it looks as if i
will not make it back to work at their timeline.
I want to draw out the entire amt of my retirement fund which is a 403b plan. It is disallowed as i have greater than 5 thousand in the fund. They could
pay one lump sum of 5000 but not anything greater than
this.
Please advise

July 21, 2011 at 12:12 am
(29) Douglas says:

My wife was fired in 2009 after 17 yrs with the company.. They let her take a 50% lump sum distibution of her retirement. To this day they maintain the other 50%,..paying interest @ approx 4%. Is this legal?,..The company say its due to the PPA of 2008…Thanks for any info..

May 18, 2012 at 10:44 am
(30) bella says:

Does any one ever answer these questions. There are some good ones I would like to get the answer to them.

January 31, 2013 at 1:32 pm
(31) Joan says:

I have a qualified IRA annuity contract. I am currently unemployed so now my exwife has a court order to garnish my IRA. I was undern the impression that qualified plans are protected against claims
Are they?

October 25, 2013 at 2:37 pm
(32) henry l leitz says:

Question????
How can I protect my IRA from these slim-bags in Washington who want to pass legislation to transfer it to a government GRA? Is there any solution? Henry

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