The newly-enacted Pension Protection Act of 2006 is the culmination of years of efforts to shore up unsound defined benefit plans and provide greater personal savings options for employees. But the new law goes much farther by also including several changes for charitable donations and college savings plans. Here are some select measures to note for this year, and for years to come.

Changes for 2006
Individuals age 70-1/2 and older who must take required minimum distributions from IRAs can opt in 2006 and 2007 to roll IRA funds over to a charity (up to $100,000 each year). Such distribution becomes tax free, although no charitable contribution deduction is allowed. Those taking advantage of this break may reap even greater tax benefits because the rollover minimizes adjusted gross income (AGI), the benchmark for determining eligibility for many other tax breaks (e.g., qualifying to convert a traditional IRA to a Roth IRA and deducting up to $25,000 of rental losses on residential reality). This rollover counts toward required minimum distributions.

Businesses, such as restaurants, groceries and farms, can contribute their food inventory to tax-exempt organizations and obtain a larger charitable contribution deduction than is usually permitted. As long as the food is “apparently wholesome,” donations in 2006 and 2007 by partnerships, S corporations or any other business entities qualifies for this break. Similarly, donations of book inventory to public schools, grades K through 12, by C corporations (no other types of business entities) qualify for an enhanced charitable contribution deduction in 2006 and 2007.

Get ready for 2007
Companies with 401(k) plans can obtain a guarantee of nondiscrimination by using automatic enrollment of employees. Doing this allows owners and highly-paid employees to maximize their elective contributions. To make automatic enrollment work, employers must make certain mandatory contributions for employees and give them the opportunity to opt out of participation (i.e., receive their full compensation rather than contributing a fixed portion of it to the plan).

Qualified retirement plans must allow non-spouse beneficiaries to roll over inherited benefits to an IRA. While surviving spouses can make a rollover to their own IRAs, non-spouse beneficiaries do not have the same opportunity. This means that non-spouse beneficiaries must start taking distributions from the IRA immediately, although
funds not withdrawn immediately will continue to enjoy tax-deferred growth. This change benefits plan participants who do not have spouses named as their beneficiaries.

Fiduciaries, such as mutual funds, can give plan participants and beneficiaries personalized investment advice. In the past, only generic advice was permissible; customized advice was penalized as a prohibited transaction.

Reporting to the government will become easier for some businesses. For plan years beginning on or after January 1, 2007, the annual return filing requirements for one-participant plans (e.g., profit-sharing plans for sole practitioners) will be eased. The IRS is directed to exempt plan reporting if assets at the end of the plan year do not exceed $250,000 (currently only plans with assets that do not exceed $100,000 in any year after 1993 are exempt from reporting). Also, the U.S. Department of Labor is directed to simplify its plan reporting requirements for plans with fewer than 25 participants for plan years beginning after December 31, 2006.

Down the road
Starting in 2008, funds in qualified retirement plans will be able to be rolled over directly to Roth IRAs (currently rollovers must go through traditional IRAs). Such transfers will be allowed in 2008 and 2009 only for individuals eligible to convert to Roth IRAs (i.e., those with modified adjusted gross income of no more than $100,000) -- there is no income limit starting in 2010.

Many favorable retirement plan rules, such as increased contributions limits to 401(k) and other qualified plans, the existence of Roth 401(k) plans, and the tax credit for small employers to start retirement plans, were scheduled to expire at the end of 2010. The Pension Protection Act makes these changes permanent. What this means:

  • Companies that had been leery of adopting Roth 401(k) s because of their temporary nature should now consider offering this option to employees. It allows employees to contribute money on an after-tax basis so that earnings can become entirely tax free later on.
  • Owners and other individuals in a position to fully utilize contribution limits will be able to stash more money on a tax-advantaged basis in qualified retirement plans and IRAs. Contribution limits, including limits on catch-up contributions by those age 50 and older, will be adjusted annually for inflation. Exception: The catch-up contribution for traditional and Roth IRAs, currently $1,000, will not be adjusted each year.

While this information covers several key points within the Pension Protection Act, it would behoove businesses to educate themselves to the new law.  Schedule a meeting with your accountant or other financial advisor to learn which provisions are critical to your organization and how the overall act can benefit not only your firm, but your employees as well.