Highlights from the New
laws containing tax provisions, the title of the newly passed
Pension Protection Act of 2006 only tells part of the
story. The legislation, which President Bush signed on August
17, 2006, does contain numerous provisions involving pension
plans, but it also includes changes in
the tax rules for
charitable contributions, college savings plans, and
more. Here are eight highlights from the massive piece of
legislation spanning more than 900 pages.
Unfavorable New Rule
Corporate-Owned Life Insurance
corporate owned life insurance (COLI) issued after the
August 17, 2006 enactment date of the Pension
Protection Act, an unfavorable new provision
generally requires businesses to include death benefit
proceeds (in excess of premiums paid) in taxable
Exceptions apply in any of
the following situations:
The insured individual was employed
within 12 months of the date of death.
The death benefit proceeds are paid to
buy back certain equity ownership
insured individual was a "highly compensated employee"
when the COLI contract was issued. A highly compensated
employee is defined as someone who is a more-than-5
percent owner, a director, or any employee ranked in the
top 35 percent by pay.
For Public Safety
Pension Protection Act creates a new exemption
from the 10 percent premature withdrawal penalty tax for
early distributions from government defined benefit
pension plans to qualified public safety employees who
leave their jobs after age 50. Under the normal rules,
the 10 percent penalty tax generally applies to those
who leave jobs before age 55. The new exemption applies
to eligible distributions after August 17,
Taxpayer-Friendly Retirement Plan
Rules Are Now Permanent
Thankfully, the new law eliminates
uncertainty when it comes to saving for retirement. The reason
has to do with numerous rules that were set to end in the
Background: Under a tax law
passed in 2001, a host of beneficial rules for retirement
plans and accounts were scheduled to expire after 2010 under a
ďsunsetĒ provision. For 2011 and beyond, the less-favorable
rules were scheduled to kick back in.
Pension Protection Act now makes the tax breaks
permanent. This is welcome news for retirement savers and
employers since it allows them to plan ahead with more
certainty. Here are the most important provisions from the
2001 law (the Economic Growth and Tax Relief
Reconciliation Act), which will be permanent fixtures in
the tax code:
Higher maximum amounts for defined
contribution retirement arrangements including simplified
employee pensions, as well as additional elective deferral
contributions for participants age 50 or older.
Higher maximum amounts for SIMPLE plans and
additional elective deferral contributions allowed for
participants age 50 or older.
Larger maximum annual benefits allowed under
defined benefit pension plans.
Bigger maximum amounts for traditional and
Roth IRAs; additional catch-up contributions allowed for
account owners age 50 or older.
Roth 401(k) and Roth 403(b) arrangements,
which were first allowed in 2006. These accounts combine
some characteristics of Roth IRAs and employer-sponsored
401(k) or 403(b) plans. Because they were set to expire in
2010, some employers were reluctant to set them up. Their
permanent status may make more organizations willing to get
The "saverís tax credit" of up to $1,000 for
those with modest incomes who contribute to 401(k) plans and
IRAs (subject to income-based phase-out ranges that depend
on filing status). Before the Pension Protection
Act, this credit was scheduled to expire after 2006.
For 2007 and beyond, the new law also mandates inflation
adjustments to the income-based phase-out ranges. Therefore,
more individuals will be able to claim the saver's credit in
More flexibility to arrange for tax-free
rollovers of funds between various types of retirement
accounts and plans. Also, faster vesting for employer
matches of employee contributions to retirement
The revised top-heavy nondiscrimination and
coverage rules and revised rules for employee stock
The small employer tax credit for starting up
new retirement plans, which is worth up to $500 a year for
College Savings Plan Rules Also Made
The current super-beneficial federal tax rules for Section
529 college savings plans were also part of the 2001 tax law.
And like the retirement provisions described above, these
favorable provisions were scheduled to expire after 2010. This
includes the federal-income-tax-free treatment of qualified
withdrawals from Section 529 plans. (Before 2002, tax had to
be paid on distributions at the child's rate.) The Pension
Protection Act makes the existing rules permanent.
Now for the bad news: The new legislation also grants the
IRS power to issue ďanti-abuseĒ rules to prevent taxpayers
from using Section 529 plans in certain tax-saving strategies
that go beyond what Congress intended. For example, the
government doesnít like the fact that individuals can
currently use Section 529 plan accounts as estate tax
avoidance vehicles that allow them to retain a great
deal of control over how the funds are used.
Beginning in 2007: More Beneficiaries
Able to Roll Over Money from a Deceased Individualís
Under the current rules, only an individual who is a
deceased personís surviving spouse can roll over, into his or
her own IRA, distributions received as a beneficiary of the
decedentís qualified retirement plan. Other beneficiaries
cannot take advantage of the tax-saving rollover strategy.
However, beginning in 2007, the Pension Protection
Act will allow a non-spousal beneficiaryís IRA to receive
a tax-free rollover of a qualified distribution from the
decedentís retirement plan. To qualify, the rollover must be
accomplished with a direct (trustee-to-trustee) transfer.
Similarly, rollovers will also be allowed for amounts paid to
a non-spousal beneficiary of a decedentís Section 403(a)
annuity, Section 403(b) annuity, or governmental Section 457
Once in the IRA, the rolled-over amount will fall under the
required minimum distribution (RMD) rules that apply to
This new provision is significant because it extends the
valuable tax-free rollover privilege to beneficiaries who are
not spouses. Remember that only direct rollovers will qualify.
Because required minimum distributions must be taken with
respect to rolled-over amounts (calculated under the rules for
inherited accounts), a new IRA should be established to
receive the rollovers. In general, the timing and amount of
the required withdrawals from that IRA will depend on: the age
of the deceased individual at the time of his or her death and
calculations based on the age of the beneficiary using the
IRS-approved life expectancy tables.
Direct Deposits of Tax Refunds into
For tax years beginning in 2007, an individual will be
allowed to arrange for a direct deposit of all or a portion of
his or her federal income tax refund into his or her IRA (or
into a spouseís IRA if the individual files jointly).
This will allow more people to save for retirement with less
In 2007: Liberalized Rules for Rolling
Over After-Tax Contributions
Under current law, individuals are allowed to make tax-free
direct rollovers of after-tax contributions from qualified
retirement plans into defined contribution plans. For this
privilege to be available, however, the receiving plan must
provide separate accounting for the after-tax contributions
and the related earnings. The same taxpayer-friendly rule
applies to direct rollovers of after-tax contributions between
Section 403(b) tax-sheltered annuity arrangements (subject to
the separate accounting requirement). Rollovers of after-tax
contributions can also be put into IRAs (no separate
accounting is required in this case).
Beginning in 2007, the new law will permit rollovers of
after-tax contributions from a qualified retirement plan into
a defined benefit plan (subject to the separate accounting
requirement). To qualify, the rollovers must be accomplished
via direct (trustee-to-trustee) transfers.
Inflation Adjustments to Phase-Out
Ranges for Deductible Traditional IRA and Roth IRA
Because of income based phase-out rules, some individuals
face restrictions on IRA contributions. Beginning in 2007, the
new legislation will require inflation adjustments to the
phase-out ranges for:
- Deductible contributions to traditional IRAs (the
phase-out rules only apply for years during which the
taxpayer or spouse participates in an employer-sponsored or
self-employed retirement arrangement).
- Roth IRAs.
Before this favorable change, the phase-out ranges (which
are based on modified adjusted gross income) were fixed
without any inflation adjustments.
Key Point: Inflation adjustments will allow more
individuals to make deductible contributions to traditional
IRAs and contributions to tax-free Roth IRAs.
In 2008: Direct Rollovers from
Retirement Plans into Roth IRAs Will Be Allowed
Beginning in 2008, the Pension Protection
Act will permit eligible individuals to make direct
(trustee-to-trustee) rollovers of distributions from
retirement plans into Roth IRAs. This new Roth conversion
privilege will apply to rollovers from qualified retirement
plans, Section 403(b) tax-sheltered annuity arrangements, and
governmental Section 457 plans. Unfortunately for 2008 and
2009, only individuals with modified adjusted gross incomes of
$100,000 or less will be eligible for Roth conversions. For
2010 and later years, the $100,000 rule will be eliminated
(thanks to the Tax Increase Prevention and Reconciliation
Act passed earlier this year). So, many individuals will
eventually be able to take advantage of the Roth conversion
Key Point: Under current rules, an individual must
first roll over retirement plan distributions into a
traditional IRA and then convert that account into a Roth
IRA. Under the Pension Protection Act, this
two-step procedure wonít be necessary after 2007.
Retroactive: Favorable New Rules for
Retirement Account Distributions Received by Military
The new law opens up a brand new exception for military
reservists to the 10 percent premature withdrawal penalty tax
(which generally applies to distributions from tax-favored
retirement arrangements made before age 59 1/2). Even better,
this new exception is retroactive. Qualified reservist
distributions are defined as early payouts taken from: an IRA;
or elective deferral contributions to a 401(k) plan or 403(b)
tax-sheltered annuity plan; or a similar arrangement.
Qualified distributions must be received by a person who,
of his or her status as a member of a military reserve
component, was ordered or called to active duty after 9/11/01
and before 12/31/07 for a period of more than 179 days or for
an indefinite period. Also, qualified distributions must occur
during the period that begins on the date of the order, or
call to duty, and ends when the active duty concludes.
Earlier this year,
another new law expanded retirement planning options for
members of U.S. armed forces serving in combat zones.
Click here for a rundown of the
The Pension Protection Act also permits a
reservist to "recontribute" all or part of a qualified
distribution to an IRA during the two-year period that begins
on the day after the end of active duty (or, if later, the
two-year period that ends two years after August 17, 2006). By
taking advantage of this beneficial rule, federal income tax
is avoided on the amount paid back into the IRA.
Strategy: If following the new rules would
result in a lower federal income tax bill for a tax year that
is closed for amended return purposes, a reservist can still
request a refund by filing a claim within the one-year period
that begins on August 17, 2006.