New Pension Legislation Extends Tax Breaks For Retirement Saving
Designed to bolster the nation's ailing pension system, comprehensive retirement plan reform approved by Congress in August also makes permanent the Roth 401(k) and higher contribution limits for IRAs and 401(k)s. In addition, the law clarifies the rules surrounding automatic enrollment of employees in 401(k) plans and the transition from defined benefit to cash balance plans.
The Pension Protection Act of 2006 requires defined benefit plan sponsors outside of the airline industry to cover 100% of the liabilities in their pension plans over seven years, up from the current minimum funding level of 90%. Employers operating plans that remain underfunded below certain levels face stricter funding requirements, restrictions on benefit offerings and payouts, and limits on executive deferred compensation. The law also imposes new disclosure and reporting requirements to ensure that plan participants and company shareholders receive regular updates on the funding status of pension plans.
To ease the burden of higher minimum funding levels, the law permits larger tax deductions for contributions to pension plans—employers may deduct up to 150% of current plan liabilities. However, the measure also reduces the predictability of funding requirements by restricting the smoothing of investment returns and averaging of interest rates.
The legislation addresses the legal status of cash balance plans and other types of hybrid plans. Cash balance plans combine elements of both defined benefit and defined contribution plans. The measure shields companies with cash balance plans from lawsuits by older workers who claim they do not have time before retirement to save enough money to cover their benefit losses after their employers moved them from a traditional pension to a cash balance plan. The clarification of the rules governing the transition from defined benefit to cash balance plans could make the hybrid option more attractive to some employers.
In addition, the measure includes provisions designed to encourage employee participation in defined contribution plans. The law settles outstanding legal issues by explicitly allowing automatic enrollment of workers in 401(k) plans by employers. Employees who have been automatically enrolled in a plan retain the right to opt out, but must take action to do so. In addition, employers are permitted to make default contribution decisions on behalf of 401(k) plan participants who have made no investment choices. For the first time, plan sponsors are, under certain conditions, allowed to provide personalized investment advice to participants.
The law also makes permanent incentives for qualified retirement savings contained in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). These provisions, many of which were due to expire in 2010, include higher contribution limits and catch-up amounts for IRAs and 401(k) plans, accelerated vesting of employer matching contributions, and higher deductible amounts for employer contributions to employee retirement accounts. By making the newly available Roth 401(k) a permanent part of the tax code, the legislation is expected to encourage 401(k) sponsors to add a Roth option to their plans. Furthermore, the law puts an end to uncertainties surrounding 529 college savings plans by mandating that qualified withdrawals will remain tax-free in the future. The law also allows tax-free distributions from IRAs to charities through 2007, up to a limit of $100,000.
