Declining stock prices and lowered interest rates in the early part of this decade not only affected your invested retirement assets and money market accounts, but also collapsed the accumulated pension assets of many large national retirement plans.
Factors such as the Sept. 11, 2001 attacks and other economic variables, along with corporate scandals including Enron and WorldCom, played a role in the economic fallout.
As a result, the federal “insurance” program through the Pension Benefit Guaranty Corporation became an endangered species, as more than $11 billion in pension assets, covering more than 391,000 workers, went into default between 2002 and 2004.
The Pension Benefit Guaranty Corporation’s long-term financial solvency was called into question. In order to put a regulatory plug in the burgeoning liability dike, Congress passed and President Bush signed the Pension Protection Act of 2006, known as PPA 2006.
Time will tell whether the PPA will in fact protect large national retirement plan assets and the workers covered thereunder, or make it more attractive to terminate the future participation of new workers in such plans, as did Dupont in Delaware shortly after the law was signed. If the latter occurs and more companies decide to voluntarily terminate their plans, the act’s legacy might actually be the opposite of what was intended.
But the act contains many other provisions that could affect us “average Joes,” from IRAs to long-term care to annuities to charities. Here are a few areas where PPA 2006 may reach out and touch the average taxpayer.
Non-spouse IRA rollovers
Previously, only surviving spouses of deceased plan participants could roll over plan assets into his or her own IRA and delay the income tax bite.
However, under PPA 2006, beginning in 2007 you may leave 401(k) plan or other employer plan assets to a non-spouse beneficiary, such as your child, through a direct transfer from the qualified plan to the rollover IRA. In this case, “rollover” is a misnomer as the transfer must be a direct trustee-to-trustee transfer from the plan to the IRA without any intervening stop.
According to national IRA expert Ed Slott, CPA, “This provision also applies to trusts, meaning that the transfer from the plan will work when a (properly drafted see-through) trust is named beneficiary of the company plan. The inherited IRA must be titled properly as maintained in the name of the deceased participant, such as ‘Mr. Smith IRA (deceased Jan. 1, 2007), FBO, Ed Smith, son.’”
Slott added, “This single provision could have a multibillion dollar effect on non-spouse plan beneficiaries who can now stretch inherited company plan funds in an inherited IRA over their lifetimes,” rather than pay tax on the IRA assets within 5 years.
Tax refunds to IRAs
Beginning in 2007, tax refunds (from tax year 2006 and thereafter) can be directed to your IRA. When you file your taxes in April, you will be able to elect via new IRS Form 8888 the transfer of all or a portion of your tax refund to your IRA or to your spouse’s IRA if you file a joint tax return. But be careful – you will need to tell your IRA custodian which tax year the IRA is being funded when the tax refund is made directly to your IRA (or that of your spouse). This is especially true if you file after April 15, as the custodian, without specific directions from you, will fund the IRA for the following year, not the previous year.
Provisions have been now made permanent
The following tax provisions were previously written to “sunset” after 2010 but are now made permanent in the law by PPA 2006.
- Catch-up contributions for individuals age 50 years of age and older.
- Waiver of 60-day rollover rule when a “hardship” is declared.
- IRA and Roth IRA contribution limits increased.
- Rollover of after-tax contributions between certain retirement accounts.
- Employer plan contribution limits increased and annually adjusted for inflation.
- Expanded portability between IRAs and employer plans, such as IRAs-to-401(k)s.
- The “saver’s credit” for low-income taxpayers.
- Small business pension “start-up” credit.
- Roth 401(k) and Roth 403(b).
- “Deemed IRAs” in employer plans.
Making charitable gifts by using your IRA rollovers
For tax years 2006 and 2007 only, if you are age 70½ or older, you are able to give some or all of your IRA assets, up to $100,000, directly to a charity of your choice (but not to a grant-making foundation, a donor-advised fund or a charitable gift annuity). The transfer must be direct from your IRA to the charity and may be used to satisfy your required mandatory distribution.
So if you do not need the money bumped out of your IRA after age 70½ and you are charitably inclined, this may be a better way to give to your favorite charities than taking the money from your IRA, paying the income tax due, then contributing to the charity, especially if you do not itemize your deductions and would normally lose the benefit of the deduction by claiming the standard deduction.
Also, because there are limits on the deductibility of charitable gifts – for example, 50% of adjusted gross income for cash gifts to public charities — your direct transfer to the charity can accomplish your charitable inclinations more efficiently.
How? Because even though you do not get a tax deduction for the gift from your IRA to the charity, neither do you include the transfer amount as income. Remember, though, that there is a window of opportunity here only until Dec. 31, 2007.
Roth IRA conversions
Under the new law, effective in 2008, you will not need to establish a traditional IRA to act as a conduit from your employer’s qualified plan (i.e., 401(k), 403(b), etc.) to a Roth IRA (via conversion). However, you will need adjusted gross income of less than $100,000 to do so (until 2010, when the $100,000 adjusted gross income limit is eliminated). So the new law allows taxpayers to roll over assets from a qualified plan to a Roth IRA without first having to go through a traditional IRA. That is one for tax simplification.
Use of life insurance/annuities to fund long-term care
Beginning in 2010, you will be able to add a long-term care rider to a life insurance policy or annuity and use the cash value of the policy or annuity to fund the long-term care rider cost, as well as to fund long-term care policy premiums.
The use of the cash values will not be considered taxable income but will serve to reduce your cost basis in the policy or annuity, but not below $0. In other words, if you have a policy or annuity with a high tax cost basis (premiums paid/deposits made), you will be permitted to use those cash values, tax free, to cover the long-term care rider costs. Further, you will also be able to effect a tax-free exchange between annuity contracts even if one annuity does not have an long-term care rider (usually the older annuity).
But be aware that only tax-qualified long-term care policies are permitted under this provision, meaning older policies issued before 1997, are disallowed. Many of those older long-term care policies have better provisions for determination of when an “incapacity” occurs, and long-term care policyholders of such insurance will want to think long and hard before replacing such coverage with a newer tax-qualified policy that satisfies the provisions under PPA 2006.
Additionally, long-term care policies funded using life insurance or annuity cash values will disqualify those premiums for your long-term care policy/rider as medical expense deductions on your federal income tax return, as you can do now for a portion of the premium (currently, the older you are, the more you can deduct).
As 2010 gets closer, you will want to examine your life insurance policies and annuities to determine whether they can or should be used to fund long-term care premiums. Since tax issues are at the heart of the decision, make sure you talk to your tax advisor or financial planner to help you understand your alternatives.
Active duty reservists permitted penalty-free withdrawals
For individuals called to active duty for at least 179 days, distributions from retirement plans, including IRAs, occurring between Sept. 11, 2001, and Dec. 31, 2007, will escape the 10% penalty for distributions before age 59½.
Further, the new law also allows distributions after Sept. 11, 2001, to be rolled back into an IRA within the later of:
- 2 years after the end of active service, or
- enactment of the law.
This timetable allows wide latitude for reservists to revisit amounts withdrawn from their qualified plans that were used to cover financial shortfalls and replace the monies withdrawn from IRAs for at least the next 2 years.
Final points to consider
As you will note from the preceding points, not all parts of the new law are effective on one date. The table on page 40 delineates the various dates when major plan provisions come into play.
From a financial planning perspective, I encourage you to start or continue saving through qualified retirement plans, as the new law has made such saving more flexible and tax efficient. Setting aside dollars now in traditional IRAs could lead to the production of tax-free retirement income after the now-liberalized rules on Roth IRA conversions take effect in 2010.
If you are over age 70½ and do not need your required mandatory distribution for spending, you have only until Dec. 31, 2007, to consider a charitable transfer. Likewise, the new provisions for tax-free transfers to non-spouse beneficiaries of qualified plans may require you to visit with your estate attorney to ascertain its applicability to your overall estate plan.
So do not look at PPA 2006 as something to deal with later, thinking that certain parts are not effective right now. Visit with your financial planner or tax advisor for a PPA 2006 financial fire drill. The new law contains many provisions not mentioned here, so send me an e-mail (Kenneth.Rudzinski@lfg.com), and I can e-mail you a readable summary of PPA 2006.
For more information:
- Kenneth W. Rudzinski, CFP, CLU, ChFC, CASL, is a certified representative of Lincoln Financial Advisors Corp., a broker/dealer (member SIPC) and a registered investment advisor in Wilmington, Del. He has been cited in Money magazine and in Who’s Who in Finance & Industry. He can be reached at The America Group, Foulkwood Professional Building, 2036 Foulk Road, Suite 104, Wilmington, DE 19810; 302-529-1320; fax: 302-529-1324; e-mail: kenneth.rudzinski@lfg.com.
- Ed Slott, CPA, is not affiliated in any way with Lincoln Financial Advisors Corp. He can be reached at www.irahelp.com.
- Lincoln Financial Advisors Corp. or its representatives do not give tax or legal advice. The information in this article is from sources deemed reliable by the author. CRN 200610-2001019.
