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Roundup of New Pension Law Changes

The new Pension Protection Act of 2006, signed into law on August 17, 2006, is the biggest overhaul of the pension plan laws in years. But there's much more to the new law than just that: It also imposes tough new requirements for charitable deductions, preserves tax breaks for college savings and enhances other retirement planning incentives—just to name a few of the key provisions.

Here is a brief overview of the most significant new law changes.

Funding defined benefit plans: The new law requires employers to fund defined benefit plans to cover 100% of the liability as opposed to the current 90% required. Plans that are not fully funded at the beginning of 2008 may gradually increase funding over a seven-year period.

Tax law impact: The extra cost could force employers to either revamp or drop their defined benefit plans.

The new law also encourages employers to create a funding cushion through higher deduction limits. For plan years beginning in 2006 and 2007, the maximum deduction amount is increased from 100% to 150% of plan liabilities. After 2007, the new limit is equal to (1) the target cost for the year, (2) the amount necessary to the fully fund plan liabilities if at-risk standards apply, (3)50% of the unfunded liability and (4) an additional cushion based on projected compensation increases, all minus the value of plan assets for the year.

Hybrid plans: The new law provides legal protection to employers who want to convert a traditional pension plan into a hybrid “cash balance” plan. It insulates employers from age-discrimination lawsuits by employees who could claim such a switch harms older workers.

Automatic 401(k) plans: Under the new law, it will be easier for employers to establish automatic-enrollment 401(k) plans. Employers can also automatically increase the percentage of contributions by employees.

Tax law impact: With automatic enrollment, it is expected that participation by eligible employees could jump substantially.

Investment advice: The new law permits providers of individual retirement accounts (IRAs), 401(k) plans and other plans to offer personalized investment advice to participants. Generally speaking, any fees received by advisors for these services, including commissions, cannot be based on the investment options selected by the participants.

Roth IRA rollovers: After 2007, participants will be able to directly roll over funds from a qualified retirement plan to a Roth IRA (assuming other requirements are met). Currently, a two-step process is required: Roll over the funds from a qualified plan to a traditional IRA, and then roll over from the traditional IRA to a Roth IRA.

Qualified retirement plans: Many favorable retirement plan provisions in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) were scheduled to expire after 2010. The new law repeals these “sunset” provisions—including higher contribution and benefit amounts, catch-up contributions for older workers, faster vesting on employer matching contributions and various other enhancements—and makes them permanent.

Retirement saver's credit: Unlike most other sunset provisions, the special retirement saver's credit available to certain low-to-middle income employees would have ended after 2006. This credit, with minor modifications, has also been made permanent by the new law.

Inherited plan assets: For distributions after 2006, a non-spouse beneficiary can elect to roll over the assets in the decedent's qualified retirement plan to an IRA of his or her own. Previously, this benefit was only available to spousal beneficiaries.

Charitable contributions: The new law tightens the rules for deducting donations of clothing and household items, while enhancing benefits for food and book donations by business entities. It also permits, for the first time ever, tax-free distributions of IRA proceeds for charitable purposes, through the 2007 tax year. Significantly, the new law denies deductions for cash contributions unless the donor has written proof as to the amount of the contribution, the date and the name of the charity.

Tax law impact: This change gives taxpayers zero leeway. Cash donations must be substantiated by a cancelled check, bank record, or credit or debit card statement.

Conservation easements: On the plus side, the new law raises the deduction limit for qualified conservation easements from 30% to 50% of adjusted gross income, if certain conditions are met. This tax break is available only for 2006 and 2007.

S corporations: Under the new law, the reduction of a shareholder's basis in the stock resulting from a corporate charitable donation will equal the shareholder's pro rata share of the adjusted basis of the donated property. This change is effective for contributions made through 2007.

Section 529 plans: The new law preserves tax breaks for Section 529 plans that were scheduled to expire after 2010. Besides allowing tax-free distributions for qualified higher education expenses, taxpayers can continue to roll over funds to a different state plan each year without changing the beneficiary. Also, investors can still use a Coverdell Education Savings Account and 529 plan for the same beneficiary in the same year.

Tax law impact: These changes are expected to invigorate Section 529 plans, which had showed signs of declining in popularity.

It is recommended that you consult with a professional tax adviser to determine how the new law affects you and your business.

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