Pension Protection Act

The Pension Protection Act of 2006 (passed August 17, 2006 and mentioned in a 10/25/06 Wall Street Journal article) has quite a few parts to it that I will address. It not only dealt with pension plans but also 401k and IRA plans and charitable contributions.

CASH REQUIREMENTS

1) Starting in 2008, the corporate bond interest rate can be used rather than the 30-year Treasury bond interest rate. This may result in a slightly higher discount rate (if the rate ends up being higher than what was used for 2006) for use in the present value calculations of the lump-sum benefit but, my understanding is that plans with less than 100 employees are not required to make this change.

2) The maximum cash contribution has been calculated differently now. The maximum contribution is much higher than as calculated under the old rules for 2005. In 2005, you could only fund to the maximum of 100% of the liability but now the employer can fund up to 150%. This, by the way, is the RPA (Retirement Protection Act) liability which is the projected benefit not the liability as of today.

3) Under-funded plans still are required to continue to make cash contributions and will be required to bring the funding amount to 90-100% over a 7-year period.

PAYOUT BENEFIT TO RETIREES

4) The maximum benefit from the Pension Plan as a payout to retirees has always existed but has continually been indexed for inflation. It is now in 2006 $175,000. The rate used to calculate this maximum is 5.5%.

NET PERIODIC PENSION COST (Expense on the Income Statement and the Pension Liability amount on the Balance Sheet)

5) The discount rate used for the cash requirements is different than the rate used to calculate the financial statement values. The discount rates to calculate the pension expense (the FASB-87 requirement on the financial statements) can be different. The PPA'06 act may affect this in the future but if under 100 employees then the company may not be affected.

SERVICE PROVIDER REQUIREMENTS

6) Pension providers and 401k providers are required, if they do give advice, to provide "computer generated" analysis of mutual funds and other investments used for plans and show no bias toward what they recommend (effective January 1st). As has been the case for some time, when the provider puts on their "advisor/planner hat" they do not have to act in the client's best interest (a fiduciary standard) rather than their own company's interest (selling funds that provide them with commissions). The "objective computer model" the provider uses is suppose to be audited by an independent third-party annually. This will be interesting to see how Merrill Lynch and other big broker/dealers implement this or steer away from providing advice.

7) Employers can automatically enroll employees who do not enroll in the 401k (the employee then would have to opt-out rather than the current opt-in process) and the employer must offer a "life-style" or "balanced fund" to put employees in if they do not elect their own mutual funds. They could be automatically enrolled at 3% in year one, 4% in year 2, 5% in year 3 and then the maximum rate of 6% for years following three. Effective January 1, 2008, the participant must be placed into a balanced fund and/or a lifestyle fund of some sort. Again, they are not required to accept the change but they are required to then "opt-out" and consciously choose the money market reserve account which is now the default fund if no choice is made.

OTHER BENEFITS OF PPA'06 ACT

8) This PPA'06 Act has made permanent the EGTRRA provisions that were set to expire. The limits are indexed to inflation. 401k limits are $15,500 (under 50) and $20,500 (50 or over) for 2007; the act indexes IRA and ROTH IRA compensation/income limits; makes permanent the $1,000-$2,000 non-refundable tax credit for low-income individuals who contribute to a retirement plan and other items.

9) Non-spouse beneficiaries of retirement plans now have the same benefits as spousal beneficiaries and can roll over 401k's and IRA's to an inherited IRA (if done properly) and take distributions over their life expectancy rather than a lump-sum or maximum 5 year payout.

10) 529 college plans have been made permanent. They were set to expire in 2010. (As a side note, but not part of this act, the Prepaid 529 plans were counted as the child's assets (at 35%) in college financial aid but will no longer be counted as the child's but the parent's (at 5.6%) and that is good news for those affected); changes were also made to portability of funds between states and contribution limits.

11) Those aged 70 and 1/2 or older can donate to charity directly from their IRA and not have to pay tax on the IRA distribution up to $100,000 for 2006 and 2007 years only.

12) This act also eliminates deductions for clothing, furnishings, appliances and the like unless they are in good condition. You must have a receipt from the charity. If the item is over $500 and verified then the $500+ donation is an acceptable, deductible donation. Checks and money gifts are not deductible unless you have a report from the charity/church of the amount donated.

13) Long-term Care policies can be combined with special annuities paid for long-term care and afforded special tax treatment and allowing the cash-value of a life insurance policy to pay the LTC benefit.