Pension reform

In mid-August, President Bush signed
into law legislation that is expected to
encourage millions of investors to increase their enrollment in retirement
plans, such as 401(k) programs, and
boost the amount they contribute to
these plans each year. The new law provides other valuable benefits for
investors, such as permanent “catch-up”
provisions for older workers and additional rollover options for plan participants. Catch-up provisions enable older
workers to put more of their earnings in
retirement plans than younger workers.

The law also changes how death benefits are treated for income-tax purposes.

“In the past, if you inherited assets in a
retirement plan from an individual who
was not your spouse, you had tax consequences to contend with, some of which
were painfully complex,” says Sherry
Maynard, a financial consultant, Chartered
Financial Analyst and Chartered Wealth
Advisor with J.J.B. Hilliard, W.L. Lyons.

Smart Business talked to Maynard
about some of the other pension law
changes and how they will affect workers in the very near future.

Why has the law been changed?

These changes came about because
the government realized that literally
millions of Americans covered by
defined-benefit pension plans may not
receive all or part of their benefits
because so many of these programs are
underfunded. As a result, the legislation
requires corporations to aggressively
fund traditional defined-benefit plans.
Companies must also make sure their
defined-benefit pension plans are fully
funded within seven years.

Prior to the law, companies were
required to fund 90 percent of their
defined-benefit plans. Underfunding has
been prevalent among companies within
industries that have faced difficult economic times for years, most notably the
steel, auto and the airlines industry.
Many workers have only lost benefits
that would take years to recoup.

Underfunding has also created a huge
deficit for Pension Benefit Guaranty
Corp. (PBGC), a federal corporation
responsible for insuring certain benefits
under private defined-benefit pension
plans. (PBGC currently protects the pensions of 44.1 million American workers
and retirees in more than 30,000 private
defined-benefit pension plans.) PBGC
has already had to bail out pensions at a
number of companies, particularly in the
steel industry. With companies in the airlines and auto industries feeling pressure of mounting pension obligations,
the deficit at PBGC is likely to continue
climbing before it declines. Over time,
the legislation is intended to help reduce
PBGC’s deficit and return it to solvency.

How does the new law deal with inheritances?

Under the new law, ‘a child or any
other nonspouse who inherits money in
such a retirement plan can transfer it
directly into an IRA.’ That allows the
heir to spread out distributions over
numerous years — and can ease the tax
bite considerably.

Even features within the 529 plan, a
state-sponsored program designed to
help parents finance education expenses, will benefit because many of them
were set to expire at the end of 2010.
Now, however, tax-free account withdrawals will continue to be permitted
and investors will continue to be able to
roll over their 529 plans to a different
state plan once a year without requiring
a change in beneficiary. The legislation
also extends the option to invest in both
a 529 plan and a separate Coverdell
Education Savings Account for the same
beneficiary in the same year.

How will the new law affect existing 401(k)
plans?

The already popular 401(k) plan is
expected to see a significant increase in
participation because, under the new
law, employees will automatically be
enrolled in a company’s 401(k) plan
unless they choose otherwise. Before
the law change, employers had to ask
employees if they would like to participate.

What impact will the new law have?

The new legislation will not be a quick
fix for the underfunding problem.
Pension plans are underfunded by about
$313 billion, and the new rules include
long transition periods and special relief
for some struggling industries. The
PBGC, which has a $23 billion deficit,
has estimated its exposure to ‘new probable terminations’ by companies at $108
billion.

SHERRY MAYNARD is a financial consultant, Chartered
Financial Analyst and Chartered Wealth Advisor with J.J.B.
Hilliard, W.L. Lyons Inc. in its Columbus branch office. Reach her
at (614) 210-6284 or [email protected].