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 firstname.lastname@example.org.