On August 17, 2006, President Bush signed The Pension Protection Act of 2006 (“PPA”). Contained therein are lots of things for Corporate America to act upon but tucked away in the close to 400 pages of legalese are several important changes that will impact individuals – particular emphasis given to retirement savings and charitable giving.

The following are some of the significant points:

NON-SPOUSAL IRA ROLLOVERS
Prior to PPA, the most favorable treatment was reserved for spouses.

Beginning in 2007, non-spousal beneficiaries of a qualified plan (e.g. pension, 401(k)) will be permitted to receive a tax-free rollover to an IRA.

Implementation appears rather straightforward. The beneficiary establishes a new IRA (separate and distinct from his/her existing IRA) to receive the proceeds of the qualified plan. A trustee-to-trustee transfer is effected to avoid constructive receipt. Rolled over proceeds fall under the required minimum distribution rules for inherited IRAs allowing for “stretched” withdrawals – the result of which is prolonged tax-deferral of the money in the account.

The thing to watch out for is that the person receiving the rollover must be a “designated beneficiary” such as an individual, a group of individuals or individuals defined in a “see-through” trust. Estates and non-see-through trusts do not meet the definition of a “designated beneficiary”

INFLATION-ADJUSTED IRA PHASEOUTS
Beginning in 2007, income phase-outs that determine whether a taxpayer may contribute to a Roth IRA or deduct contributions to a traditional IRA will be subject to annual inflation adjustments.

DIRECT ROLLOVERS FROM QUALIFIED PLANS TO ROTH IRAs
Beginning in 2008, trustee-to-trustee transfers from a qualified retirement plan (e.g. pension, 401(k)) to a Roth IRA will be permitted.

In essence, the two-step process of rolling a retirement plan to a traditional IRA followed by conversion to a Roth is combined into a single step.

There are two somewhat obvious items here that are worth mentioning. First, income taxes are due at conversion of the qualified plan to a Roth IRA. Second, the $100,000 Adjusted Gross Income (“AGI”) limitation remains in effect until 2010.

MOST PROVISIONS OF EGTRRA (2001) MADE PERMANENT
Sunset provisions included in EGTRRA have been removed for many popular programs. Some items made permanent include…

  • tax-free qualified withdrawals from §529 college savings plans
  • increased contribution limits to defined-contribution plans (e.g. 401(k))
  • increased contribution limits for IRAs
  • “catch-up” contributions for those age 50 and older

RETIREMENT PLAN PROVIDERS MAY OFFER INVESTMENT ADVICE
Beginning in 2007, employers and retirement plan providers may hire and pay “fiduciary advisors” to provide investment advice and implement strategies on behalf of defined contribution plan participants and beneficiaries. These “fiduciary advisors” must be registered brokers, banks, insurance companies or affiliates.

At the risk of being self-serving, we say LOOK OUT! The fiduciary standard – putting the interest of the client before self-interest – is a foreign concept to the product-pushers of the financial world. No matter what sort of “wall” is put in place between providers of retirement plans and the “fiduciaries” that will provide advice, we suspect there will be ample opportunity for “legal self-dealing” where the interests of the company are placed before those of the plan participants. Look no further than the improprieties of recent years (e.g. late-trading of mutual funds) for examples. Putting it bluntly, leopards don’t change their spots!

TRACKING CASH CONTRIBUTIONS TO CHARITIES
The current standard permits an income tax deduction for cash contributions of less than $250 even if there is no documentation.

Beginning in 2007, cash contributions must be supported through some sort of documentation – the most popular forms to be a canceled check or a written statement from the charity. The existing rule requiring a receipt from the charity for donations exceeding $250 remains in force.

Theoretically, day-to-day contributions that go undocumented (e.g. money placed in church collection plates) will be disallowed. It may sound silly but you might want to start bringing your checkbook on Sundays!

STRICTER RULES FOR CLOTHES AND HOUSEHOLD GOODS
Beginning in 2007, charitable donations of clothing and household items not deemed in “good” condition or better will be disallowed for income tax purposes. One exception permits a single item in “less than good” condition if it’s appraised at more than $500.

CHARITABLE CONTRIBUTIONS DIRECT FROM IRAs
Effective immediately and applicable to 2006 and 2007, those age 70 1/2 or older may take “qualified charitable distributions”. The distribution goes directly from the IRA trustee to the charity (“split interest” entities such as charitable remainder trusts and pooled income funds are excluded) and is never handled by the IRA owner who, incidentally, does not report the distribution as taxable income.

Since the distribution isn’t considered income, an income tax deduction is not allowed – that would amount to double counting.

There are some important points worth mentioning…

First, the maximum “qualified charitable distribution” for 2006 or 2007 is $100,000.

Second, from a practical standpoint, those who stand to benefit are users of the standard deduction (as opposed to itemizers) and those who would otherwise by impacted by limitations on itemized charitable donations.

Third, the entire contribution comes from the pre-tax portion of the IRA.

Finally, we interpret the legislation to mean that the “qualified charitable distribution” counts towards meeting the annual required minimum distribution (“RMD”). After all, it is a distribution and there’s nothing in PPA stating that it does not count towards meeting the RMD.

There’s lots of other good “stuff” contained in PPA which, incidentally, is an excellent cure for those of us suffering from insomnia. For the curious and/or sleep deprived out there, we’ll gladly send you all 386 pages (although it only takes a couple to put you to sleep).

For everyone else, PPA creates some interesting planning opportunities. How does it affect you? Give us a call.