More On Legal & Compliancefrom The Advisor's Professional Library
- Updating Form ADV and Form U4 When it comes to disclosure on Form ADV, RIAs should assume information would be material to investors. When in doubt, RIAs should disclose information rather than arguing later with securities regulators that it was not material.
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
Hailed as the most sweeping reform of America's pension laws in over 30 years, the Pension Protection Act of 2006 (PPA) was signed into law by President Bush on August 17, 2006. As its name implies, the law focuses mainly on pension plans, completely overhauling rules to ensure that employers adequately fund their plans (see "The PBGC's Prospects" sidebar).
But of interest to many more advisors and their clients are the numerous other significant tax changes within the Act, many of which will make it easier to save for retirement. What follows highlights, perhaps from a different perspective, some of the Act's provisions that offer new ways to help your clients plan for their retirements.PPA Highlight No. 1:
Memo to Nonspouse Beneficiaries:
Only Withdraw the RMD in 2006
Nonspouse beneficiaries, including certain trust beneficiaries, who inherited a participant's account in a qualified retirement plan (QRP), 403(a), 403(b), or 457 plan will want to hold off on withdrawing anything other than the required minimum distribution (RMD) from these plans during 2006. What will they receive in return for doing nothing?
Beginning in 2007, a nonspouse beneficiary who may otherwise have been required to take a lump sum distribution will be permitted to request a direct rollover of the inherited benefits into an inherited or "beneficiary" Individual Retirement Account or Individual Retirement Annuity (collectively "IRA"). The transfer must be a direct trustee-to-trustee transfer and the nonspouse beneficiary must abide by the RMD rules. For a nonspouse beneficiary, this ability to "roll over" inherited retirement plan assets may provide for many more years of tax-deferred growth. Remember, the law of the land is frequently not the law of the plan. Verify with both the retirement plan administrator and the IRA custodian that neither their document provisions, operational capabilities, nor administrative procedures prevent a nonspouse beneficiary rollover.
It is hoped that the IRS will issue regulations that will address situations where a trust or estate has been named as beneficiary and it is advisable to move the inherited retirement benefits into a beneficiary IRA in the name of the trust's or estate's ultimate beneficiary(ies)--not the name of the trust or estate.PPA Highlight No. 2:
EGTRRA's Increases in Retirement Plan
Contribution Limits Made Permanent
PPA makes permanent The Economic Growth and Tax Relief Reconciliation Act of 2001's (EGTRRA) increases in IRA and employer-sponsored plan contribution limits and provides additional benefits for certain individuals.
The IRA contribution limit is $4,000 for 2006, increasing to $5,000 in 2008, and indexed for inflation thereafter. Clients who have attained age 50 or over during the tax year may make additional "catch-up" contributions of $1,000 for 2006. Certain 401(k) plan participants may be eligible to make special IRA catch-up contributions of $3,000 per year for 2006 through 2009; however, they must forego the standard $1,000 catch-up opportunity.
Investors' elective salary deferral limit for employer-sponsored plans such as 401(k) and 403(b) plans is $15,000 for 2006 and--like IRA contribution limits--are indexed for inflation thereafter. Their catch-up contributions of $5,000 for 2006 are also indexed going forward.
The employer's deductible contribution limit for QRPs and SEP IRAs has been permanently increased to 25% of eligible payroll, exclusive of any employee salary deferrals, thus enabling your self-employed clients to continue maximizing their total plan contributions at relatively low income levels.
Remember that the deadline for calendar-year employers to establish employer-sponsored retirement plans is December 31. The only exception to this rule? A SEP IRA plan may be adopted as late as employers' tax filing deadlines, usually April 15, plus extensions. The deadline for employers to fund deductible contributions is generally their tax filing deadline, plus extensions.PPA Highlight No. 3:
Relief on Hardship Distributions
For Some Military and Plan Beneficiaries
The Pension Protection Act offers additional financial relief from economic hardships to some very specific groups: qualified military reservists and certain retirement plan participants.
Many reservists called to active duty following September 11, 2001, found it necessary to take taxable distributions from their IRA, 401(k), 403(b), or 457 and incur the 10% premature distribution penalty. For those who were or will be called before December 31, 2007, serve for at least 179 days, and who took distribution between the call to and the end of active duty, PPA provides relief from the 10% premature distribution penalty. The law is also retroactive; therefore, qualified reservists who incurred the 10% penalty in prior tax years should amend their filing and request a refund.
Additionally, provided the distribution was a Qualified Reservist Distribution, the reservist may redeposit up to the amount withdrawn in an IRA. This re-contribution is non-deductible and may be made in one or more installments up until two years following the later of the end of active duty or August 17, 2006. While more detailed guidance remains forthcoming, we know PPA allows a participant in a 401(k), 403(b), 457, or Non-Qualified Deferred Compensation (NQDC) plan to request a hardship distribution when a financial hardship is incurred by a person who is a beneficiary under the plan. Restricted in the past to hardships incurred by the participant and the participant's spouse and dependents, this provision creates a new class of qualifying individuals.PPA Highlight No. 4:
New Age Discrimination
Protection in Cash Balance Plans
Some actuaries and third-party administrators have long-hailed cash balance plans, and some other hybrid plans, as valid and useful tools. Critics, however, charged that they may discriminate against older workers, such as when a defined benefit plan is converted to a cash balance plan. Congress considered cash balance plans in general and conversion issues in particular, and arrived at various statutory requirements designed to protect cash balance plans from charges of age discrimination.
PPA establishes prospectively, beginning on or after June 29, 2005, that those hybrid plans which meet the statutory requirements do not violate age discrimination rules. Although the new law offers no such protection to cash balance plan conversions prior to June 29, 2005, recent case law developments bode well.PPA Highlight No. 5:
Charitably Minded Clients
Should Consider IRA Distributions
Perhaps the most anticipated provision in the new law is the charitable IRA contribution. Under prior law, clients took a taxable IRA distribution for charitable giving purposes and, if they were able to itemize, might be able to claim at least a partially offsetting charitable deduction. PPA allows certain IRA owners to take tax-free withdrawals up to $100,000 annually from their IRAs (includes Roth IRAs but not SEP or Simple IRAs) when the amount withdrawn is used for charitable giving purposes.
For your clients to qualify, their distributions must meet specific criteria: They must be paid to a qualified charity and have been otherwise includable in income. If so, qualified amounts distributed will not be considered in calculating taxable ordinary income--and here's the trade-off--or in calculating the charitable contribution deduction amount. Moreover, if a distributing IRA holds pre- and post-tax dollars, qualifying charitable distributions will be deemed to have been made first from the pre-tax balance.
Additionally, distributions must be made on or after the date donors attain age 70 1/2. In coordination with RMD rules, qualified distributions may be applied toward satisfying donors' RMDs for the distribution year. To satisfy a $60,000 RMD following a $40,000 qualified charitable distribution, your client need only withdraw $20,000 to satisfy his or her RMD.
As you probably know, PPA is spelled out in hundreds of pages of tax code and can't be adequately analyzed in any one article--this is just a sample of important considerations for your clients. Also, while most of the above changes were effective as soon as the Act was passed, PPA includes numerous provisions that either became effective later in 2006 or will do so in 2007 and 2008, most of which also impact retirement savings plans. Changes to watch for include the ability to deposit federal income tax refunds directly into IRAs, automatic enrollment safe harbors for employer-sponsored retirement plans, and direct rollovers from qualified retirement plans to Roth IRAs.
Susan Hartman is a tax planning consultant for Raymond James with expertise in ERISA and financial and estate planning for affluent investors. She specializes in supporting the firm's financial advisors with analysis, developments, and strategies related to her specialities. She can be reached at firstname.lastname@example.org.