Will the new pension reform law give income planning more punch as advisors try to make sure clients have sufficient retirement income? Some planners were contacted to find out.
H.R. 4, the Pension Protection Act of 2006, was signed into law by President Bush on Aug. 17, 2006.
“Income planning has a direct correlation to income accumulation,” and the new law will help with saving, according to Tom Foster, national spokesperson for The Hartford Retirement Plans Group, Simsbury, Conn.
Some major changes that will power up the income plan include making the Roth 401(k) and Roth 403(b) permanent, says Foster. So will eliminating the possibility of a return to the old contribution limits. The baby boomer catch-up provision is now permanent as well. A $2,000 saving credit that helps lower-paid employees is now also being made permanent, he continues.
Automatic enrollment in 401(k) plans, allowed under the new law, will not only increase what contributions lower-paid employees can make; it will also allow highly compensated employees to contribute more since the amount they can contribute is tied to what the average-paid employee contributes, according to Foster.
For the automatic enrollment provision, the new law preempts state laws under a safe harbor test, he adds.
Uncertainty about the future of tax rates makes it desirable for many in higher income brackets to convert to Roth IRAs, says Foster. Under this new law, starting in 2008, those with under $100,000 in adjusted gross income can take money from a qualified plan and put it directly into a Roth IRA, he explains. And, after 2010, there will be no AGI limit to prevent people from making these conversions, he adds. However, those who are eligible to take distributions and decide to convert will need to move money from a qualified plan into a traditional IRA and then into a Roth IRA.
During a two-year window starting in 2011 and 2012, a “very important” feature becomes available. This is the ability to spread tax liability for the conversion over these two years. After 2012, the full liability is charged when the conversion is made, Foster says.
The new law also allows for a combined 401(k)/defined benefit combination product to be offered, with the flexibility and guarantees associated with each product, Foster notes.
Additionally, starting in 2007, tax refunds can be directly deposited into an IRA, he continues. Also, those over age 70.5 can make a tax-free contribution to a charity from an IRA if the amount is no larger than $100,000, he says.
“The new law is very helpful, but I don’t know if it will address the problem,” says Bill Knox, a financial advisor with Regent Atlantic Capital, Chatham, N.J. It is helpful because it makes changes made in EGTRRA permanent and offers some “rare pre-tax opportunities.”
But even with the changes in the new law, Knox has some “pessimism about what it will take to wake this country up about what it takes to retire.” After accounting for inflation, the greatest return that consumers can realistically hope for is 4%-5%, he says. Meanwhile, consumers are not currently saving enough, Knox continues.
One benefit the new law offers, he says, is the ability to extend tax-free rollovers in 401(k) plans to beneficiaries who are not spouses. This will be helpful in income planning, according to Knox.
A positive change in the new law is the shoring up of the rules about funding defined benefit plans, according to Jim Holtzman, a financial advisor with Legend Financial Advisors, Pittsburgh. But, the new requirements may prompt employers to close up those plans entirely, Holtzman notes. Companies have been steering away from these plans and Holtzman says he wonders whether the changes will accelerate that trend.
Another feature of the law that could help with income planning, according to Holtzman, is the ability to roll over monies from qualified retirement plans into Roth IRAs.
In addition, the ability to offer employees financial advice in relation to their 401(k) or other options could be a benefit for income planners, he says. But, he continues, that really depends on the quality of advice being given.
Bedda D’Angelo, president of Fiduciary Solutions, Durham, N.C., says that after reading the entire 900-page document, she believes that “it will not affect income planning at all.” She breaks down the four macro components of the act into:
1) Corporate funding requirements of defined benefit plans.
2) Lawfulness of converting defined benefit plans to cash balance plan.
3) More liberal rules for funding 401(k) plans.
4) Definition of an investment advisor.
“Although companies have to fund defined benefit plans at 100%, they have many years before they must be in compliance,” D’Angelo notes. “Many companies will convert their defined benefit plans to cash balance plans. Conversion to a cash balance plan will adversely affect older employees and will adversely affect their retirement income planning.
It will not affect younger employees, she continues, “because they will have the time to accumulate assets in their cash balance plan and will still have the ability to purchase an annuity at institutional rates when they retire. Older employees will be able to purchase an annuity, too, but the cash balance will be much lower and not enough to compensate them for the income stream they would have had from their defined benefit.”
Additionally, D’Angelo continues, “companies will now have the ability to enroll all employees in a 401(k) plan and employees who want to may opt out. Under present rules, employees must opt in. This will probably increase the savings rate of the lowly compensated since paperwork is often a deterrent to do anything. If the lowly compensated are deferring more to a 401(k) plan, then the highly compensated are permitted to defer more as well (as per top heavy plan rules). There is also easing in the top heavy rules.”
On the issue of financial advice, D’Angelo says that companies “may completely eliminate their fiduciary liability for investment selection and advice, provided they delegate the investment management to a qualified investment advisor. A qualified investment advisor can be just about anyone who uses a computer model based on modern portfolio theory. Prior law prohibiting rendering of investment advice by the party that sells the investments has been lifted so conflicts of interest are now legal.”
In general, she says that “basically, the act transfers responsibility for retirement accumulation to the individual. This is not a problem for highly compensated people but will adversely affect the quality of life for the lowly compensated about 30 years from now.”