Getting With The Act

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provided the distribution was a Qualified Reservist Distribution, the reservist may redeposit up to the amount withdrawn in an IRA.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 [email protected].