Updated: May 3, 2013 12:14PM
Originally published: August 7, 2006
The Pension Protection Act has a lofty sounding title, but many of its provisions will have a beneficial impact on your individual retirement savings. While the bill will make it more difficult for large companies to avoid funding their pension obligations, individuals will be more directly affected by changes in the 40l(k) plans that have been replacing traditional pension plans.
Here’s a closer look at some key features:
Company sponsored 40l(k) retirement plans are optional. Unfortunately, too few workers have been opting to participate. In fact, according to a study by the Employee Benefits Research Institute, only 75 percent of family heads who are eligible to sign up for 40l(k) plans actually do so.
The new pension bill should help solve that problem. It provides incentives to companies that create an automatic enrollment process for their employees by deducting 3 percent of salary for starters, then automatically increasing the employee’s contribution every year by one percentage point to at least 6 percent, or as high as 10 percent of salary.
If they meet these conditions, companies will be exempt from onerous “non-discrimination” rules that sometimes limit the contributions of top wage earners. But the company must also agree to match on a dollar-for-dollar basis the first 1 percent of the employee contribution, plus match the next 6 percent of contributions at a 50-cent-on-the-dollar basis -- or else simply give every employee a 3 percent contribution.
Some companies will find this matching provision costly, but Congress is hoping the technical incentives they’ve created will encourage companies to restructure their plans along these “auto-pilot” provisions. Companies that don’t match might be called “stingy!”
New provisions in this bill not only allow, but encourage, companies to provide sources of specific investment advice for the fund choices within the plan -- probably from the plan’s fund providers. Big mutual fund companies like Vanguard, Fidelity and T. Rowe Price are already offering some form of guidance through third-party advisers, such as Financial Engines. But now that Congress has “blessed” giving advice to participants, employers will no longer think they have a liability if they offer it.
“The real winners out of these provisions are the employees who will get on the savings track sooner and who will get more help in making investment choices,” says Steve Utkus of Vanguard’s Center for Retirement Research.
Stuart Ritter, a certified financial planner with T. Rowe Price points out: “These new provisions will really be helpful -- but only if you act to take advantage of them by increasing your savings and following good advice.”
A third aspect of the new Pension Protection Act is the extension of many tax provisions that were set to expire in 2010. Now, uncertainty is removed about the future tax status of many popular retirement plans:
* Roth 40l(k)s are made a permanent feature of the tax code. While there is no tax deduction for contributions, all withdrawals including investment growth are tax-free. Employers who hesitated about offering this feature, might now make it available.
* Higher IRA and 401(k) limits and “catch-up” contribution limits for those age 50 and older will now be made permanent
* College 529 Savings Plans, which grow money for college tax-free, are now assured of tax-free withdrawals into the future.
* A savers tax credit for lower-income workers who contribute to 40l(k) or other savings plans or IRAs was also made permanent.
This complicated bill also includes more stringent rules regarding charitable contributions and the requirements for maintaining records regarding those contributions. Importantly, the bill might completely revise the way you name beneficiaries for your 40l(k) plan, because it now allows plan rollovers to IRAs for non-spousal beneficiaries.
Overall it appears that both houses of Congress figured out that this country needs more individual savings for retirement, more advice about how to do it right, and more permanence to the tax laws that encourage savings. The Pension Reform Act is a big step in that direction. And that’s The Savage Truth.
Terry Savage is a registered investment adviser.