It took federal lawmakers almost two years of debate, half a dozen stabs at earlier legislation and an end-of-session deadline to finally agree on a law designed to shore up company pension plans.

But buried in the 900-plus pages of the Pension Protection Act of 2006 are several tax provisions that will benefit individuals who do their own golden years’ saving.

The law also contains welcome news for folks looking for ways to cover the high cost of college. The philanthropic, however, face some new, good and not-so-good donation guidelines.

 

Law could affect pension
The new pension law primarily makes changes to retirement plans, on both corporate and individual levels.
But several provisions also provide tax breaks for, and call more tax examiner attention to, other areas that affect individual taxpayers.
The 10 new tax provisions
  1. Automatic enrollments
2. Investment advice
3. Refunds to retirement
4. Easier rollovers to Roths
5. Permanent IRA contribution levels
6. Saving the Saver’s Credit
7. Tax-free 529 distributions
8. Proving donated goods’ value
9. More record keeping
10. Giving away IRA money

Defined-contribution plans get a lot of attention in the new pension law. These are company-sponsored retirement plans such as 401(k)s, which help you save for tomorrow while simultaneously reducing today’s tax bill.

These retirement plans require employees to take an active part in saving for their post-work years. That, say financial experts, poses a couple of challenges.

Many workers invest their 401(k) money too cautiously or worse, they don’t put any money at all into the plan. The new pension law will change that.

1. Sign right up, automatically

“Historically, with 401(k) plans, you affirmatively elected in,” says Mark Luscombe, principal tax analyst at CCH, a tax publisher and software provider. “Now companies will be permitted to assume you’re in unless you choose otherwise.”

Workers who are “kind of lazy about doing anything for retirement” could find this a good move, says Bob D. Scharin, senior tax analyst with RIA, a Thomson business and provider of tax information and software to tax professionals.

But will it work?

“Whether it will actually increase participation, we’ll have to wait and see,” says Luscombe. “Some workers, when they see a cut in their paycheck, might barge in and elect out.”

Some companies are already automatically enrolling employees in savings plans, but the new law clarifies the situation. It offers employers additional guidance and makes it easier for companies to institute the system beginning in 2008.

While such a system might mean more work for a business, Luscombe says some companies might choose that method because it could provide benefits for upper-level employees.

To prevent company plans from disproportionately benefiting higher-income workers, federal nondiscrimination rules require that companies make sure their plans represent all employee levels.

“When there’s greater plan participation by workers in the lower pay ranges, employees with larger salaries are allowed to also contribute more,” says Luscombe.

2. Investment advice

When companies automatically enroll employees in 401(k)s, expect the default plan to be one that doesn’t pose too big a risk. Such plans, however, also tend to offer lower, and slower growing, returns.

Many workers, when given a choice, already pick “safer” 401(k) options. For some, that’s a wise move. But it’s not right for all.

In an effort to help employees determine which plan best suits their needs, the new law allows for workers to get investment advice regarding their various company-sponsored options.

However, any fees or commissions for the advice cannot be based on the savings plan a worker chooses. This prohibition was included in the new law to answer concerns that advisers would guide workers toward plans that benefit the fund company more than the employee. Expect companies, workers, consumer groups and Uncle Sam to be closely monitoring how well this safeguard works.

3. Refunds to retirement

If you have an IRA, in addition to your company retirement plan, the pension law wants to help you add to that, too. When you get your tax refund next year, you can tell the IRS to deposit it directly into your IRA. The IRS has been sending refunds to filers’ checking and savings accounts for years. Now IRAs will be added, along with new Form 8888 that will let you split and deposit a refund into as many as three accounts.

Some tax-prep companies were already providing the direct-to-IRA service, says Luscombe, but there was concern about the associated fees. Now individuals can accomplish it themselves, but Luscombe’s “suspicion is that a lot of people won’t take advantage of this.”

4. Easier rolling into Roths

Since the Roth IRA appeared in 1998, thousands of retirement savers have been drawn to its tax-free earnings and withdrawal potential. But the plans pose a problem for workers who want to take their company retirement accounts with them when they leave jobs.

Currently, you must put your former workplace’s 401(k) or similar-plan money into a traditional, individual retirement account. The reason: Both the traditional IRA and company account contain tax-deferred contributions and earnings, so they are treated the same under the tax code; i.e., you’ll pay taxes on the money when it’s withdrawn.

Once all the money is in a traditional IRA, then you can convert that account to a Roth. The new pension law cuts this two-step process in half.

Beginning in 2008, you can directly roll defined-contribution-plan money into a Roth IRA. You’ll have to meet the other Roth conversion requirements, such as making less than $100,000. And taxes on the converted amounts will still be assessed. But those tax calculations will now be done as part of the simpler, one-step transfer.

5. Permanent IRA contribution levels

Contributions to all IRAs got a boost in 2001 when major tax-law changes increased the amounts individuals are allowed to contribute to these accounts: $4,000 this year and next; $5,000 in 2008; adjusted for inflation after that.

But those amounts will drop back to the $2,000 level in 2010. And the catch-up provision that now allows workers age 50 or older to add another $1,000 to an IRA would have disappeared.

Such future contribution worries are no more. Current IRA contributions levels and catch-up allowances, as well as similar provisions at greater levels for 401(k)s, will be permanent, thanks to the pension law.

6. Saving the Saver’s Credit

The Saver’s Credit was also made permanent. This tax break, created to reward lower-income workers who put money into a retirement account, was set to expire at the end of 2006. Now eligible workers can continue to claim the credit, which could cut up to $1,000 off a filer’s tax bill. And next year the income levels used to determine eligibility and actual credit amounts will be indexed for inflation. This should allow more taxpayers to take the credit or at least keep many from becoming ineligible.

While the new pension law technically was designed to address retirement issues, it contains several tax provisions in other areas.

7. Tax-free 529 distributions

One of the most welcome nonpension provisions is the permanent continuation of tax-free withdrawals from Section 529 college savings plans. The tax exclusion had been scheduled to expire at the end of 2010. There is a bit of a retirement connection: With the 529 tax-free option now in full and perpetual force, some parents and students won’t have to resort to tapping IRAs to pay for school.

Charities, and those who give to them, also got some special attention in the pension law, not all of it to taxpayer liking.

8. Proving donated goods’ value

IRS officials have long suspected that taxpayers inflate the value of donated items. The law had been changed this year to tighten rules on donated cars. Now a similar approach is being taken in evaluating the deductibility of donated clothing and household goods.

The IRS can now deny deductions for goods that are of “minimal monetary value.” Specifically, the law requires that these items be in good used condition or better.

How will the tax examiner know? When you give goods, you have to fill out Form 8283, Noncash Charitable Contributions, detailing your generosity, and send it in with your return. True, taxpayers can still inflate the used property’s value there, but with the new guidelines, tax examiners might be looking at this form, and asking follow-up questions, more than usual.

This new requirement will likely get more attention in December, as folks make year-end donations to maximize annual charitable write-offs.

9. More record keeping

The IRS also wants you to get more substantiation for your cash gifts, which include actual dollars, checks and credit card donations.

Previously, you had to get a receipt or other acknowledgement from a charity if you gave $250 or more. Now, for a monetary gift of any amount, you’ve got to have “a bank record or a written communication” from the charity detailing the group’s name and the date and amount of the gift.

A canceled check is fine. If you charge a contribution, your credit card statement should be sufficient. And many charities already provide a receipt for all monetary gifts, regardless of the amount.

You don’t have to send these contribution confirmations in with your return. Just have them on hand if the IRS asks. And the tougher substantiation rule doesn’t take effect until 2007, so you don’t have to reconstruct all those smaller amounts you gave earlier this year.

10. Giving away IRA money

One new charitable tax provision will please older philanthropists and the groups they support.

If you are 70½ or older, you can have money from your IRA sent directly to a charitable organization. This is most beneficial to traditional IRA holders, since much of the money in these accounts is eventually taxable, but the option also is available to Roth account holders.

The main benefit for taxpayers is that the IRA gift keeps the donated amount out of the giver’s taxable income tally, thereby lowering the filer’s tax bill a bit.

It could also be a worthwhile giving method for filers who otherwise wouldn’t get a tax deduction, such as those who take the standard deduction.

Many older filers claim the standard amount, says Scharin, because they get a larger standard deduction than younger taxpayers. They also are more likely to have paid off or paid down their mortgages, meaning they no longer have it and other large amounts to itemize.

“If someone is claiming the standard deduction, they’re not getting charitable contribution tax benefits anyway,” Scharin says, “so now you can at least avoid paying tax on the IRA distribution.”

This also might be a good strategy for individuals who face donation limits based on their income. Generally, you cannot donate an amount that exceeds 50 percent of your adjusted gross income. But when the money goes directly to the charity from the IRA, it doesn’t count against that limit because it’s not included in gross income, says Scharin.

If this giving technique works for you, and you’re old enough to use it, make plans now. This provision is only in effect for 2006 and 2007.

And remember that no double dipping is allowed. Since this distribution is tax-free, if you do itemize you cannot deduct the gift on your Schedule A. The ability to keep the money out of your taxable income, however, should help offset the deduction loss.

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