Pension reform gets tricky

A month after passage of the most sweeping pension reform in decades, experts still are sorting out what the 907-page law means.

“With that many pages, people are interpreting it as we go,” said retirement specialist Kevin Myeroff, a certified financial planner and author of “Countdown to Retirement: Designing Your Financial Future.”

Overall, the Pension Protection Act of 2006 is heralded as good for individuals. But there are also predictions that many companies with pensions will bail on them.

And there are some clauses having nothing to do with retirement that will be a pain for taxpayers who donate to charity, or a boon for parents of college-bound children.

The main purpose of the reform is to stabilize pensions.

Most companies with traditional pensions must make sure they’re 100 percent funded — instead of 90 percent funded — over the next seven years. Current underfunding nationwide is estimated at $450 billion. Pensions that are seriously underfunded won’t be allowed to increase benefits and must kick in money faster to catch up.

In addition, the independent Financial Accounting Standards Board at the end of the year will start requiring companies to include pension funding obligations on their balance sheets. That could reduce some companies’ net worth.

The American Benefits Council, a trade association representing companies that provide benefits to employees, says the law will probably cause some companies to close perfectly good pension plans to new employees or to drop pensions altogether.

That could shower even more problems on the federal government’s Pension Benefit Guaranty Corp., which is already dealing with a $23 billion deficit. An exodus from pensions would reduce the pool of companies paying in.

Here’s a rundown of some other major pluses and minuses of the new law.

On the plus side

“Automatic enrollment in 401(k)s: Companies are encouraged to automatically enroll employees in their 401(k) plans by deducting 3 percent of the employee’s paycheck. If the employee doesn’t want to save for retirement, he or she must sign papers within 90 days to opt out.

Because of the new law, it’s predicted that 10 million more people will contribute to their 401(k) in the next five years, according to the Profit Sharing/401(k) Council of America.

“IRA/401(k) provisions: A law passed in 2001 included increased contribution limits for IRAs and 401(k)s and established other tactics to help people save for retirement. Those provisions were set to expire in 2010, but the new law made them permanent.

“529 contributions: Likewise, the law that makes earnings in 529 plans exempt from federal taxes was set to expire in 2010. This tax break also was made permanent, as long as the money is used for qualified college expenses.

“Charity donations from IRAs: Retirees can give up to $100,000 directly from an IRA without paying income tax on it. Previously, donors had to move money into their personal accounts and it was taxed as income; then it could be donated. “It’s a great thing for charities,” Myeroff said, because big donations likely will increase.

“Hardship withdrawals: Workers currently can make an emergency withdrawal from a 401(k) or similar retirement plan if they’re facing an issue such as medical bills, the purchase of their first home, college tuition and eviction or foreclosure. Under the new law, a withdrawal can be requested if the account holder’s beneficiary is facing a hardship.

“Breaks for domestic partners and other non-spouse beneficiaries: When someone with a retirement plan dies, the new law will allow the money to be transferred to the non-spouse beneficiary’s IRA. That beneficiary could be a child, parent, partner or acquaintance. “People aren’t tied to holding company stock: In this post-Enron era, workers who hold company stock in their retirement plans will find it easier to sell the stock. Most plans will have to offer at least three investment choices besides stock in publicly traded companies, and employees must be permitted to sell stock they bought with their contributions any time they want. Further, after three years on the job, employees must be allowed to trade stock bought with employer matches.

“Savers credit: The clause that gives a tax credit of up to $1,000 to low-income workers who contribute to retirement accounts becomes permanent. It was set to expire at year’s end.

On the minus side

“Charitable donations will be scrutinized: Taxpayers will be required to get a receipt for every dime they contribute to a charity. This means everything from change tossed in the Salvation Army kettle to the $5 bill in the church collection basket could be disallowed if there’s no receipt. Currently, the IRS doesn’t require receipts for cash donations under $250.

In addition, donated clothing or other property won’t be able to be taken as a tax deduction unless it was in “good” condition. The IRS will define what “good” means in the future.

“Hardship withdrawals: Because people will be able to withdraw money from a retirement account if their beneficiary is facing a hardship, people may connive to get money for a vacation or to pay off their new boat, Myeroff said.

Since beneficiaries can be changed easily, a person who wanted a withdrawal could just find an acquaintance who has medical bills or is having trouble paying the rent or mortgage, and then temporarily make that person the listed beneficiary. “People will play the system,” Myeroff said.