By Tom Anderson, CEO & Founder
PENSCO Trust Company, San Francisco, CA

According to data collected by the Federal Reserve Board, 45 percent of households in which the homeowner or spouse was employed contributed to employer-sponsored retirement plans in 2004, and 58 percent owned a retirement account of some kind. Among married-couple households headed by individuals between 45 and 54 years old, median retirement assets in 2004 were $103,200 (roughly $50,000 each). Unmarried householders aged 45 to 54 had a median balance of even less: $32,000. This may sound like a lot to many folks until they realize they may have to live on their savings over their expected lifetimes.

With the potential dependence on Social Security looking more like a Las Vegas bet ten years from now, there is much concern among Americans and the Government about accelerating the American savings rate. Clearly, with greater life expectancies, many people will need to stay employed well into their “retirement” if they expect to maintain their lifestyles — unless they take action now to take advantage of new opportunities in retirement savings.

For this reason, the government is beginning to address concerns about the growing numbers of Americans who are approaching retirement without a life raft. If you are one of them, take control now by learning about the new opportunities for saving. Then, take action. It is your life, and taking action now will allow you to rest easy later.

So, what has the government done to try to help you prepare for your retirement? On August 3, 2006 the United States Senate passed the Pension Protection Act of 2006 (PPA) that will provide many benefits to those with pension plans and IRAs. First and foremost among these are the many provisions of the Economic Growth and Tax Relief Reconciliation Act (EGTRRA), a tax reconciliation bill, which were scheduled to expire on December 31, 2010. With PPA, the following retirement account contribution limit provisions are now permanent:

In the wake of enormous retirement plan losses (e.g., ENRON), beginning in 2007 through 2009, eligible employees of similar bankruptcies may make additional contributions of $3,000 per year to their retirement plans to allow them to catch up. However, there are some other very specific qualifying factors required to receive this benefit.

The enactment of the PPA also allows those over age 70.5 to contribute up to $100,000 directly to charities of their choice without having to report the donation on Schedule A, which can impact the amount of their eligible deductions and result in unnecessary taxes. Unfortunately, this provision expires in 2007. What's the big deal? Well, prior to the recent change, those earning in excess of $150,000 per year (income including distributions out of their IRAs intended for contribution), would not be able to deduct the full amount of their charitable contribution before paying taxes. Now, the contribution goes directly (sent by the IRA custodian) from their IRA to the charity, and the amount is never included in their income. Thus, no deduction is necessary, and therefore, the donation is tax free. The result is that those high-earning individuals who are inclined to donate have an even greater incentive than before to give to the charity of their choice.

For the tax years 2001–2009, IRA distributions to a military reservist (including the National Guard) who was called to duty after 9/11/2001 and before 9/31/2007 for 180 days or more will not be subject to the standard 10 percent penalty as long as the distributions are taken during the period of active duty. These same reservists may also be eligible to re-contribute part of these distributions to their IRAs prior to the end of two years of active duty, provided that they do not claim a deduction for the re-contributed amounts.

Beginning in 2006, there are “catch-up” contribution increases — in $500 increments — to adjust for the cost of living for 401(k)s, 403(b)s, and government 457(b)s. So, for 2006, the limit was $5,000, and will be increased by $500 per year beginning in 2007.

Another very important change, generally effective after January 1, 2007, applies to defined contribution plans that also allow participant contributions or deferrals (such as a company’s 401(k) plan, and which are holding publicly traded employer securities — think ENRON). Such plans, including ESOPs, are now required to allow participants to diversify into alternative investments meeting requirements similar to the standard diversification requirements as defined by 404(c) of ERISA. Essentially, this means that if your pension holds the public stock of the company sponsoring it (e.g., your employer), the sponsor is required to offer you a choice of at least three mutual funds (the required minimum) that are diverse in terms of risk and reward.

However, the company is permitted to allow you to diversify beyond the minimum, including into other classes of investments such as real estate or private equity if it so chooses, while being reasonably protected from liability under the 404(c) provision. Participants may reinvest deferrals and after-tax contributions immediately into alternative assets, and after three years of service, may also diversify from the company’s stock. While there are some exemptions to this change, the rule is designed to avoid having employees locked into their company’s stock exclusively. So, if your employer offers a 401(k) you can contribute to or have your salary deductions fund, and you own the employing company’s stock in your retirement account, you may want to ask about this important change. This new rule is designed to help you diversify for the purpose of hedging against possible losses associated with the “all eggs in one basket” situation that mired ENRON employees.

This change reflects the aftermath of public outrage following the downturn of the stock market from 2000–2005, when retirees lost $1.7 trillion in retirement savings — in many cases because they were locked into failing investment choices. The liberalization of restrictions on diversifying has been coupled with an increase in FDIC insurance for self-directed retirement plans and IRAs to $250,000 per individual per bank. On April 1 of 2006, the FDIC raised the limits for the first time in history. The fact that limits on other deposits remain at $100,000 per individual illustrates the government’s desire to secure personal retirement savings.

Another important change effective with PPA is the idea that companies can automatically enroll their employees into their pension plan. Doing so provides the employer with fiduciary protection related to any default investments (assuming the employee doesn’t specify investment selections), and helps to address the issue of full plan participation; which can aid highly compensated employees whose contribution limits would otherwise be reduced due to insufficient employee participation.

With the PPA, non-spouse beneficiaries of pension plan participants may now receive direct rollovers to beneficiary or inherited IRAs effective January 1, 2007. Prior to that time they had to take taxable distributions before the fifth anniversary of the death of the participant. This is a very important benefit that allows non-spouse beneficiaries (e.g., children) to “stretch out” their inherited pension plan proceeds over their expected lifetime as opposed to having to receive them as taxable income within a fixed five-year timeframe.

Beginning in 2008, assets held in 401(k)s, 403(b)s, and 457 government plans can roll over directly to Roth IRAs. These rollovers are taxable and reportable in the participant’s 1040, and the participant’s eligibility to roll them over still follows the Roth IRA conversion rules until 2010. However, the previously required step of rolling them first to a traditional IRA is now unnecessary. Also in 2010, the eligibility limit on income (e.g., capped at $100,000 adjusted gross income) for Roth conversions will be lifted temporarily, under the provisions of the Tax Increase Prevention and Reconciliation Act (TIPRA) of 2005, effective in 2010. What does this mean? It means that beginning in 2010, regardless of your income (if eligible within the context of your plan’s rules), you will be able to convert pension funds assets to Roth IRAs, enabling them to grow tax-free thereafter during your lifetime and into the lifetimes of your beneficiaries.

Another very important new development, applicable to both pension plans and IRAs, effective August 18, 2006, is the idea that certain prohibited transactions can be corrected entirely by “undoing” or correcting the transaction(s) if a correction is made within 14 days of when the transaction(s) should have been discovered. The provision covers acts that involve the acquisition, holding or disposition of any security or commodity (e.g., a collectible) that is prohibited. The exemption does not apply to company stock, real estate transactions, or to a case in which the fiduciary knew or should have known that the transaction was prohibited. To “correct” means to undo the transaction to the fullest effect, to make good on any loss to the account or plan, and to restore to the plan or IRA any profits gained by the prohibited transaction.

Another major change is the ability of a plan fiduciary to provide investment advice, conduct an investment transaction pursuant to the advice, and receive fees in conjunction with the advice and/or transaction. The fiduciary must meet certain standards including being a bank, trust, insurance company, broker/dealer, or an affiliate or employee of any of the preceding organizations. There are also specific limitations under which these exemptions apply. In the past, there were very strict rules concerning the compensation of a plan fiduciary. However, government concerns over the lack of investment sophistication on the part of many investors have resulted in this change, which is designed to provide more flexibility in this regard.

As you can see, our government is continuing to respond to consumer demand for more improvements to the retirement system, and the passage of the 2006 Pension Protection Act further underlines that logic. Furthermore, in light of the fact that the government clearly recognizes the plight of the Social Security system, PPA emphasizes the growing importance of private retirement savings as an essential element in an individual’s retirement planning. Nevertheless, concerns are still widespread about what will happen when boomers retire in greater numbers and then begin to rely more heavily on Social Security. My guess is that we’ll see many more improvements to our retirement system in the very near future. But don’t wait — take control of your future now.