Deciphering the New Retirement Law
In the past decade, Congress has produced an oversized bill every few years that has changed the rules for your retirement planning.
This year's version is H.R. 4, The Pension Protection Act, which President Bush signed into law on Aug. 17. As the title suggests, the primary thrust of the bill is to bolster the traditional (defined benefit) pension system by requiring employers to beef up their contributions and maintain certain plan funding levels to ensure they'll be able to pay the pensions they've promised to their employees.
But like most of these huge bills, this one also includes myriad other retirement and employment law changes that could affect your retirement planning—regardless of your age, how much you've already saved for retirement, or the type of retirement plan you have.
Many of the other provisions in H.R. 4 are designed to address concerns with the retirement system as they have been documented in numerous studies. For instance: About a quarter of U.S. citizens who are eligible do not sign up for 401(k) plans, most of us aren't saving enough for retirement, and many people lose savings momentum by not paying attention to their 401(k) investments.
To encourage maximum savings in tax-deferred plans, H.R. 4 kills the "sunset" provision that would have allowed the maximum contribution limits to revert to much lower levels. This means that you'll still be able to contribute up to $15,000 a year if you're under 50, and up to $20,000 in catch-up contributions if you're over 50, and that the amounts will rise with inflation in forthcoming years.
For IRAs, the contribution limit stays at the current $4,000, with an extra $1,000 allowed for the 50-plus crowd. These amounts will also be allowed to rise with inflation in coming years.
These limits are most helpful to higher earners who can afford to max out their contributions. But if you're just starting on your career or if you have a son or daughter doing that, the bill offers two strong incentives to get in the habit of saving for retirement: Automatic enrollment in a 401(k) and making the "Saver's Credit" permanent.
SAVING THE SAVER.
Here's how the new automatic enrollment feature would work: In companies that adopt this provision, effective in 2008, a new employee would be automatically signed up for a 401(k) unless he specifically opts out. The employee contribution would rise annually from 3% at the start, to 4%, then 5% and 6% in subsequent years, leveling off at six.
The Saver's Credit, which was due to expire at the end of 2006, allows an individual taxpayer with adjusted gross income of $25,000 or less or jointly filing taxpayers with $50,000 of adjusted gross income or less, to receive a credit for up to 50% of money they deposit into a 401(k), IRA or similar retirement account.
The amount of the credit declines as income increases. In addition to making the credit permanent, H.R. 4 allows you to authorize direct deposit of the tax credit from the federal government to your retirement plan, effective in 2007.
In a similar strategy designed to prevent diversion of your cash into lattes and new cars, the bill also requires the government to come up with regulations for sending some or all of your tax refund directly from the IRS into your own or your spouse's IRA. The bill requires the system to be in place by Jan. 1, 2007.
To address the problem of employees who are unsure how to make 401(k) investment decisions, starting next year the law will allow financial advisers such as an investment company, bank, insurance company, or registered broker-dealer to advise participants in a company plan on how to invest their money.
Despite the requirement that the advice must be based on a computer model certified by an independent third party, Karen Ferguson, director of the Washington-based Pension Rights Center, which advocates for individual employees, warns that you should still maintain a healthy skepticism about any advice offered by advisers who will benefit from selling you a mutual fund or any other financial product.
Finally, H.R. 4 offers hope to mature workers who prefer phased retirement to retiring cold turkey. For years many employers have said that federal law prevented them from keeping employees on the payroll once they started to collect their traditional pension.
HELP ON THE WAY.
Under the new law, starting in 2007 once you're 62 there will be no legal barrier to staying on the job at your company—working full or part-time—while collecting your pension benefit. But this will only apply if your employer decides to implement the policy.
No brief summary could do justice to a bill that runs to 907 pages. If you want to delve more deeply, you can look at this official summary prepared by the Congressional Joint Committee on taxation. And one of H.R. 4's better features is that it will require your employer to send you more detailed information about your retirement plan in the future. A summary of these requirements will appear in my next column.