RETIREMENT PLAN PROVISIONS IN 2006 ACTS

by J. Kenneth Nowell, CPA

WARNING - THIS IS NOT A COMPLETE LIST OF SAID CHANGES TO THE TAX LAWS, ONLY THOSE THAT THE AUTHOR CONSIDERS MOST NOTEWORTHY.

1. Removal of sunset provisions

Now, barring new legislation from Congress, the following incentives are now indefinitely part of our tax code:

The increased compensation limit to 25% of eligible compensation for defined contribution plans.

 

The increased benefit limit ($175,000) for defined benefit plans.

 

Increased maximum eligible compensation for determining allowed plan contributions (now $220,000).

 

Increased employee contributions to SIMPLE plans (now $10,000).

 

Increased IRA and Roth contributions (now $4,000).

 

Catch-up contributions allowed for those 50 and over.

 

Allowance of provisions in 401(k) plans to allow employees to elect an allocation of some or all contributions to a "Roth 401(k)" account.

 

Enhanced features of §529 College Savings Plans.

 

And more!

First, effective 1/1/08, you will now be able to convert money directly from most defined contribution plans directly into a Roth IRA (as opposed to having to roll them into an IRA first).  At least for now, the $100,000 limit on modified AGI to be eligible for the conversion remains.

However, that changes after 2009, when (if the law hasn't been changed by then), the $100,000 limit disappears, effective 1/1/10.  Furthermore, there is a one-time "sale" on these conversions.  Remember when Roth was first introduced in 1998?  All income generated by conversions to Roth plans was spread over four years (1998-2001).  It's making a comeback in 2010.  Any income from conversions in 2010 will be deferred until 2011 and 2012 (1/2 in each year), unless you elect to tax it all in 2010.

Isn't that exciting?  Actually, for many of my clients, this can be of some convenience.  If you saw your CPA, and you were eligible for the Retirement Savings Credit, wouldn't it be great if you could just direct a portion of the refund directly into the Roth or traditional IRA account that you were suggested to add to?  Well, now you can do that, effective with 2006 returns.

Just to keep your retirement plan administrator from being bored, a change has been made in the required schedule of vesting to determine how much of employer contributions an employee is entitled to.  So for all those with defined contribution plans containing vesting provisions, the schedules change as follows:

YEARS OF SERVICE	PRIOR VESTING SCHEDULES		NEW VESTING SCHEDULES
	"Cliff" method	Graduated method	"Cliff" method	Graduated method
1	0%	0%	0%	0%
2	0%	0%	0%	20%
3	0%	20%	100%	40%
4	0%	40%	100%	60%
5	100%	60%	100%	80%
6	100%	80%	100%	100%
7	100%	100%	100%	100%

Note that if you prefer the "cliff" or "all-or-nothing" method for vesting, your employees go from 0% to 100% two years sooner, whereas the change in the graduated system only speeds up the process by one year.  Which plan do you think the government is trying to coax us into?

For distributions after 2006, the Act now permits a tax-free trustee-to-trustee transfer from a decedent's retirement plan (not only an IRA, but a defined contribution plan, defined benefit plan if applicable, annuity, or §457 plan) to a non-spouse beneficiary's IRA.  Of course this will still result in an inherited IRA, which must be distributed at least over the life expectancy of the beneficiary.

Stay tuned!  Effective for plan years beginning after 2009, employers with 500 or fewer employees will be able to establish plans with a defined benefit portion and a defined contribution portion.  This plan will be developed under IRC §414(x).

Click HERE for more information on this recent development to retirement plans.  It has been decided that distributions from said plans are to be prorated between nontaxable contributions and potentially taxable growth (if distributed prematurely).

Author's recommendation - if you are leaving the employer with the 401(k) plan, roll the plan into a ROTH IRA.  The distribution rules for the Roth IRA treat all distributions as first coming from the original contributions, thus averting potential taxation on a partial distribution.