10 Things Every Taxpayer Needs to Know About the Pension Law
By Maggie Beetz
The Pension Protection Act, signed into law on August 17, 2006, is designed to address
the nation-wide problem of under-funded pension plans. The law penalizes noncompliant
companies and encourages employee contributions, but many of the changes directly
impact taxpayers of all ages, regardless of retirement status.
“Taxpayers will benefit from many of the act’s provisions, some of which come in
the form of tax breaks, but individuals cannot take full advantage of the tax breaks
until the new laws are fully understood,” said Michael Smith, Managing Authorized
Taxpayer Representative at tax services firm FSI Tax Corp. (www.fsitax.com).
The following is a rundown of the most important tax code changes and how they will
likely affect taxpayers, as well as retirees.
1. Direct IRA Tax Return Deposits
Taxpayers can now have their tax returns deposited directly into their IRA accounts.
The IRS already offers taxpayers the option to automatically deposit returns into
checking and saving accounts. By adding IRA accounts, legislators hope taxpayers
will contribute more funds toward their retirement accounts.
2. 529 College Savings Plans
Many temporary tax laws enacted by the 2001 tax cuts were made permanent by the
Pension Protection Act. This includes the ability to make withdrawals from 529 college
savings plans without suffering tax penalties.
“Tax-free college savings withdrawals may seem inappropriate in a pension law, but
this provision is welcomed by parents who would otherwise resort to tapping their
IRAs to fund their children’s education,” said Smith.
3. Saver’s Credit
Another 2001 tax break that was set to expire this year is the Saver’s Credit, a
tax credit matching up to $2,000 for lower-income workers who put money into their
retirement accounts. This tax break benefits workers who earn less than $25,000
because pre-tax contributions lower the taxpayer’s reportable income and the Saver’s
Credit provides additional tax relief with its matching funds.
4. Increased Contribution Levels
In 2001, the IRS temporarily raised employee-sponsored retirement plan contribution
levels from $2,000 to $4,000 this year, $5,000 in 2008 and then adjusted by inflation.
The higher limits were set to expire in 2010, but the act made them a permanent
This change, also intended to encourage increased contribution amounts, applies
to 401(k)s, IRAs, 403(b)s, 457s and catch-up contributions for workers aged 50 and
5. Direct Rollovers from a 401(k) to a Roth IRA
Employees who move from one workplace to another were previously permitted to transfer
their 401(k)s to traditional IRAs, both of which require taxes to be paid once money
is withdrawn. Only then was the individual allowed to transfer the account into
a Roth IRA.
The law now permits former employees to transfer their employer-funded retirement
accounts directly into a Roth IRA, a popular option due to the fact that contributions
are made after taxes are taken from earnings, which means that there are no taxes
due upon withdrawing funds.
“The tax code changes enacted by the Pension law benefit taxpayers and steer them
toward contributing to their own retirements,” explained Smith. “While companies
should be held accountable for funding employee pensions, each taxpayer should take
advantage of changes that make it easier to ensure a secure retirement.”
Tax Deductions for Charitable Giving
Non-pension-related tax code changes include several provisions that significantly
increase charitable giving regulations, some of which are unlikely to please donors.
5. Documenting Items
To discourage taxpayers from inflating the value of non-monetary charitable donations
for inflated tax deductions, the IRS now requires taxpayers to fill out a form detailing
the gifts. Additionally, any significant household item, valued at more than $500,
must be appraised before the taxpayer can take a deduction.
Many charitable organizations, including Goodwill Industries International, say
the new provisions will guard against worthless donations more suitable for the
trash bins, but critics argue that increased regulation will discourage would-be
donors and cause a decrease in charitable giving.
6. Documenting Monetary Gifts
Monetary donations will also require documentation. Regardless of the amount, a
taxpayer should retain proof of any donation. Appropriate documentation can be a
bank record, canceled check, credit card statement or receipt from the charity.
“These records are not required to be included in the tax return but they should
be kept on hand should the IRS request proof,” advised Smith.
7. Direct Donations from IRAs for Seniors
Another tax law that many charities support affects only seniors. For the next two
years, donors 70 ½ or older will be able to donate to charities directly from their
IRAs, an accommodation that keeps the donated amount tax-free and avoids tax penalties
for early withdrawals.
This provision benefits eligible taxpayers who take the standard deduction, which
many older filers do because they receive larger standard deductions. This can also
benefit individuals facing donation limits. Generally, people cannot donate more
that 50 percent of their incomes, but the money does not count as income when it
comes directly from the IRA.
Officials at charities such as United Way claim that despite being temporary, this
provision will likely bring in tens of millions of dollars.
Other Pension Provisions
8. Automatic 401(k) Sign Up
Employers are allowed to automatically sign up employees for a 401(k). This change
encourages participation from people who may not otherwise bother to sign up for
the plan in the first place, though they will have the option to opt out.
9. Investment Advice
Because employees often choose safer investments for their 401(k)s, which generally
result in modest returns, the act allows them to receive investment planning advice
to encourage riskier investments with the potential for higher returns. The act
also provides protection against dishonest advisers who steer employees toward decisions
that could increase their own profit.
10. Non-Spousal Benefits
Two provisions that expand allowable withdrawals are pleasing gay rights activists.
The non-spousal rollover lets retirement account assets be transferred to a designated
beneficiary upon the retiree’s death and the hardship distribution allows retirement
account assets be used for a medical or financial emergency of a beneficiary other
than a spouse or a dependent.
The majority of the Pension Protection Act aims to ensure that companies fully fund
traditional pension plans over a seven-year period, starting in 2008. But many provisions
promote increased individual employee participation in retirement planning.
Smith said that while the new law expands allowances and makes it easier for individuals
to increase retirement savings, it may be a step toward employee-funded retirement
plans – a move that has many critics concerned.
Maggie Beetz is a writer for FSI Financial Literacy based in Columbia, MD. FSI Financial
Literacy aims to spread financial awareness to clients of FSI Tax Corp., Debt Shield,
Inc. and the general public.