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TAX LEGISLATION CONTAINS BENEFITS FOR A VARIETY OF SAVERS & WORKERS

           August 2006

Last week, Congress passed and the President signed a complex tax measure.  The new law contains over 900 pages of actuarial and tax complexity that this article will cheerfully avoid.  While most accounts of the law focused on funding of defined benefit plans, the law also contains a variety of other measures intended to increase the country’s dismal savings rate.    

Defined Benefit Plans to Receive Accelerated Funding 

Government statistics show that U.S. defined benefit plans covering nearly 35 million workers and retirees are underfunded by $450 billion.  This underfunding by the approximately 30,000 plans now needs to be eliminated by 2015.  Companies with defined benefit plans at greater risk of defaulting have to make larger contributions on an accelerated schedule. 

But those that face the largest challenges are getting longer to make up the shortfall.  The government is worried that those with the largest underfundings (specifically, the airlines) will ditch the plans entirely, and thus cause the government’s Pension Benefit Guarantee Corporation to shoulder the burden to retirees.   To try to avoid this, the law provides a massive inconsistency by giving the airlines a longer funding period.  The airlines have 17 years to fully fund their plans if the airlines have already frozen benefits, and 10 years otherwise.      

401(k) Plans Enhanced 

401(k) plans now cover far more employees than traditional pension plans.  Employers’ continue to make broader use of these defined contribution plans.  The new tax law encourages this.  Specifically: 

1. The higher contribution limits for 401(k) plans and IRAs that were first enacted in the 2001 tax act, and which were scheduled to expire in 2011, have been made permanent.   

2. 401(k) plan sponsors now have explicit legal protection that they can automatically enroll employees in the plan, unless the employee specifically opts out.  Before the law change, around a quarter of plan sponsors had automatic enrollment.  Some employers were concerned that the automatic enrollment might violate certain state’s laws, a concern that as now been eliminated.  This provision will cause an estimated $2 trillion of additional investment over the next ten years.   

3. Employers are rewarded for adopting automatic enrollment.  401(k) plans that have an automatic enrollment feature are now eligible for safe harbor treatment under the ADP/ACP and top heavy tests that can limit contributions for higher-income participants.  The vesting and contribution requirements for such plans are less onerous than what currently exists for safe harbor 401(k) plans.   

4. Employees facing uncertainly as to how to invest can now receive advice from the mutual funds that hold the plan’s assets.  The change loosens conflict-of-interest restrictions that previously prevented mutual funds from providing such advice.  Mutual funds with 401(k) holdings can now provide investment advice to  plan participants so long as (i) the fees received by the investment advisor do not vary based on which investment options are chosen, and (ii) the advice is based on a computer model (vs. judgmental selection).   

No more Excuses to Avoid Education Funding 

IRC Section 529 college savings accounts are now made permanent.  Without this change, tax exemption of these accounts was set to expire in 2010.  These plans had become quite popular, but concern about whether the tax benefit would become permanent had kept some with younger children (and grandchildren) from opening or increasing accounts.  Moneys earmarked for college education should be placed into these accounts.     

Some provisions that you may have read about did not make it into law.  Specifically, increases in the minimum wage, and reductions in the estate tax did not pass.   

Fulcrum Financial Inquiry is a licensed CPA firm that provides valuation, forensic accounting, and damages analysis services. 

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