Pension Protection Act of 2006 Offers Tax Savings
August 2006
Summer is unfortunately over. While you were away, Congress passed the Pension Protection Act of 2006, which was primarily intended to improve the financial stability of large corporate defined benefit plans. Within this Act, there are a few tax goodies, which may reduce the tax bite on your IRAs and employer sponsored retirement plans.
Under the new law, you will be able to transfer up to $100,000 a year in IRA money directly to a charity without recognizing the taxable pension income. However, this provision is not as great as it sounds because you also do not get to deduct the associated charitable deduction. A number of charitable organizations have already promoted this provision in order to jump start gifting programs, so it is important that you understand the benefits of a charitable rollover of your IRA.
What is the difference between taking a taxable IRA withdrawal and then making a deductible charitable contribution versus doing a non-taxable IRA rollover to a charity but getting no visible charitable deduction on your return? On its face, it would seem that the results would be the same. However, the individual tax code is full of thresholds and limits such as for miscellaneous itemized deductions and itemized deductions in general just to name a few. As well, the alternative minimum tax credit is phased out for income above $150,000. Your charitable deductions are limited to 50% of AGI. All of the thresholds and limits are based upon AGI thus giving you a reason to keep your income down with a charitable rollover. It is usually going to be better tax wise to do the direct rollover. We estimate the impact of the phase-outs at 5-10% and more if you are in AMT.
Is it better to do an IRA rollover than to give appreciated securities to a charity? You get a full ordinary tax deduction for a gift of appreciated securities whereas the benefit of a charitable rollover is limited to reduced phase-outs and limitation. However, we think gifting the IRA is a better alternative because of the way IRAs are taxed in your estate. Your estate has to pay estate tax on an IRA distributed to your heirs and your heirs must pay income tax on an IRA withdrawal. Versus, if you leave your heirs appreciated securities; there is only estate taxes to pay. Therefore, for 2006 and 2007, we advise you should make planned charitable contribution from your IRAs. Of course, this recommendation assumes that you will not need the money in the IRA for living expenses.
Other miscellaneous provisions: the amount of your charitable rollover is counted when fulfilling your minimum IRA withdrawal calculation. On the negative side, charitable rollovers cannot go to donor advised funds or charitable remainder trusts.
Another significant change, a child, grandchild, or significant other may roll over a deceased interest in a qualified retirement plan, government plan, or tax-sheltered annuity into an IRA. The taxpayer can then take minimum distributions based upon their remaining life, significantly extending the use of the retirement assets. Previously, this beneficial provision only applied to a spouse and nonspouses had to withdraw the qualified plan money within a year and pay tax on the entire amount. This change is effective after 12/31/06, but distributions related to deaths in 2005 also qualify.
The Pension Protection Act of 2006 made permanent favorable retirement provisions that were to expire in 2010. You can contribute $4,000 to IRAs, $15,000 to 401(k)s, and make catch-up contributions of $1,000 for IRAs, $2,500 for SIMPLEs and $5,000 for 401(k)s. These amounts are adjusted for inflation. After 12/31/2007, you can rollover from a qualified retirement plan, tax-sheltered annuity, or governmental plan directly to a Roth IRA if your AGI is less than $100,000. Prior to this change, you had to go through a hassle by transferring the plan to a traditional IRA then to a Roth. The two-step process became a one-step transaction.
Finally, no tax law can be passed without a dreaded increase in substantiation requirements. This one is a doosey. The $250 requirement for substantiation is extended to all contributions no matter how small. Cash, check or other monetary gift donations, regardless of amount, must be substantiated by a bank record or a written communication from the charity indicating the amount of the contribution, the date the contribution was made, and the name of the charity.
Call Geoff Langdon at 302-656-6632 or email glangdon@coverrossiter.com for more information on these or any other tax planning matters.